Operational Guidance on the New Conditionality Guidelines May 8, 2003

1. The recent comprehensive review of the Fund's conditionality culminated in the adoption of a new set of conditionality guidelines by the Executive Board on September 25, 2002. The new Conditionality Guidelines replace the 1979 Conditionality Guidelines and the Interim Guidance Note on Streamlining Structural Conditionality of September 18, 2000. A review of experience with the new guidelines, looking at how they have been implemented and at their impact on program implementation, will be conducted in 2004.

2. As discussed in the staff statement attached to the new guidelines, the key principles that should guide the Fund in designing and setting conditionality are: (i) national ownership of reform programs, (ii) parsimony in program conditions; (iii) tailoring of programs to a member's circumstances; (iv) effective coordination with other multilateral institutions; and (v) clarity in the specification of conditions.

3. This note elaborates on the operational implications of these principles and the new conditionality guidelines. It is not intended as a comprehensive stand-alone guidance note, but rather as an aid to the implementation of the new guidelines. The operational issues covered in the note are grouped into three areas: (i) the process of negotiation and program design; (ii) the design of conditionality; and (iii) the presentation of conditionality in Board papers for the use of Fund resources. In some cases, implementing the new guidelines will involve the development of new practices. In other cases, new practices have already been adopted in selected cases, which should now become routine.

I. Negotiation and Program Design Process

4. The new guidelines indicate that: (i) authorities have the lead role in drafting their program documents; (ii) the Fund should encourage members to build broad support for sound policies; and (iii) Fund programs and conditionality should be coordinated with other international institutions in countries where those institutions are also involved.

5. The new guidelines establish the explicit presumption that the primary responsibility for the design of the program lies with a member's authorities. The intent is to promote ownership by strengthening the authorities' role in the process, especially as it relates to LOIs. There is no requirement that country authorities draft the LOI and MEFP, but staff should be responsive when authorities desire a greater role in the drafting of these documents. As with some other aspects of the new guidelines, this may require allowing more time for program formulation. The guidelines implicitly recognize that experience in this regard will vary, and that the authorities might have limited capacity or inclination to draft program documents. This encouragement is intended to foster greater flexibility in program design without weakening conditionality or the quality of Fund-supported programs, for which Fund staff retain their responsibility. Drafting technical memoranda would continue to require a high degree of collaboration between staff and country authorities.

6. Staff should seek proposals from country authorities at an early stage in the policy dialogue and be flexible in program design when possible to meet the authorities' preferences. Briefs for negotiating missions should outline the authorities' initial proposals to the extent possible and the proposed staff response. These proposals could reflect exchanges during previous Article IV consultations, staff visits, or bilateral meetings, such as those during the annual meetings. When the staff is not in a position to report any views, that should be made clear in the brief. The guidelines emphasize the importance of flexibility in order to allow considerations of ownership, implementation capacity, and member's circumstances to influence program design. When time pressures on negotiations are high, the ability to provide for such flexibility will necessarily be constrained.

7. Staff should encourage and assist members in broadening support for sound policies. Participatory processes are already a requirement in PRGF arrangements and have been adopted in many other program countries. Staff should encourage the authorities to engage in a transparent participatory process in developing a policy framework, and should continue to be prepared to assist the authorities in this process including by giving seminars, meeting with various interest or political groups (parliamentary committees, trade unions, business groups, etc.) and by being available to the media. In doing so, staff should be aware of the authorities' views on staff contact with domestic groups and, if necessary, seek their prior agreement. Resident representatives could be particularly useful in providing this assistance. Broadening political support for policies may require allowing greater time for program formulation.

