1. Introduction
Towards the
end of the 1990s there appeared to be an emerging consensus that the IMF should
discontinue its lending to low income developing countries. A series of reports
claimed that this was an inappropriate role for the Fund to play and that it
would be better performed by aid donors or by the World Bank1. The
institutional comparative advantage of the IMF was claimed to lie elsewhere –
largely in dealing with economic and financial emergencies in emerging
economies; although even in this role there has also been considerable debate
about the Fund’s performance2. Critics argued that while the Fund
was not designed to be, and should not become, a development agency, mission
creep had caused it to gradually move in that direction.
The notion
that the Fund should not be lending to poor countries would have sat uneasily
with the portfolio of IMF lending at the beginning of the 1980s. At that time,
the clientele of the Fund almost exclusively comprised low income countries.
Better-off developing countries had been enjoying access to private
international capital markets and had preferred to exploit this rather than to
borrow from the IMF. It was only after 1982, and in the wake of the largely
Latin American Third World debt crisis, that the Fund once again began to lend
to some of the highly indebted emerging economies. With the fall of Communism,
there was further diversification of IMF lending as economies from Eastern and
Central Europe also began to use IMF resources.
Nor did the
path of disengagement from low income countries seem to be the one favoured by
the IMF3. Instead, in the mid 1990s, it had been a co-sponsor of the
Heavily Indebted Poor Country (HIPC) initiative, through which eligible low
income countries were intended to be able to exit their debt difficulties, and
in 1999 it remodeled the facility through which most of its lending to poor
countries took place, to become the Poverty Reduction and Growth Facility
(PRGF).
Adjacent to
the debate about whether the Fund should be lending to poor countries, there is
a related debate about the effects of IMF-supported programmes on poverty and
‘the poor’. Here the issue is whether policies endorsed by the IMF have a
negative effect on economic growth, on social expenditure and on income
distribution. In principle, even if the Fund was to withdraw from lending to
low income countries and was to focus more narrowly on programmes in emerging
economies, the question of the Fund’s impact on poverty would not go away4.
Although this
paper touches on the effects of IMF programmes on poverty, its focus is on the
Fund’s relationship with low income countries. In discussing this relationship
the first challenge is to impose some constraints. After all there is hardly
any aspect of the Fund’s operations that could not legitimately be considered
as part of this relationship. A list of relevant research topics relating to
the IMF could include the following: why do some countries turn to the Fund
while others do not; under what economic circumstances do countries demand IMF
assistance; in what way does domestic politics exert an influence on the demand
for IMF loans; what determines the response of the IMF and to what extent does
politics influence it; what factors determine the design of IMF programmes, the
blend between financing and adjustment and the nature of adjustment policy; is
conditionality stricter for some countries than for others and does strictness
relate to the breadth or depth of conditionality; what has been the effect of
the Fund’s recent policy of ‘streamlining’ conditionality; what factors
determine whether programmes are implemented; does the degree of implementation
make a difference to macroeconomic outcomes; what are the effects of IMF
programmes; is the IMF over-ambitious in setting targets; why do some countries
keep coming back to the Fund (prolonged users or recidivists) while others are
only temporary users and seem anxious not to repeat the experience; is IMF
lending inadequate or excessive; is there a moral hazard problem associated
with IMF lending and is it of the debtor or creditor variety; how should the
IMF’s operations be financed, and are quota-based arrangements satisfactory; is
there a significant role for the SDR to play; to what extent should IMF lending
be subsidized or should it only be available at penalty rates; does the Fund
have an appropriate array of facilities through which to lend, and if not, how
should it be reformed; do IMF programmes have a catalytic effect on other
financial flows and, if so, to what extent is this associated with the
liquidity that the Fund provides or the endorsement of economic reform via
conditionality; does the Fund perform a useful signaling and monitoring role;
does it possess an appropriate organizational structure or are there issues of
governance that need to be addressed, and if so how; what should be the
division of labour between the IMF, World Bank and aid agencies? It would not
be hard to add to this list. Indeed the hard thing is to stop. But even as it
stands, all of these issues have relevance for low income countries, and many
of them could be examined specifically from the viewpoint of low income
countries, raising the question of whether there are differences between low
income member countries and middle
income ones, or even amongst the low income countries themselves. And this,
even without getting into detailed analyses of the PRGF and related strategies
for poverty reduction upon which much of the recent discussion of the IMF’s
involvement with low income countries has concentrated5.
Rather than
trying to cover all the above topics or to dip whimsically into them, this
paper attempts to address a number of more fundamental issues pertaining to the
IMF’s relationship with poor countries. The concept of ‘mission creep’
mentioned above has, in the main, been applied to the increase in the Fund’s
dealings with poor countries and the expansion in IMF conditionality in the
1980s and 1990s associated with structural adjustment. It implies that the
relationship has not occurred by design but rather as an ad hoc response to
circumstances and to myopic ‘political’ factors6. According to this
view, short term expediency has dominated purposeful analysis. This could
result in a lack of enduring commitment to the role. Just as the Fund argues
that programmes are unlikely to succeed unless they are nationally owned, so
one might argue that the Fund’s relationship with poor countries is unlikely to
be successful, or at least as successful as it could be, unless the
international community and the Fund fully endorse it. So is there a
justification for the Fund to be involved in low income countries, and if there
is, what form should this involvement take? As far as justification goes, while
there are certainly those who feel uncomfortable with the idea of the IMF as a
development institution or as a conduit for resource transfers from richer to
poorer countries, there are relatively few who oppose the IMF’s role as a
balance of payments institution7. Of course, not all countries
experiencing payments imbalances need assistance from an international
financial institution. The question is therefore whether poor countries
encounter balance of payments difficulties, and whether they need the help of
an international financial institution such as the IMF in seeking to overcome
them.
In dealing with
balance of payments disequilibria, policy is likely to involve a blend between
external financing and adjustment. Some strategies will be more
financingintensive and others more adjustment-intensive. However, the choice
will be subject to different sets of constraints in different countries.
Limited access to external financing may force one country to opt for short
term adjustment, while in another the political costs associated with balance
of payments correction may impose a constraint on how far an incumbent
government will pursue adjustment. Of course, some countries may be more
constrained both in terms of financing and adjustment. For them there will
simply be fewer options when it comes to balance of payments strategy. There
will be less policy flexibility. What is the optimal blend between financing
and adjustment for low income countries? How constrained is their choice? And, to the extent that these constraints
force them to turn to the IMF, do the lending and adjustment policies favoured
by the Fund allow them to adopt a superior balance of payments strategy? These
are the questions this paper considers8.
