Conditionality

Analysis

ESAF, Surviving The Spotlight?

14 June 2000 | Briefings


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The IMF has taken few steps to openly evaluate its operations. Unlike the World Bank, it has no external evaluation department and it has no systematic procedure for evaluating the impacts of its surveillance operations, lending programmes and policy advice. This lack of systematic, objective evaluation has led to a stalemate between those who support the IMF‘s economic strategy and those who do not. The disagreements about the effectiveness of the IMF‘s programmes financed through its concessional loan facility the Enhanced Structural Adjustment Facility (ESAF) demonstrate this well. With both those for and against IMF reforms able to present evidence showing success and failure of its programmes, but with no independent body with full access to the Fund’s information and policy documents able to mediate between the two, there has been little hope that IMF supporters and critics could find common ground to work together to improve the institution’s functioning.

To try to remedy this situation, and in response to non-governmental organisations’ calls for a fully independent review mechanism, the IMF executive board decided to establish an ad hoc external review mechanism on a trial basis. The first review undertaken examined the functioning of the ESAF. The review team comprised a group of consultants headed by Kwesi Botchwey, the former Ghanaian finance minister and their report was published in March this year. This “external” review was intended to compliment an “internal” review which was carried out by the Fund’s staff and which was published in September 1997. Some of the recommendations of the external report are outlined below.

Ownership and political constraints

Programmes that include large numbers of conditions tend to perform poorly and this is implicitly acknowledged in the internal review of ESAF which found that 75% of ESAF programmes were delayed by interruptions or were not completed, largely due to policy disagreements between IMF staff and governments. “Ownership” of reforms by borrower governments is widely regarded as an important element in the success or failure of programmes, however, to date the IMF has only paid lip-service to encouraging greater ownership. The external review recommends a course of action to address this:

  • a borrowing government should develop its own medium to long-term programme before entering into negotiations with the Fund and it should take steps to build national consensus behind the programme. Where the government does not have the capacity to do this itself it should seek technical assistance or hire consultants to provide advice;
  • to build consensus throughout the government, rather than only in the finance ministry, and improve management of reforms, governments should establish Economic Management Teams (EMTs) with members drawn from various government departments and comprising members of the cabinet, and technical and political staff;
  • National conferences can be useful for building consensus, especially where there is a high degree of inclusivity and openness;
  • the IMF should take steps to dialogue with the country’s political leadership, and make efforts to “understand the country’s political constraints and possibilities” prior to beginning formal negotiations with a country;
  • the timing and duration of IMF missions should be arranged to allow adequate time for governments to prepare in advance of negotiations with the IMF.

These are useful recommendations but the IMF‘s staff and Executive Board appear to regard ownership more sceptically. Both are concerned that there needs to be a balance between ownership and ensuring that a programme is appropriately specified to address a country’s economic problems. The staff conclude that “ownership is an important but not a sufficient condition for successful reform.” Leaving aside the question of what might constitute a good technical solution, we would stress that ownership is essential if governments are to embrace reform, a well specified programme is not effective if it is not properly implemented as the IMF‘s analysis of programme breakdowns testifies. Moreover, while government initiatives to consult with the public should be encouraged, they should be truly consultative, and the IMF should not regard them as a means for persuading doubters that theirs is the only solution.

We welcome the suggestion that the Fund should be more aware of the political constraints facing many reforming countries before they start negotiations. While the Executive Board may be concerned that the IMF should not be put in a position where it must judge whether or not a programme is politically feasible, we believe that such questions must be addressed by the staff if they are to help design useful programmes rather than “state of the art” technical fixes which do not bear any reality to the political context in which they must be implemented. Failure of staff to acknowledge political constraints is likely to have contributed to programme breakdowns.

The changing nature of conditionality

The external report identifies two separate methods of applying conditionality reflecting the need to encourage greater ownership of programmes, and the shift in countries’ needs between the stabilisation phase when crisis management is the priority and in the post-stabilisation phase of reform when investment for sustainable growth and poverty reduction should be the priority.