8. Explicit assessments of potential implementation difficulties should be included in briefing papers. Assessments should reflect specific challenges to broader ownership in a country as well as other country-specific issues such as constitutional and political structures. Such assessments take on particular importance when implementation of key measures hinges on legislative approval or on actions by lower levels of government (e.g. fiscal adjustment by sub-national governments or reforms in state-owned enterprises with significant autonomy), rather than on executive actions alone. In some instances, where implementation requires cooperation by several ministries, the positions of these ministries are relevant to the assessments. To help ascertain prospects for successful implementation, an arrangement may require the approval of specific measures by the entity responsible for the decision (e.g., the cabinet, the Parliament, sub-national governmental bodies) as prior actions. In some cases, where there are doubts as to whether a particular critical measure would be implemented after approval, it should be made a prior action (see also paragraph 12).

9. Briefs should include an assessment of technical capacity, including capacity building in the program. Briefing papers and staff reports should explicitly identify key capacity weaknesses, explain how those weaknesses may affect the ultimate design of the program, and highlight the measures under the program to build capacity in those areas.

10. Collaboration with other multilateral institutions. The staff should consult with the staffs of other multilateral institutions involved in the country early on in the program design process. Briefing papers should clearly spell out the separate programs agreed with the relevant multilaterals, how these programs together address the authorities' broad goals, and provide details of coordination in the areas of overlap, including a clear delineation of responsibilities (in line with the lead agency principle). Continued close communication will be essential to adapt coordination as the Fund-supported program is being implemented (see also paragraph 20).

II. Designing Conditionality

11. Program conditions generally must be critical to the achievement of program goals, to monitoring implementation, or necessary to the implementation of specific provisions under the Articles of Agreement. The new Guidelines replace the somewhat weaker standard of macro-relevance in the Interim Guidance Note on Streamlining Structural Conditionality of September 2000. All conditions, whether inside or outside the Fund's core areas, must now be judged to be of critical importance for program goals. Critical importance means that excluding the condition would seriously threaten the achievement of program goals or the Fund's ability to monitor implementation. Structural benchmarks may be included if they are on key components of a broader reform measure that is judged to be critical (e.g. steps in a tax reform or privatization program), as long as they are applied as parsimoniously as possible. Determining which measures are critical inherently involves an element of judgment in the context of the overall macroeconomic framework of the program.

12. Use of prior actions. Prior actions may be used as conditions for a new arrangement or for completing a current review when a critical measure needs to be implemented immediately in order to achieve program goals, or when there are significant doubts that the measure would be implemented later if specified as a performance criterion. Conditions set for the completion of future reviews are not prior actions and should not be referred to as such; rather, they are either performance criteria or benchmarks. As with other forms of conditionality, prior actions are to be applied parsimoniously and must be justified in terms of their criticality to program objectives. In assessing the use of prior actions, staff should be guided by the experience that implementing prior actions has not been shown to increase the likelihood that other subsequent measures under the program will be successfully implemented.

13. The scope of reviews should be clearly specified. Reviews will continue to have backward- and forward-looking components. The policy areas on which the backward-looking component of the review is to focus should be specified, to the extent possible, in the form of performance criteria, indicative targets and structural benchmarks. Reviews also remain forward-looking, providing the opportunity to assess prospects for achievement of program objectives in light of a range of available information. This may entail modifying program objectives as new information becomes available; for example, if additional adjustment is needed owing to changes in economic conditions. To limit the possibility that reviews will be used to add conditionality unless clearly justified by changes in circumstances, the original program documents should give at least a broad sense of the uncertainties that could require additional or modified conditionality during reviews. Adding new conditionality during a review in areas previously without any conditionality would require a clear justification as to why the related measures had become critical to program objectives.

14. Outcomes-based conditionality. The guidelines explicitly allow for performance criteria to be set on targets and objectives as well as on actions. While outcomes-based conditionality is not expected to be widely applicable, staff should be receptive to appropriate circumstances in which its use would provide greater flexibility in designing programs and in adapting them to subsequent developments. However, outcomes chosen as conditions must still be reasonably under the control of the authorities, so that exogenous shocks do not force undue use of waivers and thereby lessen assurances to the member of the availability of Fund resources under the arrangement. Moreover, outcomes-based conditionality should be designed to avoid situations in which targeted outcomes are achieved by unsustainable or inappropriate policies, such as reaching a higher revenue target by increasing tariffs. (See http://www.imf.org/External/np/pdr/cond/2002/eng/modal/010802.htm and http://www.imf.org/external/np/sec/pn/2002/pn0226.htm for a detailed discussion).

