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Inflexibility on aid scale up haunts IMF fiscal conditions

19 June 2006


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The rigidity of Fund programmes is causing chafing at the collar in governments and civil society organisations in low-income countries, as the debate over the scaling up of aid rages.

The confiict between advocates for greater social spending and the IMF’s fiscal affairs department flared during the spring meetings, when the department’s deputy director Peter Heller walked out of a meeting with civil society after a disagreement about whether national governments or the IMF were behind budget austerity.

Why is flexibility not being built into Fund programmes?

The meeting theatrics reflect a bigger debate on how aid can be effectively increased to help low-income countries meet their Millennium Development Goal targets. An open letter from civil society organisations attending a financing for development conference in Abuja, Nigeria in May alleges “nations such as Uganda and Bolivia, for example, have been offered additional aid for education, yet have turned it down in part due to IMF pressure, as well as concerns about lack of long-term predictability of aid flows. In Kenya, IMF-imposed caps on the national budget have prevented the Ministry of Education from hiring the 60,000 teachers that it needs to expand primary schooling.”

A Fund working paper released in April sought to counter the claim that IMF wage bill ceilings in PRGF programmes stand in the way of increased aid spending. But the paper, titled Aid scaling up: Do wage bill ceilings stand in the way?, itself notes that the flexibility of conditions needs to be improved and that “more could be done to enhance the transparency of how additional donor funds for wage spending are being accommodated in wage bill ceilings in IMF-supported programs.”

A research paper on aid volatility by Fund staffers Prati and Tressel highlighted a similar point when examining the Fund’s stance against surges in aid spending because of their negative effect on exports. “An important caveat is that, in years of negative shocks, which account for 44 per cent of the observations in the sample, foreign aid may have a positive effect on exports. This suggests that foreign aid might help buffer exports from negative shocks and that, under these circumstances, tightening of macroeconomic policies in response to a surge in aid would be unnecessary and inappropriate.”

The implication is that nearly half the time the Fund’s standard advice on how to manage increased aid may be wrong, and that countries need more flexibility in how they deal with aid flows. This flexibility in economic policy should be accompanied by greater consistency in aid flows and more clarity from donors about their timing, advice reinforced by both documents. It also complements a recent loosening of the Fund’s unofficial stance on what appropriate inflation levels are in low-income countries. Increasingly Fund staff are talking of high single digit and even low double digit inflation being acceptable in low-income countries that are starting to receive scaled up aid. A draft policy document penned by Heller, titled Managing Fiscal Policy in Low Income Countries: How to Reconcile a Scaling up of Aid Flows and Debt Relief with Macroeconomic Stability, holds out the promise of increased flexibility from the IMF, but it it is unknown if or when it will be approved by the board.

The question remains as to why such flexibility is not yet being built into Fund programmes. Nicaragua’s revised policy conditions for its PRGF includes a wage bill cap that, while slightly higher than expected inflation (9.8 versus 8.8 per cent), does include the ministries of health and education under the ceiling. Nicaraguan NGO coalition Coordinadora Civil points out, “In Nicaragua, particularly within the prospects of a ‘medium-term budget framework’ drafted under the IMF, the ceiling on government expenditure would remain virtually frozen at about 20 per cent of GDP.” The recently devised Tanzanian programme still targets four per cent inflation, despite the talk of increased fiscal space. There is no provision in either of the country agreements for review of these conditions if major donors increase their aid. The conclusion may be that the Fund’s rhetoric simply does not meet the reality.