In the stabilisation phase it is envisaged that policy conditionalities should continue to be applied up-front in return for resources, ie., ex ante. However, it is recommended that the process is made more flexible by providing governments with a menu of reforms from which to choose, taking into account each countries’ political climate and aims. While the staff welcome this suggestion it is not without some reticence, “of course, when there is such a range of feasible options that would reach broadly the same goals for adjustment and reform over time, the introduction of more choice can only be welcome” [emphasis added].

We support the introduction of flexibility into the conditionality framework as a means for encouraging greater ownership, however, we wonder to what extent, given that the IMF‘s ideology is embedded in free-market, neoclassical economics, staff will be able to specify or agree to other reform paths that actually present real alternatives for governments. Generally, we would argue that ex ante conditionality has proved to be less than useful for encouraging governments to adopt policies they do not agree with, therefore, we would recommend that, unless greater flexibility is achieved, that the Executive Board should instruct the IMF management and staff to adopt ex post conditionality.

The report recommends that ex poste conditionality, ie, conditionality is placed on outcomes rather than on specified policies, should be adopted in the post-stabilisation phase to provide more effective support for home-grown programmes. Rather than determining policy in these countries the Fund would simply monitor a few key macroeconomic variables and focus on encouraging and managing increased external inflows whilst continuing to provide technical assistance. Thus, the important role for the IMF would be to provide a “seal of approval” and to signal to other donors and private investors that the economy is functioning well. As part of this signalling function the IMF should “taper in” rather than “taper out” resources in this period to encourage further investment.

Unfortunately, the staff do not agree that a shift to ex post conditionality would be beneficial or even possible. They argue that it is not appropriate to provide resources before policies have been specified because it would be unclear whether a programme was still “on track” and whether funding should continue. While the external report does not provide much detail as to how a process based on ex poste conditionality would work several points can be made in its defence:

  • policies could still be identified in advance by the government, however, while the IMF might advise on what policies would be workable it would not specify what policies must be adopted and it would only monitor policy outcomes;
  • explicitly defining policies in advance and monitoring their implementation as required with ex ante conditionality has not led to successful reform and programmes have frequently broken down;
  • problems with programme breakdowns have led to either “stop-go” financing ie., financing is halted and then resumed later, which is harmful to the reform process and makes budget planning difficult, or donors have chosen not to suspend funds thereby rendering ex ante conditionality meaningless.

Focus on social impacts

Examining the social impacts of ESAF programmes the report finds that on the whole low income groups do not lose out more than higher income groups. However, certain groups may be vulnerable to falling incomes and this may be long lasting. Although there is no systematic negative impact on poor households the report urges the IMF to be more aware of the social impacts of its programmes. Therefore, it is recommended that the Fund should:

  • draw on the expertise and data of the World Bank to assess the potential impacts of programmes on the poorest socioeconomic groups before they are implemented so that appropriate social safety nets can be designed in advance;
  • programmes should be monitored during implementation to ascertain the impact on the groups identified as vulnerable, divergence between actual and projected impacts should signal the need to revise programmes;
  • there should be more systematic monitoring of social spending;
  • to minimise social impacts, in particular to avoid large, temporary contractions in aggregate income, attention should be paid to the sequencing of fiscal and structural reforms. Reforms that benefit the poorest should be given early priority and care should be taken to ensure that structural reforms are not implemented too hastily, causing further destabilisation of the economy.

We welcome the conclusion that there should be proper analysis of which socioeconomic groups are likely to be harshly affected by reforms and that agree that safety-net programmes should be designed before reforms begin. However, much greater care needs to be taken in designing these programmes to ensure that those who are intended to benefit from them are able to do so, in this regard it is important to note the evaluators’ comment that “it is not possible to devise a priori safety nets interventions which will work across ESAF programs”. Moreover, we suggest that stabilisation reforms must be designed in the context of a long-term programme designed to eradicate poverty and agree with the evaluators that short – and long-term trade-offs must be explicitly analysed.