The paper is
organized in the following way. Section 2 provides a brief empirical summary of
the extent of poor countries’ balance of payments problems and their dealings
with the IMF. It shows how many resources they have drawn from the Fund and
under what facilities; it also shows how many poor countries have made
prolonged use of IMF resources. Section 3 builds on this to examine the nature
of the balance of payments problems faced by poor countries, and the relevance
of balance of payments theory in explaining them. It also investigates
conceptually the policy options available to poor countries. Section 4
examines, in broad terms, ways in which the IMF might assist poor countries in
dealing with their BoP problems. To defend a role for the Fund, it has to be
the case that BoP policy with the IMF is better than BoP policy without it.
Having discussed the potential role of the IMF in poor countries, Section 5
investigates the extent to which current operations and instruments allow it,
or encourage it, to perform this role. Section 6 offers some concluding
remarks, but also provides an opportunity to raise other related issues that
have not been covered in the main body of the paper.
At the outset,
however, it is appropriate to note the excessive degree of generalization and
aggregation that will permeate the discussion that follows. The economic and political
circumstances in low income countries differ widely. The Fund is frequently
criticized for acting as if one size fits all. Accentuating the differences
between emerging economies and low income countries is certainly necessary but
hardly sufficient to guarantee the institutional flexibility that might
maximize the Fund’s effectiveness in poor countries.
2. Poor Countries’ Balance of Payments Problems and the IMF: A Selective Empirical Background
Part of the
problem in discussing the IMF’s relationship with low income countries is
indeed their diversity. Some exhibit persistent current account balance of
payments deficits, but not all. Many turn to the IMF for financial support in
seeking to deal with their balance of payments problems, but not all. Of those
that turn to the IMF, some become prolonged users of IMF resources, but not
all. Many hold relatively low levels of international resources, but not all.
Most do not have significant access to private capital markets, but some do.
Most receive foreign aid in one form or another, but their degree of reliance
on it varies. Similarly, degrees of external indebtedness vary. Generalisation
therefore runs the risk of becoming scientifically unsound. Identifying the
characteristics of a ‘typical’ low income country risks becoming a caricature.
This, having been said, some broad statistical picture does provide a useful
backdrop to what follows.
The data in
Table 1 imply that, relative to other country groupings, poor countries tend to
experience fairly persistent current account deficits. But is this misleading?
A detailed analysis of the behaviour of current account imbalances over the
period 1970-2001 has recently been undertaken by Edwards (2003). Unfortunately
from our point of view he conducts his analysis on a regional basis rather than
on the basis of income per capita. His Asia region therefore includes middle
income emerging economies as well as low income developing countries. It is his
African region that includes the greatest concentration of poor countries. His
results show that, as a percentage of GDP, African countries have tended to
have the highest mean current account deficit over 1970-2001. However, only 7
of the 49 African countries are persistent
‘high deficit’ countries. This implies that poor countries encounter relatively
severe current account balance of payments difficulties but that deficits are
usually reversed quite rapidly either, one supposes, as a consequence of
beneficial shocks neutralizing negative ones, or as a result of induced policy
responses that are designed to offset the effects of negative external shocks
or more persistent adverse trade effects on the balance of payments. Indeed,
without access to external finance, countries are, in principle, forced to
eradicate deficits. For this reason data on current account deficits are not a
good measure of payments problems. A sufficiently strict demand deflationary
policy may reduce the level of imports to such a degree that a trade deficit is
eliminated or a surplus created. But this is not necessarily a signal of a
healthy balance of payments since, at the same time, economic growth may have
been curtailed. Regenerating growth could then lead to a reemergence of a current
account deficit. The balance of payments deficit is in effect being suppressed;
and the balance of payments problem is being reflected by low economic growth
rather than by a current account deficit. Growth in productive potential which
enables exports to be expanded and imports to be reduced may, of course,
strengthen the current account.
Faced with
temporary negative shocks countries may, in principle, deplete international
reserves which are, after all, held as an inventory against trade instability
and other external shocks. But Table 2 suggests that, relative to other country
groupings, low income countries hold low reserves. What is the logic here? It
is a matter of balancing benefits and costs. While their vulnerability to trade
instability suggests that low income countries should hold relatively large
reserves in order to stabilize national income, their relative poverty suggests
that they should avoid the high opportunity cost of holding them. Holding owned
reserves may therefore be a relatively inefficient way of meeting the liquidity
needs of low income countries. It may be preferable to have access to credit as
and when it is needed.
The
combination of balance of payments problems, low reserve holdings and, as Table
3 suggests, relatively limited access
to private international capital is reflected in the use of IMF resources by
low income countries that is shown in Table 4.
Over 1991-2002 poor countries accounted for the largest proportion of
IMF arrangements. They have also accounted for a large proportion of the
prolonged users of IMF resources (see Table 5 ). There are a number of issues
here that are worthy of detailed investigation. What determines whether low
income countries borrow from the IMF?
What influences their demand for credits and the Fund’s willingness to
supply them? What are the
characteristics of prolonged users of IMF resources, and are those low income
countries with persistent deficits also prolonged users? Interesting as these
questions are, we shall not explore them in detail, but will make do with a few
general observations.
There have
been many studies over the years that have examined the economic circumstances
in which countries seek assistance from the IMF, and the economic
characteristics of those that do9. Although not uniquely so, the
characteristics are reasonably descriptive of low income countries. Further
research into the prolonged use of IMF resources has again identified
characteristics common in poor countries10. These include structural
features such as weak terms of trade and high degrees of export concentration.
Significantly, over-expansionary demand management policies – particularly in
the form of monetary expansion - do not appear as a particular feature of
prolonged users or indeed users in general. More recent research has examined
the extent to which both the demand and supply of IMF credits are tempered by
political and, in some cases, institutional factors11. Some
governments may find borrowing from the Fund (and the implied conditionality
and loss of sovereignty) particularly unpalatable. Other governments may
actively seek the Fund’s endorsement as a way of strengthening their position
vis a vis opposition groups12. The Fund may rule some countries as
ineligible to borrow because they are in arrears. Or the Fund’s principal
shareholders may favour some potential borrowers, and disfavour others for a
series of strategic and commercial reasons. Are there political features on
either the demand or the supply side that uniquely characterize low income
countries? Do they experience higher levels of political instability and
conflict; are they less democratic? Perhaps political opposition to involving
the Fund will be less strident; there may be an aura of resignation to the
Fund’s involvement. Similarly, the relevance of low income countries to the
commercial interests of advanced economies – though not necessarily their
military interests – may tend to be less, and economic crises in poor countries
may represent less of an immediate and direct threat to international financial
stability13. But here we are beginning to move from evidence to
conjecture. In the context of this paper the relevant empirical point is that,
in general, low income countries have persistently encountered balance of
payments problems that have frequently pushed them towards the IMF. In spite of
the Fund’s infusion of liquidity they have often experienced a reasonably rapid
reversal in their balance of payments. If this is a fair representation of the
facts, does it imply that the Fund has been playing an important and beneficial
role in allowing low income countries to follow optimal balance of payments
strategies or failing in this role.
