IMF Conditionality
When a country borrows from the IMF, its government makes commitments on economic and financial policies—a requirement known as conditionality. Conditionality is a way for the IMF to monitor that its loan is being used effectively in resolving the borrower's economic difficulties, so that the country will be able to repay promptly, and make the funds available to other members in need. In recent years, the IMF has worked to focus and streamline conditionality, in order to promote national ownership of strong and effective policies. |
What is "conditionality" and why is it necessary?
IMF loans are generally conditional on the adoption of appropriate policies to resolve a country's balance of payments difficulties and to establish adequate safeguards for the temporary use of IMF resources. Conditionality also provides the member with assurances on what is needed for the IMF to make its financial resources available.
In setting program-related conditions, the IMF is guided by the principle that the member has primary responsibility for the selection, design, and implementation of its policies. The reform measures may go beyond just solving the immediate external imbalance problem. This is the case if the measure is considered to be critical for achieving the program goals that may lay the basis for economic stability and economic growth over the longer term—for example, containing inflation, reducing public debt, or strengthening financial systems.
Together, these policies constitute a member country's "policy program," which is described in a letter of intent(which often has a memorandum of economic and financial policiesattached to it) that accompanies the country's request for IMF financing. The objectives of a program and the types of policies involved depend on country-specific circumstances. However, the overarching goal is to restore or maintain balance of payments viability and macroeconomic stability, while setting the stage for sustained, high-quality growth.
How is compliance with program conditions assessed?
Most IMF loans feature phased disbursements. This allows the IMF to verify that a country is continuing to adhere to its commitments. Program monitoring relies on different tools:
• Prior actions are measures that a country agrees to take before the IMF's Executive Board approves a loan or completes a review. Such measures ensure that the program has the necessary foundation to succeed, or is put back on track following deviations from the agreed policies. Prior actions could include, for example, adjustment of the exchange rate to a sustainable level, elimination of price controls, or formal approval of a government budget consistent with the program's fiscal framework.
• Performance criteria (PCs) are specific conditions that have to be met for the agreed amount of credit to be disbursed. There are two types of PCs: quantitative and structural.
• Quantitative PCs typically refer to macroeconomic policy variables such as monetary and credit aggregates, international reserves, fiscal balances, or external borrowing. For example, a program might include a minimum level of net international reserves, a maximum level of central bank net domestic assets, or a maximum level of government borrowing. Quantitative PCs may be supplemented with indicative targets. These are often set for the later months of a program, and are then turned into PCs,with appropriate modifications, as economic trends firm up.
• Structural PCs are also clearly specified structural measures that are critical for the successful implementation of the economic program. These vary widely across programs but could, for example, include measures to improve financial sector operations, reform social security systems, or restructure key sectors such as energy.
• Structural benchmarks are measures that cannot be monitored objectively to be PCs or are small steps in a reform process that would not individually warrant an interruption of IMF financing but that are part of a reform that is critical for program success.
• Inflation consultation clauses are another category of conditionality used in countries with an inflation targeting framework. They are designed so that if an inflation band is breached, the member cannot draw unless a Board consultation has been completed.
• Another important monitoring tool is the program review, which is an opportunity for the Executive Board to carry a broad-based assessment of progress towards meeting the program's objectives. Reviews are used to discuss the economic policies underlying a program and introduce changes to the program that may be necessary in light of new developments. In some cases, a country might request a waiver for a breached PC—for example, when its authorities have already taken measures to correct the deviation.
How has conditionality evolved in recent years?
IMF lending has involved policy conditions since the 1950s. Up to the early 1980s, IMF conditionality largely focused on macroeconomic policies. Subsequently, however, the complexity and scope of the structural conditions attached to IMF loans increased significantly. This broadening and deepening of conditionality reflected in part the IMF's growing involvement in low-income and transition countries, where structural problems hampering broader economic stability and growth were particularly severe.
In 2000, the IMF concluded an extensive review of conditionality—a consultative process that also involved consultations with stakeholders outside the IMF—aimed at enhancing the effectiveness of IMF-supported programs. This review recognized that successful economic policy programs must be founded on strong country ownership. Accordingly, the IMF has been striving to focus more sharply and be more clear about the conditions attached to its financing, and to be flexible and responsive in discussing alternative policies with countries requesting financial assistance. Revised guidelines on conditionality, which take these objectives into account, were adopted by the IMF's Board in September 2002. The IMF's Executive Board reviewed the application of the new guidelines in March 2005, concluding that substantial progress had been made and encouraging the staff to further these efforts.
In 2007, the IMF's Independent Evaluation Office (IEO) completed an assessment of structural conditionality in IMF-supported programs. The report provided impetus to the ongoing effort to make conditionality more focused and relevant. In light of the IEO's finding that the number of structural conditions has not declined and that some conditions were not critical for the achievement of program goals, the IMF's Executive Board called for strengthened efforts to achieve parsimony by focusing on criticality and providing rigorous justification for conditions.
The management implementation plan in response to the Board-endorsed IEO recommendations was discussed by the Executive Board in May 2008. The plan calls for sharpening the application of the 2002 Guidelines on Conditionality by requiring better justification of criticality, establishing explicit links between goals, strategies and conditionality, and enhancing program documents. The plan also entails the upgrading of MONA (a database with information on the conditionality in IMF-supported programs) to improve program monitoring and making the MONA database available to the public.