Post-stabilisation: loosening budget controls

The external report notes that the growth rates of a few ESAF countries have been good but they are the result of policy reforms and will not be sustainable in the future unless there is rising investment. Therefore, it is proposed that there should be a clear distinction between reducing budget deficits in the stabilisation phase and the need to encourage investment in the post-stabilisation phase. Thus, it is recommended that in the post-stabilisation phase the IMF should loosen its requirements for tight budgetary control and allow deficits to widen temporarily so that investment can be financed by increased aid and private foreign capital. This analysis is supported by Joseph Stiglitz, Chief Economist at the World Bank, who argues that in an economy where there are profitable government investments to be made, for example in the social sectors, and budget deficits can be financed by a steady and reliable stream of aid finance, then they should be allowed to increase. Similarly, Stiglitz observes that post-stabilisation, current account deficits should not be viewed as inherently bad nor good and where the rate of return on investment exceeds the cost of international capital then the IMF should support sustainable current account deficits.

The external report does not examine the IMF‘s primary policy focus of achieving low (single digit) rates of inflation, but it should be noted that contrary to the IMF‘s policy stance, Stiglitz has argued that there is no evidence to suggest that inflation rates below 40% are harmful to a growing economy. This contradicts the conclusions of the internal review of ESAF which suggested that the Fund should make even greater efforts to achieve single digit rates of inflation. It is not clear on what evidence the IMF has formed its judgement. In the absence of any clear evidence, we would add that the IMF should loosen its requirements that countries should seek to attain very low rates of inflation.

Post-stabilisation: acting as a catalyst

To encourage more external flows to supplement domestic resources and raise investment rates, the evaluators recommend that the IMF should not withdraw its financial support in the post-stabilisation phase. Instead the Fund should provide more money during this phase to signal clearly to private investors and donors that countries have emerged from the stabilisation phase. Moreover, given that the IMF perceives that aid is most effective in a good policy environment, increasing resources in the post-stabilisation phase should help to boost countries reform efforts. The IMF staff object to this suggestion on the grounds that “it is hard to see how such a scheme would be consistent with the objectives of ESAF.” The Executive Board has also objected to this proposal on similar grounds. This is clearly not a substantial argument against changing how the ESAF operates, there are much stronger reasons for questioning the validity of this suggestion:

  • the evaluators support IMF involvement in the post-stabilisation phase because strong signals need to be sent to donors and investors that a country is no longer in difficulty. However, while donor funds are clearly linked to IMF programmes, there is little evidence to suggest that actions by the IMF stimulate private sector resources in ESAF countries;
  • while the IMF‘s “seal of approval” role creates an implicit link between its programmes and donor provision of finance, the World Bank generally does more to secure funding from donors, for example through consultative group meetings, than does the IMF;
  • there is no reason why another donor or group of donors should not provide a “seal of approval”;
  • given the limited resources available in the current ESAF and that no agreement has been reached to refinance ESAF (and even if it, it is predicted that its annual disbursement levels will not increase if it is refinanced), it is not clear that the IMF will be able to increase its lending to ESAF countries in the post-stabilisation phase even if it becomes more selective about which countries it lends to;
  • As the report notes, it is aid generally not ESAF funds which catalyses private investment.

Given the apparent reluctance of the staff and executive board to radically change the IMF‘s approach to conditionality and ownership or to reexamine how ESAF resources could be more effectively used, we suggest that the remit of the IMF should be rolled back. The IMF has gradually extended its grip on policy formulation in developing countries as its focus has shifted away from purely macroeconomic considerations into areas of structural reform, this has most recently been demonstrated by its move into its “second generation” reforms which have a much deeper structural and micro focus. However, even though ESAF programmes have had a medium-term focus which has emphasised the need for structural reform, the IMF has had only limited success in achieving growth objectives and its programmes have had negative impacts on investment rates, suggesting that current growth rates may not be sustainable. Moreover, at present it is not clear when a country has moved beyond the stabilisation phase because the IMF tends to be involved in countries for several years (once a programme has been completed often another is immediately embarked upon). Therefore, given that the IMF has had more success in achieving its stabilisation objectives and that it has limited resources, the role of the IMF should be narrowed so that it provides resources only in the context of crisis management after which a country should be required to graduate from the IMF and seek other sources of lending. The graduation of the country would then act as a clear signal to private sector investors that the country had moved beyond the stabilisation phase. An alternative body, perhaps the UNDP, could assume responsibility for organising the donor process once the country has graduated from the IMF.

Angela Wood, April 1998.