3. Choosing Between Balance of Payments Policy Options: Some Basic Analysis
The previous
section shows that, as a group, low income countries have encountered
relatively frequent current account balance of payments deficits and that they
have often made use of IMF resources. Recent theory relating to the current
account views deficits as the consequence of inter-temporal consumption
smoothing. Following on from conventional national accounting identities,
deficits are presented as reflecting
deficient saving relative to investment. Other things being constant, an
increase in saving is then anticipated to lead to a broadly equivalent
‘improvement’ in the current account. That empirically this does not seem to
happen, has resulted in additional theoretical and empirical investigation
designed to see whether the basic inter-temporal model may be salvaged.
However, even proponents of this approach accept that it is of relatively
limited relevance for emerging economies and perhaps even less relevant for
developing countries14. There are the ubiquitous problems of
satisfactorily explaining saving and investment, but there is also greater
uncertainty about the future, consequent upon the vulnerability to shocks, and
the more binding nature of financing constraints that are encountered in low
income countries. As a result, current account deficits, normalized for country
size, will become unsustainable and problematic in poor countries before they
would in advanced economies.
Prior to the
vogue for the inter-temporal consumption smoothing model, the current account
balance of payments was traditionally analysed using absorption, monetary and
structural approaches. Indeed, the
saving / investment approach is derived from the absorption approach. To a
large degree these approaches may be integrated within a Mundell-Fleming
(IS-LM-BP) framework. Current account deficits (or, indeed, overall BoP
deficits) can then be represented as the consequence of excessive domestic
consumption, fiscal deficits and monetary expansion, as well as structural
factors relating to the nature of domestic production and exports, the pattern
of trade, and domestic productivity and efficiency.
Each of these
explanations probably has a part of play in explaining current account deficits
in low income countries. Certainly monetised fiscal deficits are not uncommon
in poor countries. But a key feature of countries in an early stage of
development is their low level of economic diversification. If primary products
exhibit a relatively low income elasticity of demand, and if poor countries
have a high degree of export concentration on them, they will experience a
secular weakening in their current accounts. With a low price elasticity of
demand, export success in terms of volume may fail to translate into success in
terms of export revenue. Superimposed on an adverse movement in the terms of
trade, there may also be significant export instability that makes BoP
management yet more challenging15. The difficulty may be as much
associated with export excesses as with export shortfalls.
How can low
income countries respond to the current account balance of payments deficits
they encounter? One possibility is that
the response comes from elsewhere in as much as aid inflows to some extent
cover trade deficits, making them more sustainable. However, there may be
secular declines in aid flows, and aid may also be unstable16. More
generally, governments, in effect, have to make a choice about the extent to
which they attempt to correct trade imbalances or finance them. Beyond this,
they then have to choose the most appropriate means of adjustment and method of
financing.
In principle,
the choice between adjustment and financing depends first on whether the
deficit is temporary or permanent, second on the relative costs of adjustment
and financing, and third on the social time preference rate. A
financing-intensive strategy seems most appropriate where deficits are
temporary, where the cost of financing is low relative to that of adjustment,
and where there is a high social discount rate. The choice is illustrated in
Figure 1 which shows consumption choices over two periods. The intercept A on
the vertical axis illustrates full first period (short term) adjustment which
is assumed to involve a contemporary consumption sacrifice. Intercept F on the
horizontal axis involves short-term (first period) financing. This enables the
current sacrifice to be avoided but involves incurring a larger future (second
period) sacrifice when loans have to be repaid with interest. Governments then
have to choose the optimum point on the AF trade off. This depends on their
preferences as between contemporary and future consumption – the idea of
smoothing is relevant here. The optimum combination of adjustment and financing
will occur where the marginal rate of substitution between current and future
consumption sacrifices equals the marginal rate of transformation between them
( point Z in Figure 1). This optimum will be affected by the slope of AF
reflecting the relative costs of adjustment and financing and the slope of the
community (governmental) indifference curves in Figure 1, reflecting the
country’s preferences.
Given this
simple conceptual framework, a number of assumptions about low income countries
may be made. Assumption 1 is that short-term (i.e. rapid) adjustment involves a
relatively high cost. This could be the consequence of a relatively low degree
of economic flexibility and low demand and supply elasticities. It could also
be related to relatively low marginal propensities to import and the strategic
developmental importance of imports. Assumption 2 is that there will be a high
discount rate favouring future as opposed to current sacrifices in consumption
– there is a preference for current over future consumption. Taken together,
this implies that low income countries will prefer a balance of payments
strategy that involves relatively large
current financing and more gradual
adjustment, rather than rapid adjustment and little financing. However, their
choice will be constrained. With little access to private capital markets,
relatively low holdings of international reserves and with only relatively
modest inflows of aid that will not be increased in the short term, governments
may be forced to select what they perceive as a sub-optimal strategy, such as
point X in Figure 117.
The general
observation that in choosing a balance of payments strategy poor countries may
be more constrained and have less flexibility than other countries may be
conceptually illustrated by using a figure originally designed by Cooper
(1968). The vertices of Figure 2 show three alternative ways of responding to a
current account balance of payments deficit; financing, adjustment based on the
exchange rate, and adjustment based on managing domestic aggregate demand.
However, there may be economic and/or political constraints on the extent to
which each of these may be used, shown by lines F, E and D. These delineate an
area of flexibility in terms of the design of balance of payments policy for
advanced, emerging and low income countries. For advanced economies there is a
relatively large area of flexibility and these countries can exploit it in a
way that enables them to avoid borrowing from the IMF. For emerging economies
this may also be true for much of the time. However, in the midst of a crisis
the financing constraint becomes more binding and the area of policy discretion
is sharply reduced such that they may need to turn to the IMF for financial
assistance, ( as shown in Figure 2b).
For low income countries shown in Figure 2c
there is a persistently binding financial constraint, and there may be economic
and/or political factors that more sharply militate against demand compression
or exchange rate devaluation. The area of balance of payments policy
flexibility is therefore much smaller and these countries are more likely to
regularly seek assistance from the IMF. Structural adjustment is not directly
shown by the Figure but, given its relatively long term nature, will be
constrained by a lack of external finance. Additional financing to some extent
allows structural adjustment to substitute for adjustment based on managing
aggregate domestic demand.
4. Where
Does the IMF Fit In: Is There a Role for the Fund?
What is the
role of the IMF? Can it improve balance
of payments policy in low income countries?
