Fund loosens the aid noose … but just a little

10 August 2007

After reviews of its engagement with low-income members the IMF is in the process of redesigning its programmes, but its recent changes on dealing with aid inflows have not satisfied critics of the Fund’s inflexibility in allowing the scaling up of social spending.

The design of the Fund’s Poverty Reduction and Growth Facility (PRGF) programmes, lending instruments for low-income countries, was reviewed in light of the planned increase in aid from developed countries and modified by the IMF board at the beginning of July. The review brought no fundamental changes to the PRGF, but did tweak the expectations of how IMF staff will handle the spending of aid, aid projections and the use of wage bill ceilings.

The spending of aid increases has been a hot political issue since the Independent Evaluation Office (IEO) issued its report on aid to Sub-Saharan Africa (see Update 55), which found that in many cases the IMF was requiring low-income countries not to spend increases in aid, but instead use them to accumulate international reserves or pay down domestic debt. The IMF has committed itself to “generally support the full spending and absorption of aid, provided that macroeconomic stability is maintained.”

he has called the IMF requirements a tax on aid

The board refused again to clarify how the idea of macroeconomic stability was determined saying that the Fund should use, “a conceptual framework to guide country teams in giving advice to LICs on a case-by-case basis, without specific quantitative performance thresholds for the spending and absorption of additional aid.” The policy paper drawn up by Fund staff listed several reasons why increases in aid might not be spent: “A policy of partial spending and absorption is appropriate for countries with low reserves and/or high external debt”, “the authorities may also choose to smooth the use of aid over time”, and “an absorb but do not spend approach can be used to lower domestic public debt and/or reduce inflation.”

Critics of the Fund have said that de facto the Fund applies overly stringent targets on reserves and inflation levels before allowing the spending of aid. They also complain of the Fund’s restrictions on borrowing to finance aid shortfalls and spending of unanticipated increases in aid. The Fund policy paper admitted that the institution has not fully addressed these concerns – “there has been a partial move toward accommodating the spending of unanticipated aid and offsetting unanticipated shortfalls” – but still demands countries comply with its definition of macroeconomic stability before being allowed to spend aid.

The background paper gave details of how aid spending has or has not been allowed in the current PRGF countries. It showed that Afghanistan and Benin had not been allowed to spend any increases in aid or loans, whether they were for projects or programme support. Additionally the following countries were not allowed to spend any of their increased programme, as opposed to project, grants: Burundi, Cambodia, Dominica, Ethiopia, Guyana, Kenya, Malawi, Nepal, Niger, Rwanda, Sierra Leone, Tajikistan, Uganda and Zambia.

Gorik Ooms of health NGO Médecins Sans Frontières has called the IMF requirements a tax on aid. “The word ‘tax’ seems appropriate, because we’re talking about aid flows that were intended to be absorbed and spent—most often to increase public expenditure to achieve the Millennium Development Goals—and the IMF arbitrarily levied a substantial part of it, to be used as international reserves (unabsorbed aid), or as public savings (unspent aid). … It is not clear if the IMF ever asked the permission of the donors of these aid flows for the application of this tax.”

Aid projections tweaked upward

Much of the concern over the ability to spend aid increases would be alleviated if the increases were planned for in the first place. Countries with PRGF programmes must submit their budgets to the IMF for approval, and if aid increases were programmed into the budgets, then there would be less debate over whether they were allowed to be spent or not. The IMF has consistently blamed donors and aid volatility for this problem. Aid volatility has also been the scapegoat for the need to build buffers and reserves, with the new policy indicating that “the size of the buffer should be determined on a case-by-case basis but could vary from 50 to 100 per cent of annual aid-financed spending.”

The IMF has faced accusations of ‘aid pessimism’ in the past, and this review of PRGF design has sought to address that complaint.  Still the policy paper claims “the costs of overly optimistic aid forecasts are likely to be higher than the costs of overly pessimistic ones, as aid shortfalls might entail fiscal adjustment.” It is not clear whether they have included the costs to citizens of foregone social spending on health and education when pessimistic forecasts mean aid increases can not be spent.

Past practice had been that only firm commitments of aid, meaning formal agreements between donors and recipients, were allowed to be factored into the budget, but now “the Fund’s baseline aid projections should represent the staff’s best estimate, based on all available information, of the amount of aid that is expected to materialize, both in the immediate future and in subsequent years.” That “includes formal and informal donor indications, historical patterns, and information from the authorities. An important implication is that aid projections should not be restricted to firm donor commitments.”

But this tweak is unlikely to satisfy many aid advocates who have said that the IMF approach does not do enough to encourage aid from donors. The Fund board disagreed with this approach, as the summary of the discussion by executive directors makes clear: “most emphasised that the Fund should not actively engage in mobilising a scaling up of resources.” The IEO report called for the IMF to prepare alternative aid scenarios to demonstrate how scaling-up may take place. The board confirmed that a single scenario should be the baseline but that “the staff should be available to assist the authorities in preparing alternative scenarios of scaling up” if they request.

Buried in the policy paper is a caveat arguing against needs-based scenarios, which have been called for by NGOs, being used: “The most useful scenarios would focus on an ambitious but controlled acceleration in aid inflows, rather than on MDG- or needs-based scaling up, which may entail financing gaps that could not realistically be filled.”

Max Lawson of UK-based NGO Oxfam disagreed with this approach: “If there is no calculation of what is needed to reach the MDGs, then there is no signal to donors as to what is required, and minimal incentive to increase aid levels. It is now clear that the IMF have neither the will nor the technical understanding to engage constructively in the poverty reduction agenda. The best thing they could do would be to leave low-income countries.”

Calling off the wage bill dogs?

Another area of recent controversy addressed in the papers was the use of wage bill ceilings in IMF programmes. Wage bill ceilings are limits placed by the IMF on the overall spending by governments on civil service salaries. Health and education advocates have argued that these ceilings restrict the ability of developing countries to hire nurses and teachers (see Update 56, 51). The Fund has recently agreed that the use of wage bill ceilings should be limited.

The new policy paper admits: “although wage ceilings have been conceived as short-term measures, in practice they have shown a high degree of persistence. Recent Fund guidance emphasizes the need for avoiding the use of wage bill ceilings over extended periods of time, for flexibility in its application (with adequate safeguards for priority sectors), and for clear justification in program documents.”

But there still seems to be some confusion within the Fund about the use of the ceilings. The policy paper on the Fund’s role in low-income countries says: “The prevalence of program ceilings on the public sector wage bill—in an effort to prevent a rapid rise in wage costs from crowding out other expenditures—decreased from late 2006 to March 2007, from eight programs to three”. However, later in the same document: “As of June 2007, conditionality on the wage bill was in place in eight out of 29 PRGF arrangements, of which four were performance criteria.”

“Whilst it is good to see the IMF moving away from imposing explicit wage bill caps, most countries with PRGF arrangements will have little choice but to impose such caps themselves – because of the IMF’s unnecessarily  restrictive fiscal and monetary policies” said David Archer, the head of the education team at ActionAid International. “The IMF needs to actively support countries to explore alternative macro-economic policies that would enable governments to increase spending on education and health. The IMF needs to recognise that social spending is a productive investment that makes good economic sense and contributes to stability.”

The new policies also cover the creation of medium-term expenditure frameworks, the modalities of expenditure smoothing, the coordination of fiscal, monetary and exchange rate policies, the avoidance of aid dependency, and the strengthening of public financial management. The IMF will consider further design changes for the PRGF when the board discusses a staff proposal on the role of the IMF in the Poverty Reduction Strategy process after their August recess.