Carrots and Sticks: a quick fix for IMF conditionality?

5 April 2001 | Briefings

A short questions and answers briefing on the IMF‘s approach to conditionality

Angela Wood, Bretton Woods Project, April 2001

What has changed in the IMF‘s use of conditionality?

The Executive Board has agreed with Managing Director, Horst Köhler, that the application of IMF structural conditionality should be streamlined to focus on macroeconomic reforms and those structural reforms necessary to achieve macroeconomic targets. A more restrained application of conditionality is envisaged for structural reforms that are relevant but not critical.

In addition to streamlining the areas in which conditionality will be applied, the staff will also be required to rationalise the use of performance criteria (PC), prior actions (PAs) and structural benchmarks (SBs). Whilst the use of the former (which governments must adhere to in order to trigger the release of further portions of IMF loans) has typically been relatively constrained, the use of prior actions and structural benchmarks has increased rapidly in recent years. Now it appears likely that the staff will insist more on prior actions whilst reducing other elements of conditionality.

The use of more prior actions will change the nature of conditionality. Prior actions are “up-front” conditions, that is, they must be implemented before a country receives IMF assistance to demonstrate a commitment (often termed “ownership”) to the reform process. Whereas, structural benchmarks and performance criteria are monitored and applied during the course of a lending programme.

In addition, there is a concern that the IMF might rely more on the application of codes and standards as a back door route to applying “up front” conditionality. These are supposed to be voluntary but their application is monitored as part of the IMF‘s surveillance process and there is a danger that countries will be tacitly forced to apply them in order to access future lending. This is the approach the US congressional advisory committee, led by Allan Meltzer, has been advocating.

Which conditions will be cut?

This is hard to say. What is considered “critical” has not been defined and will be considered case by case. Trade related conditionality will remain a central feature. Basically the IMF can continue to apply any structural conditionality if it can justify that it is essential for macroeconomic stability.

Does this mean less conditionality overall?

Not necessarily. The Bank and other lending institutions are expected to coordinate better with the IMF to ensure that they pick up those areas that the IMF is stepping away from. Thus overall, the breadth and extent of conditionality will not necessarily change.

The Poverty Reduction Strategy process will facilitate collaboration between the IMF and the Bank (and potentially other donors) in the case of low-income countries, however there is no mechanism to facilitate collaboration for the middle-income countries.

Worryingly, in cases where the World Bank is unable to deliver the required input, IMF staff have stated that they will include these structural elements in their programme regardless, even though they have admitted that they often don’t have the expertise to do so. It would be more appropriate to delay reforms than to provide inappropriate advice, even if this delays stabilisation efforts temporarily.

In addition, the IMF is also introducing governance conditionality, focusing on budget management, anti -corruption measures and supporting private property rights etc. The result is that in several Poverty Reduction and Growth Facility (PRGF) programmes the number of conditions has actually increased. Governance conditionality, which is essentially structural in nature and often outside the sphere of the IMF‘s core competencies, has not been discussed in relation to the IMF‘s efforts to streamline its use of conditionality.

Will IMF reforms be different now?

The “conditionality review” did not consider whether the reforms required by the IMF have been effective at achieving their objectives. This is a major oversight, especially given that programmes often break down due to political pressure because improvements are not felt quickly enough at all levels of society, whereas hardship is often widespread and immediate.

A 1997 IMF evaluation of reforms in the poorest countries gave an optimistic conclusion but a close look at the findings revealed that the IMF‘s core objectives – balance of payments stability and growth – had not been achieved, whilst indebtedness had increased. In particular, growth rates have been insufficient to address poverty concerns. It is indefensible that the IMF continues to apply the same economic prescriptions to address poverty concerns, which have contributed to growing inequality in Latin America and poverty in Sub-Saharan Africa.

Impact assessments for programmes prior to implementation in order to ascertain whether they are likely to achieve their intended objectives and whether there will be serious unintended negative social and environmental consequences are essential but have not been discussed in relation to this conditionality review. These will be most useful if programmes outcomes are monitored regularly to ensure that they are on-track to achieve their objectives and that negative social impacts are not larger than expected.

Since mission reports are not made public its not clear whether staff actually monitor outcomes or whether they simply monitor the implementation of conditions; these should be published. It is often perceived outside the IMF that it pays more attention to the tool of conditionality rather than the objectives of stabilisation and growth, which are simply assumed to follow. At the very least, it would be helpful if the IMF elaborated its rationale for its policy advice in relation to a programme’s objectives in the Letter of Intent, or other published loan documents.

Why should the IMF bother to streamline conditionality?

Horst Köhler, is concerned that extensive and detailed conditionality may make it impossible for a country to claim “ownership” for a programme, which is considered essential for its success; and may strain the country’s administrative capacity.

World Bank studies have revealed that conditionality is not effective at inducing governments to carry out reforms which they do not agree with. Thus government “ownership” has become a key objective. However, the IMF is only concerned to lend to countries that “own” the type of reforms that it advocates. Those countries that “own” alternative policies are likely to see their funding cut as the IMF moves to a more selective use of its resources.

Whilst the IMF is concerned that governments’ administrative capacities should not be overstretched, some critics have condemned the IMF for introducing new “process” conditions by requiring low-income countries to produce Poverty Reduction Strategy Papers in addition to Letters of Intent.

In addition, the review is a response to critics who have accused the IMF of overstretching itself. Like the World Bank (See Overstretched and Underloved, the IMF has taken on many new roles and objectives in the last two decades but has not expanded its capacity. Just in the last three years it has taken on a poverty reduction remit with the introduction of the PRGF, is trying to develop expertise in financial sector surveillance and restructuring and, advise on good governance. Whilst it is important that conditionality is refocused on core areas it is an illusion that the IMF is cutting back its role and advice to core areas of expertise.

Will there be greater disclosure of loan conditions?

It has been agreed that Letters of Intent should make a clearer distinction between the authorities’ overall policy programme and the part of that programme subject to the Fund’s conditionality. This will be helpful.

In addition, the IMF should release all loan documents, for example, PRGF documents are not made public. In the case of programme documents such as Letters of Intent, these should be released in draft form at the national level for public debate before they are finally agreed with the IMF.

What are the next steps in the process?

The conditionality papers can be found on the IMF‘s website. Comments can be sent to the IMF until 30 June 2001. These will be considered by the Board in June and a new guidelines will be issued later in the year.