In the context of Figure 2 it can increase the area of BoP policy
flexibility. It can make feasible a balance of payments strategy that would not
have been possible without the Fund. In the context of Figure 1, it can relax
the external financing constraint and allow adjustment to occur more gradually,
enabling something closer to the optimum combination of current adjustment and
financing, as perceived by the government and as depicted by point Z, to be attained.
Essentially the Fund can help fill the gap in external financing that would
otherwise be left by private capital and by foreign aid
However, where
the government’s selection of point Z is dominated by short term political
considerations – such as the desire to avoid all adjustment in the run up to an
election – or where it is globally inferior, the Fund may play a positive role
in encouraging an alternative strategy. In short, the Fund can play both a
financing and adjustment role. Moreover, the roles are inter-related.
The Fund’s
involvement implies a direct impact on financing, since it makes its own
resources available to borrowing countries. But it may also exert a catalytic
effect through its impact on other sources of external financing. Its overall
impact on external financing may, therefore, be greater than its own lending.
The mechanics of the catalytic effect can operate via relieving illiquidity,
and via the conditionality that the Fund attaches to its loans which, in
principle, might signal better economic policy and performance and greater
government commitment.
There is a growing literature on catalysis
covering both the theory behind it and the empirical evidence concerning its existence18.
As far as low income countries are concerned, however, private capital inflows
are relatively modest and seem unlikely to be galvanized by the existence of
IMF programmes; this is largely supported by the empirical evidence. For them,
the connection with aid inflows will be more important. But here it seems
likely that the positive association between IMF programmes and aid flows found
in some empirical studies reflects co-ordination, or concerted lending, rather
than conventional catalysis whereby an agreement with the Fund independently
stimulates aid donors to give more aid. The strength of the association will,
in turn, depend on the complex political economy of aid; for example, what is
the objective function of aid donors and does it match that of the Fund? What is the nature of the relationship
between aid donors and the IMF. For example, are they independent actors or is
there a principal – agent relationship and if so which is which? A fundamental issue remains whether IMF
lending and bi-lateral aid flows are substitutes or complements; and whether
IMF programmes lead to a tapering out of aid19.
The provision
of finance, either directly or indirectly via catalysis, will, as noted above,
have implications for adjustment. By permitting short-term adjustment costs to
be reduced, the Fund aims to act in accordance with its Articles of Agreement
that require it to enable member countries to avoid measures destructive of
national and international prosperity. But the potential danger is that
governments may seek to reduce adjustment excessively or avoid it altogether;
there may be so-called debtor moral hazard. In part the purpose of IMF
conditionality is to police this form of moral hazard and to prevent countries
from squandering the resources borrowed from the Fund. The IMF therefore opts
to exert a direct influence over adjustment policy as well as an indirect one
via its provision of financial assistance. There will be a socially optimum
adjustment path which involves neither 100 per cent nor zero per cent short
term adjustment. Can the IMF help
countries find and then keep to this path?
The basic adjustment policy dilemma may be
easily illustrated by the simplest of all open economy frameworks where:
X – M = Y – [C + I +G]
with X =
exports, M = imports, Y = aggregate domestic output, C = consumption, I =
investment and G = government expenditure. To strengthen the current account,
either Y must increase or [C + I + G] must fall. Although a preferable
strategy, it may take time to increase Y and this may, in any case, require a
near-term increase in I and the capital component of G. If, however, the
current account deficit needs to be eliminated quickly then C and the current
component of G will have to fall to protect capital accumulation. But such cuts
will encounter domestic political resistance. IMF lending provides time to
cushion adjustment; but the time needs to be used productively. There have to
be appropriate policies to influence both Y and [C + I + G]. The key question
then is the extent to which the IMF’s involvement via conditionality helps to
put in place and to carry through the appropriate demand side and supply side
policies.
Matters would
be relatively clear cut if there were well defined correct and incorrect
policies relating to macroeconomic stability, microeconomic efficiency and
openness, and if the IMF knew and supported the correct ones while governments
either did not know the correct ones or simply chose to ignore them and
implement the incorrect ones. Unfortunately things are much more complex than
this, and it is this complexity that is at the heart of much of the debate
surrounding the IMF’s involvement in both developing and emerging economies.
To some extent
there is a prima facia argument that
referral to the Fund indicates that governments have made mistakes and not
pursued the correct policies. But another feature of low income countries is
their vulnerability to shocks which may adversely affect the current account
and the fiscal balance. A bad harvest, or a fall in export prices may reduce
both export revenue and tax revenue. Or, where sovereign debt is denominated in
US dollars, an increase in world interest rates or an appreciation in the US
dollar will lead to an increase in government expenditure expressed in domestic
currency. Apart from such exogenous shocks, it may also be the case that
the characteristics typically found in
developing countries make it more of a challenge to conduct macroeconomic
management. It may be more difficult to control government expenditure, to
increase tax revenue, to avoid monetising fiscal deficits, to control the
supply of money and to pursue inflation targeting. Exchange rate depreciation
may also be less effective if the inflation it induces impedes its relative
price effect, if foreign trade price elasticities are relatively low, and if
its distributional consequences create severe political problems20.
But at least
there is a reasonable degree of scientific consensus surrounding the design of
key elements of macroeconomic policy. Large fiscal deficits, either when they
are monetised or when they result in the accumulation of large amounts of short
term external debt, are likely to cause problems21. Similarly, the
counter-inflationary effects of overvalued exchange rates are unlikely to offer
sufficient compensation for the erosion of international competitiveness and
the expectations of devaluation to which they lead. Again, the fact that
countries are turning to the Fund suggests that governments may have paid
insufficient attention to the balance of payments constraint, or may have in
effect accepted that their exposure to external shocks will make it likely that
they will periodically need to turn to the IMF. Countries seek Fund assistance
when their balance of payments has become unsustainable and a policy priority
must therefore be to create or recreate sustainability. Managing aggregate
demand has a part to play in achieving and continuing to achieve this
objective, but it is unlikely to be the whole story. Again the evidence cited
earlier in this paper suggests that it is not purely and simply macroeconomic
mismanagement that leads poor countries to turn to the IMF. There will also be
structural problems.
Policy
prescriptions relating to structural adjustment and the supply side, however,
draw on less secure analytical foundations. There is less consensus surrounding
the causes of economic growth and the effects of openness, with the consequence
that there is more debate and disagreement about what policies will increase
aggregate supply in the long run. What is the appropriate role of the state? To
what extent will privatization stimulate growth? Which elements of government expenditure show
the biggest return in terms of economic growth?
What is the impact of openness and trade liberalization on growth? What
is the connection between financial liberalization and growth? In what order
should policies of economic liberalization be sequenced? On supply-side issues it is therefore more
difficult for the IMF to advocate a specific evidence-based set of policies22.
What is perhaps more certain is that economic growth may be interrupted by the
exogenous shocks to which low income countries are vulnerable (Easterly et al,
1993, Winters, 2004).
What general
messages does the above discussion contain for the IMF’s involvement in poor
countries. First, it is reasonable that IMF conditionality should establish a
broad macroeconomic framework which seeks to avoid macroeconomic disequilibrium
arising from excess aggregate demand. Second, while stabilization may almost
unavoidably imply a measure of short-term demand compression, it is also
reasonable that the Fund should seek to minimize the costs associated with this
by seeking to spread out the adjustment period. Third, emphasis should
therefore be placed on adjustment with growth. However, given the lack of
scientific consensus about the causes of growth, member countries need to be
encouraged to formulate their own development strategies that the IMF can then
endorse, monitor and support (or choose not to endorse). This will probably
involve encouraging countries to strengthen their institutions. Fourth, the
Fund should also attempt to minimize the disruptive effects of external shocks
on strategies to which it has given its approval. An implication of this is
that the Fund needs to provide adequate finance in support of something more
than a short-run adjustment strategy, unless, that is, it can effectively
mobilise other sources of capital. At the same time and fifth, the danger needs
to be avoided that increased borrowing from the IMF or elsewhere leads
countries to accumulate unsustainable levels of external debt. This implies
that loans need to be at highly concessionary rates or take the form of grants.
Finally, the Fund can assist low income countries significantly, but
indirectly, by helping to create a
conducive global economic environment, with sustained economic growth and
improved market access in advanced economies. But if these are the messages
being transmitted, how well have they been received by the IMF?
5. How Well Does the IMF Play The Role?
Critics argue
that the Fund does not play its role in developing countries at all well. What
have been the key arguments in their case. Of course not all critics subscribe
to the same list of arguments. The following is a generic list, although at
least one specific example of each argument is cited from the literature. In a
nutshell critics claim that IMF programmes and the conditionality they embody
do not work, either because they are badly designed or because they are not
fully implemented (Killick, 2004a, 2004b, Collier et al 1997). They claim that
IMF programmes have a negative effect on economic growth and on income
distribution (see references cited in footnote 4). They claim that programmes
fail to generate a catalytic effect on private capital flows and that the
failure to sustain any improvement in the balance of payments results in
countries becoming IMF recidivists (Bird and Rowlands, 2002a, Bird, 2001d).
They argue that structural adjustment programmes, or even a sequence of them,
have not resulted in improvements in economic performance (Easterly, 2002).
They argue that IMF programmes lead to a tapering out of aid (Collier and Gunning,
1999). They argue that the Fund exhibits serial over-optimism in terms of
economic growth, investment, fiscal correction and export growth, such that
short term adjustment has to be greater than envisaged at the outset of
programmes (IEO, 2003, Bird, 2004c). At the same time, they argue that IMF
lending leads to creditor moral hazard, with the prospect of such lending
reducing perceived risks and encouraging over-lending by capital markets that
then culminates in crises (IFIAC, 2000). They argue that IMF lending is, in any
case, politically motivated (Feldstein, 1998, IFIAC, 2000, Sachs, 2004). They
argue that the wider participation designed to encourage ownership has been
largely cosmetic and has not worked, and that reduced IMF conditionality via streamlining
has merely been replaced by additional conditionality from the World Bank or
aid donors (Killick, 2004a).
Each of these
claims can be the subject of legitimate, and often quite lengthy, debate. There
is a large and growing literature on all of them, dealing with both the
underlying analytics and the empirical evidence. This is reviewed in Bird,
(2003). Counterarguments can also be assembled. From the view point of low
income countries, these could include the following. First, given the deep-seated
problems they face, it is unrealistic to expect involvement by the IMF to
transform the economic situation in poor countries in the short term. Second,
given the circumstances in which countries turn to the IMF and the need to
eliminate macroeconomic disequilibrium, it may also be unrealistic to assume
that aggregate demand deflation can be avoided unless substantial aid flows can
be generated; there is likely to be an adverse short run effect on investment
and growth. Third, the catalytic effect on private capital flows is never
likely to be a significant factor in the case of low income countries; IMF
programmes do however encourage effective foreign aid by seeking to combine it
with sound economic policy. Fourth, creditor moral hazard is unlikely to be
relevant for low income countries. Fifth, policies designed to strengthen
ownership and streamline conditionality provide evidence that the Fund is
moving in an appropriate direction. And sixth, there is at least some evidence
to suggest that, under the umbrella of the PRGF, these policies are having some
beneficial effects on economic growth and poverty reduction (see, for example,
IEO, 2004).
To cut a very
long story very short, the evidence seems to suggest that the IMF’s performance
of its role in poor countries should objectively receive mixed reviews. If this
is a reasonable assessment of the evidence it implies two things. First, it may
be unwise for the Fund to disengage from its relationship with low income
countries, unless there are fairly compelling reasons to believe that the
Fund’s role could be better played by other agencies such as the World Bank or
aid donors. Would low income countries be better off without the IMF?
The operations
of the World Bank and aid donors have not escaped criticism. World Bank
policy-based lending has been subjected to criticisms relating to its design,
implementation and effectiveness (see, for example, Mosley, Toye and Harrigan,
1991). Similarly foreign aid also has its fair share of critics (for example,
Easterly, 2002a). Certainly there could be as many debates about the role of
the World Bank and aid in low income countries as there are about the IMF.
A second
implication is that rather than discontinuing its role in poor countries the
Fund should be seeking to strengthen it. How could it do better? Answering this
question could involve detailed analyses of the PRGF and the post-HIPC era, as
well as collaboration between the IMF and the World Bank, and much of the
recent material being produced by the IMF takes this approach (IMF, 2004a,
2004b). The following section adopts a rather different one and examines some
of the broader policy implications of the analysis contained in section 3.
6. Strengthening the Fund’s Role: the Issues and Options
In looking to
establish a more fulfilling relationship between the IMF and poor countries
within the context of the balance of payments problems they encounter, policy
reform might usefully focus on a number of areas and issues. Here we consider
the provision of external finance; adjustment, conditionality and the design of
IMF programmes; the implementation of programmes and their vulnerability to
external shocks; and selectivity. Many of the points made could apply to the
Fund’s dealings with all its ‘client’ countries and not just to low income
countries. The list of issues is not comprehensive.
6.i. Financing
By engineering
additional external financing, poor countries would be able to substitute
further out of short term demand-based adjustment and further into longer term
supplybased adjustment. They would be able to place greater emphasis on
structural adjustment, and on strengthening the real economy. This is not to
advocate short run macroeconomic profligacy. Poor countries need to pay due
regard to avoiding fiscal and monetary excesses and currency overvaluation.
But, at the same time, having reached a point where macroeconomic policy is
‘sound’, national prosperity will not be served by seeking adjustment through
the heavy compression of aggregate demand. Longer term improvements on the
supply side of the economy may also raise the efficiency of future short-term
stabilization policy. Foreign trade price elasticities may be increased, making
exchange rate policy more effective. Tax reform may make it easier to control
tax revenue, and financial reform may allow indirect instruments of monetary
policy to replace direct controls.
The potential
dangers associated with additional external financing are debtor moral hazard,
and the accumulation of unsustainable levels of external debt. The first of
these may be constrained by effective conditionality; it is therefore important
that conditionality is appropriately designed (see below). The second requires
that lending is at a sufficiently concessionary rate, so that the risks of
future debt problems are minimized.
With these
dangers taken into account, the question then relates to the instruments through which additional
financing is to be orchestrated. In principle, there are a number of
possibilities, although few are particularly novel. Some would involve more
direct lending by the IMF. These could take place via the General Resources
Account, but with subsidies introduced to reduce the cost to poor countries, or
through the concessionary PRGF. There is also the long-standing notion of
making additional allocations of Special Drawing Rights to low income countries23.
There are technical problems with each of these that would need to be
addressed. And each raises its own group of issues. For example, would the
resources of the General Resources Account be adequate to meet additional
demands from low income countries and, if not, how could the resources be
increased? In fact, although the IMF has
many arrangements with poor countries, the resources involved remain small
relative to those with large emerging economies. The Fund’s resources could, in
principle, be raised via further increases in quotas. Or extra general
resources could be made available for poor countries if emerging economies
developed their own regional financing agreements – there is the idea of an
Asian Monetary Fund for example, or if the Fund borrowed directly from private
capital markets to finance some of its emergency lending to emerging economies.
In what is perhaps a fantasy world one could also envisage some of the revenue
from a global tax on international currency transactions being used to help
finance the IMF’s operations ( Bird and Rajan, 2001). Each of these
possibilities could be worthy of a paper in its own right24.
Expanding or
enhancing the PRGF could be achieved by increasing direct subscriptions to the
Trust Fund or by the IMF continuing to sell off its remaining stock of gold;
although gold sales involve their own problems25. Moreover, why
would donor countries wish to channel aid through the PRGF? This would have to offer them some advantage.
A blanket allocation of SDRs to low income countries would not distinguish
between those that would have borrowed from the IMF and those that would not.
Moreover, as things stand, the SDRs would be unconditional. Certainly the SDR
facility could be used as a means of providing financial assistance to low
income countries, but to choose to modify it to fulfill this function means
that advanced (donor) countries would again have to see some advantage in
providing aid in this way. After all, an allocation of SDRs to poor countries
which then used them to finance current account deficits would still involve a
transfer of real resources from advanced economies26.
An alternative
approach would not call on the Fund to be involved with direct lending to poor
countries at all. This approach would have the IMF negotiating conditionality
and monitoring implementation but not providing its own resources. Instead, it
would be the aid agencies that would provide the money. There would then be a
clearer division of labour between the IMF and aid agencies. Such a change, if
taken to extremes, would be strategically significant since it would mean that
the Fund would not be contributing directly to alleviating liquidity problems.
A counter view is that the IMF should focus more strongly on encouraging
private sector involvement in emerging economies without lending so much
itself, and should concentrate more of its own lending on low income countries
where the chances of PSI are much more restricted and aid has been
unpredictable.
Political
realities would seem to make some of the above options less likely that others.
The more improbable ones include additional SDR allocations to low income
countries and the complete discontinuation of IMF lending to poor countries.
The more probable ones include the further refinement of the PRGF, the subsidization
of drawings under GRA facilities and closer co-ordination between the IMF and
aid donors.
6.ii. Adjustment, Conditionality and the Design of IMF Programmes.
There are a
number of elements to reforming the IMF’s adjustment role in low income
countries that lead on from the analytical discussion earlier in this paper.
Again they all merit much further discussion than they receive here. First,
while conditionality is legitimate in mitigating debtor moral hazard and in
seeking to catalyse foreign aid, it needs to be appropriate in its design.
Excessive conditionality may be counter-productive; there may be a
conditionality Laffer curve (Bird, 2001c). On these grounds, a minimalist
approach to conditionality would appear to be more appropriate. Mandatory
conditions might be limited to policies that affect a country’s ability to
repay its debts to the Fund and to avoid falling into arrears; they should be
based on the areas of broad economic consensus surrounding macroeconomic
stabilization. In the areas of economic growth and poverty, where there is much
less consensus, governments should be granted as much discretion as possible.
The Fund could make recommendations but should not impose these as performance
criteria; at least not until reasonable alternative policies selected by
governments had been shown not to work. Greater temporal flexibility in the
design and implementation of conditionality could also be introduced via
‘floating tranches’ with Fund finance being linked to the implementation of
reform. Offering governments greater discretion does not mean abandoning
conditionality. The Fund would still monitor performance, and its support would
still remain conditional on governments pursuing the strategies agreed with the
Fund. But structural conditionality would be more fully selfdesigned. This
approach would also encourage poor countries to build up their own capacity to
design long term balance of payments strategies and to establish the necessary
institutional arrangements for long run economic success; contemporary research
suggests that institutional weakness has negative effects on economic growth27.
In this
context the Fund’s decision to ‘streamline’ conditionality at the beginning of
the 2000s is a movement in the right direction. Whilst retaining macroeconomic
conditionality, streamlining involves reducing the content of structural
conditionality and reversing the trend of the late 1980s and 1990s. The stated
intention is to retain structural conditions only where they are needed to
facilitate the attainment of macro conditions. It may still be premature to
evaluate the success of streamlining. Certainly some critics have argued that
although the number of performance criteria in IMF programmes has fallen, the
‘depth’ of conditionality has not changed. Moreover, they claim that IMF
conditionality has simply been replaced by World Bank conditionality so that
the degree of overall conditionality faced by poor countries has not been
reduced and may even have increased (Killick, 2004a, 2004b). In addition, if
external financing remains inadequate, this effectively constrains structural
adjustment whoever designs it. The speed of adjustment itself then has to
adjust to be consistent with the amount of financing.
In connection
with this, streamlining does not seem to have been accompanied by a reduced
tendency for the Fund to be over-ambitious. IMF programmes still seem to set
unrealistic targets in terms of economic growth, export growth, and fiscal
adjustment as well as the amount of outside financing. They also seem to be
over-ambitious in terms of how long it takes to bring about institutional
changes such as the reform of tax administration. As a consequence, they tend
to underestimate the amount of IMF support required or the extent to which
short term adjustment will be needed. While there may be political explanations
as to why over-ambition helps in reaching initial agreement, it does little to
foster the success of programmes once they have been initiated, and may indeed
work against implementation
6.iii. The Implementation of IMF Programmes
The relatively poor record of implementation
has been another feature of IMF programmes that has recently received both
theoretical and empirical attention. From a policy point of view, the Fund has
attributed poor implementation to a lack of national ownership. The broader
participatory process incorporated into the reformed PRGF has been intended to
strengthen ownership and thereby improve implementation. But will it work? A range of issues arises28. What
factors influence implementation? To
what extent do initial conditions, the amount of IMF financing and the
existence of external shocks play a role? If implementation depends on
‘political economy’ factors, what are they? To what extent is it simply the
existence of powerful opposition groups that sabotage programmes or are there
in fact a myriad of relevant political factors? Is ownership an operational
concept? Can implementation be encouraged even in the absence of strong
ownership? Is conditionality fundamentally inconsistent with ownership or is it
an effective mechanism for dealing with ‘veto players’? Indeed, can
conditionality be used to foster ownership? Does broader participation in
negotiating programmes lead to stronger ownership and better implementation or
does this depend on the type of participation? Should the Fund, in any case, be
consulting with groups outside the government? Should the probability of
implementation be factored into decisions about alternative programmes?
There is much
to examine and debate here, but a few underlying principles could help to
direct reform while research attempts to improve our understanding of the above
issues. There is little point in
designing programmes if their implementation is a matter of indifference. Incentives
should therefore be arranged to encourage implementation. Incentives can be
both positive and negative. Thus countries can be rewarded for implementing
programmes by the amount of finance they receive. Similarly they can be
penalized for poor implementation by impaired access to future finance from the
Fund – and not just in the context of contemporary programmes. To some extent
the prolonged use of IMF resources by low income countries may reflect a moral
hazard problem in as much as new programmes are not prejudiced by a prior record
of poor implementation. Policy needs to address this29. At the same
time, prolonged use may reflect the severity of the problems that low income
countries face and these need to be accommodated within IMF programmes. Poor
implementation may not just reflect policy back-sliding by governments. It may
be caused by external shocks that are beyond a government’s control. The
implication is that programmes need to incorporate contingency provisions that
shock-proof them. The issue is then whether the Fund’s current institutional
arrangements in the form of the Compensatory Financing Facility and the use of
waivers and modifications provide adequate shock-proofing.
6.iv. Dealing with External Shocks
Low income countries exhibit a relatively high
degree of export concentration on commodities whose price in world markets is
often unstable. At the same time, where the price is denominated in US dollars,
variations in the price of the dollar may be another factor in determining how
the international purchasing power of a specific volume of exports may change.
Weak terms of trade contribute to a country’s decision to turn to the IMF, and
export shortfalls make it more difficult to achieve targets and implement
agreed programmes. Even positive shocks - export excesses - may have
macroeconomically destabilizing consequences via Dutch disease effects or by
enticing governments to relax macroeconomic discipline. On top of this, the
empirical growth literature shows how external shocks disrupt economic growth.
It is in this respect that low income countries may experience ‘bad luck’
rather than simply bad policy.
Can the IMF
help poor countries deal with their bad luck or, indeed, help them to improve
their luck? One response is for countries to use the additional revenue from
export excesses to build up reserves that can then be decumulated when there
are export shortfalls. After the Asian crisis in 1997/1998 the IMF encouraged
countries to accumulate reserves as a way of minimizing their vulnerability to
future crises - although this advice was largely aimed at emerging economies
and according to some observers may have been taken too far. The underlying
issue here relates to optimum reserve holdings. For low income countries the
opportunity cost of holding reserves will be high. Export revenue may be used
more productively than by being accumulated in the form of reserves30.
For low income countries it may, therefore, be better to facilitate their
access to liquidity when a shock occurs rather than for them to take out
expensive ‘insurance’ against shocks that may not happen. Insurance is a luxury
good that poor countries may not be able to afford. The IMF has a facility –
the Compensatory Financing Facility - that was designed initially for just such
a purpose. The CFF faced technical challenges in establishing the size of
shortfalls, the extent to which they were temporary, and in distinguishing
between export shortfalls that were beyond the control of the country concerned
and those that were not. The facility has had a chequered history. In the mid
1970s it involved low conditionality and was heavily used. After the early
1980s however its conditionality was in effect raised and its use since then
has fallen dramatically. It has been reformed on more than one occasion, but
its future remains uncertain (IMF, 2004a).
Whilst
recognizing that the devil may be in the detail, it is surely appropriate that
the Fund should seek to have within its array of lending facilities one that
permits countries that are pursuing well managed and coherent economic policies
outside the auspices of IMF programmes to gain access to quick disbursing
financial assistance in the event of temporary adverse shocks. The purpose is
to ensure that short term illiquidity does not threaten long term growth and
development. This leaves to one side the potential for the Fund to help finance
commodity stabilization schemes that would be aimed at reducing the degree of
primary product price instability and thereby reducing the vulnerability of
poor countries’ balances of payments to trade shocks rather than dealing after
the event with those that occur via compensation schemes, ( see Bird,1976, for
an early proposal to link SDR allocation to commodity stabilization).
For those
countries contemporaneously under IMF programmes the need is to effectively
incorporate a contingency component to cover temporary external shocks. For
positive shocks that lead to formal programmes being discontinued the Fund
needs to seek ways of encouraging countries to continue to pursue sound
policies that will enhance their access to foreign aid and their chances of
sustaining economic growth. This could be in the form of monitoring economic
policy and performance outside of a programme ( see IMF, 2004a, for a
discussion of such proposals). For negative shocks that mean that initial
targets are no longer feasible, the Fund currently relies on modifications to
existing programmes or waivers or replacement programmes. The shocks are dealt
with ex post. In practical terms the
flexibility that is thereby permitted has probably been beneficial (Mussa and
Savastano, 2000), but there may be better ways of handling matters. It was
earlier suggested that IMF targets tend to be over-ambitious (Baqir et al,
2003, Atoian et al, 2003). In any event, there will be uncertainties
surrounding projections. Since the vulnerability to shocks can be anticipated,
programmes could be subjected to detailed stress tests. In addition to agreeing
to one particular programme, shadow programmes could simultaneously be agreed
that would cover a range of eventualities. These would allow the fundamentals
of an agreed economic strategy to be protected from the consequences of short
term illiquidity. If what initially appeared to be a short term export
shortfall transpired to be a longer term trend movement then subsequent
programmes would need to address this. Indeed, turning to the longer term, the
Fund could play a role in seeking to ensure that exchange rate policy and
fiscal and financial policy did not discriminate against export
diversification, which could minimize the future vulnerability of the overall
balance of payments to shocks affecting individual exports. In this way and in
co-operation with the World Bank, the Fund could improve the ‘luck’ of low
income countries. Moreover, by encouraging appropriate economic and
institutional reform the Fund could help countries to handle shocks without
creating the political instability that then negatively affects economic
growth.
6.v. Selectivity
While some
critics have suggested that the Fund should not be lending to poor countries at
all, others have argued for greater selectivity. The argument here is that a
perception of overall failure is created by the Fund negotiating programmes
where there is little chance of success either in terms of implementation or
economic performance. Scarce IMF resources are therefore not being used
efficiently. If analysis of past programmes enables the factors determining
implementation to be identified, then the probability of success may be
calculated ex ante by examining these
factors. According to this view, the Fund should focus its own resources where
there is a good chance of success. In other cases it should not lend its own
resources but should instead concentrate on trying to help create the
circumstances in which conventional programmes may eventually be endorsed.
Through providing advice on economic policy and by monitoring progress, the
Fund could then encourage aid donors to provide financial support, although
ultimately this could be basically humanitarian in nature.
The idea of
selectivity builds on the notion that there is an important distinction between
IMF lending and foreign aid. Should the IMF be allocating its resources in such
a way as to maximize some notion of ‘return’. If so, at the margin it may well
be sensible to redirect its lending away from countries where the prospects of
success are low, to others where they are higher. The difficulty is in applying this basic
principle. While it may be possible to identify some countries where political
instability and conflict is so pronounced that the environment in which an IMF
programme may be negotiated and implemented is absent, there will be other
cases where any judgement is more nuanced, Applying a policy of selectivity to
any great extent will require a better understanding than currently exists of
the circumstances in which programmes are and are not successful. The existing
analytical and empirical research on implementation is still quite rudimentary,
and it is still by no means firmly established that eventual success in terms
of outcomes is strongly and positively associated with implementation –
although there are indications that point in this direction31.
7. Concluding Remarks
Although it
has attracted recent attention in association with the setting of the
Millennium Development Goals and concerns that globalization may not have
conferred benefit on developing countries, the question of the relationship
between poor countries and the international monetary system in general and the
IMF in particular has in fact been under examination for many years.
The issues
involved and the literature discussing them were sufficient to warrant at least
two surveys in the 1970s (Helleiner, 1974, Maynard and Bird, 1975). Many of the
issues remain fundamentally unchanged (see, for example, Bird, 1978, Helleiner,
1983, and Williamson, 1983). The role of economics as a discipline is to
clarify these issues, analyze them and collect relevant empirical evidence.
From this the policy options may then be laid out, with their attendant
advantages and disadvantages.
However, the
people who make the decisions may remain unpersuaded by the economic arguments
or may even make policy decisions in spite of them. They are likely to be
influenced by politics. Of course where the economics is unclear, there is a
scientific vacuum that politics tends to fill. Indeed policy decisions based on
political considerations may move ahead of the related economic analysis.
Anxious to get things done, and frustrated by what they see as lack of
progress, some economists have opted to become advocates for policy change.
In the context
of the IMF’s relationship with developing countries, many of the important
economic questions remain unanswered or at least not fully answered. They relate
both to fundamental issues such as the determinants of economic growth and
poverty, as well as to aspects of the IMF’s operations, such as the effects of
IMF programmes. Indeed economics, on its own, may be incapable of providing
complete answers to these questions. For example, in looking at the
‘life-cycle’ of IMF programmes political economy variables are likely to exert
an influence at each stage. Certainly within the context of the IMF’s
operations politics plays a central role. It strikes at the core of the
institution affecting its governance and the quotas that are the ‘building
blocks’ of its operations. Meanwhile, highly reputable economists have reached
opposing views about the Fund’s relationship with developing countries. Even on
issues where an academic consensus of sorts emerges, politics may block reform,
such as with the proposal for a Sovereign Debt Restructuring Mechanism (SDRM).
On other issues, politics may accelerate reform, such as perhaps with the
enhanced HIPC or the PRGF.
So where does
this leave us? If it seems to imply that the issues are highly complex, that
our understanding of them is still limited, that there is a potentially
explosive combination of economics and politics, and that there are no easy
answers, then it is because this is exactly what the situation is. But at the
same time the absence of easy answers is not an argument for policy inaction.
It is a matter of learning by doing, trying to avoid doing harm, and gradually
evolving towards a better outcome.
This paper
examines some of the broad principles underlying the IMF’s relationship with
low income countries. However, it avoids the contentious question of IMF
governance, a source of considerable disquiet to developing countries (see, for
example, Kelkar, Yadav and Chaudhry, 2004). Because of the structure of their
economies, poor countries face frequent balance of payments difficulties. Low
holdings of reserves, little access to private capital and unpredictable aid
flows imply that they will be constrained in financing balance of payments
deficits. The imperative will then be to achieve rapid adjustment and this in
turn is likely to mean compressing aggregate domestic demand; a strategy that
will bring with it associated economic and political costs. In principle, the
IMF can help by providing liquidity that reduces the need for short term
demand-based adjustment. It can assist with both stabilization and longer term
adjustment. It is then a matter of how well or how badly the Fund fulfils these
functions in practice. Objective examination of the evidence suggests a nuanced
conclusion. However, the rhetoric involved in the debate sometimes departs from
the reality. Moreover, largely unhelpful questions have been pursued such as
whether the IMF has become a development institution, when the distinction
between long term balance of payments policy and development policy is
sufficiently obscure to make such classification itself unclear32.
With a strong
commitment to assisting poor countries in dealing with their short term balance
of payments problems and strengthening their balance of payments in the long
run in ways that do not damage, and may facilitate, economic growth and
development, there are numerous policy options that can be considered33.
These cover external financing, adjustment and conditionality, the
implementation of programmes, coping with external shocks and selectivity.
These options have been examined in this paper. Currently, however, the policy
discussion within the IMF seems to be focusing more narrowly on the past
performance and future direction of the PRGF, the concessionary window through
which the IMF lends to poor countries. Although the discussion raises important
issues and although seeking to improve the PRGF is important, the flavour of
the internal discussion does seem to suggest an approach that starts out with
assumptions about the amount of financing likely to be available and then turns
to how this can be best used, rather than starting out by considering the
policies most likely to encourage growth, development and long term balance of
payments sustainability and then turning to the amount of external financing
and the design of conditionality required to support these policies34.
The signal is still sometimes transmitted that neither its staff and management
nor its principal shareholders are firmly and universally committed to a role
for the IMF in poor countries. Without such commitment, or to put it another
way, without ownership of this role, it is unlikely that the Fund’s full
potential to assist poor countries will be fully exploited. Even with it, the
path towards a more fulfilling relationship will remain long and arduous.
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