15. Floating tranches. The use of floating tranches is also explicitly allowed for in the new Guidelines as another possible device available to staff in the design of conditionality. Their use may enhance ownership by giving authorities greater flexibility in choosing the timetable on which reforms, particularly structural reforms, are chosen. They are most appropriate for measures, such as trade liberalization or debt restructuring, that would generate temporary balance of payments needs, or for reforms where there is some unavoidable uncertainty about the timing of the measure, or where an upfront commitment on specific timing is for some reason not desirable. However, because all conditionality should meet the same standards of critical importance and overall streamlining, structural reforms that might be appropriate for floating tranche conditionality are not expected to occur in very many cases. (http://www.imf.org/External/np/pdr/cond/2002/eng/modal/010802.htm and http://www.imf.org/external/np/sec/pn/2002/pn0226.htm for a detailed discussion).

III. Presentation in Board papers

16. Discussion of program design issues in UFR Board papers should provide a clear explanation of the choice of conditionality, in particular the judgments of criticality supporting the inclusion (or exclusion) of particular structural measures. Since the judgment of criticality depends upon program goals, these should be specified in relation to the individual country's macroeconomic framework. The linkages between structural conditions and program goals should be drawn as clearly as possible. Where possible, staff reports should also convey the discussion between staff and authorities' on policy options.

17. More detailed explanations are needed for conditions outside Fund core areas. Conditions may be established on measures outside the Fund's core areas of expertise, but require more detailed explanations of their criticality. This reflects the general presumption that non-core conditions are less likely to pass the test of critical importance.

18. Staff assessment of potential implementation difficulties should be discussed. As noted in paragraph 8, a more candid discussion on concerns about ownership will be expected in staff reports as well as briefs. It will be important to acknowledge concerns about ownership which would increase risks to program implementation from the outset to enable the Board to make more informed judgments. In these cases, staff will need to convey the rationale for going ahead, including on the basis of the implementation of key measures necessary to improve prospects for the success of the program. Care will have to be taken to ensure that a discussion of ownership does not undermine confidence in the program.

19. Program conditions should be clearly identified and distinguished from other measures in program documents. Tables for quantitative performance criteria and indicative targets are already required and are a standard part of Fund practice. All structural conditionality is also routinely identified in all UFR staff reports. An effective means of doing so is to include tables listing all quantitative and structural performance criteria, indicative targets, prior actions and structural benchmarks. If the authorities wish to list measures that are not conditionality, these should be listed separately and identified as part of the authorities' reform agenda. The status of all past performance criteria, indicative targets, prior actions, and structural benchmarks should also be reported, and discussed in more detail for unmet or delayed conditions. This can also be done in tabular form.

20. Bank - Fund collaboration. A discussion of collaboration with other multilaterals, in particular the World Bank, has also become a requirement of UFR staff reports where applicable. While much of this information should be contained in the new World Bank Relations Annex, particularly relevant information should be brought into the main staff report. Special attention should be focused on where conditionality under an earlier Fund-supported program has been discontinued but where the measures remain relevant and are being monitored by the Bank or other multilaterals. Staff reports should also discuss how the Bank- and Fund-supported programs have been coordinated - for example, where the Fund macro framework has been modified to accommodate Bank reform programs, where reforms under a Bank-supported program have been chosen and sequenced to contribute to Fund-supported program goals, etc. Monitoring responsibilities of the multilateral institutions should be clearly delineated, while bearing in mind that the Fund bears the ultimate responsibility for establishing and monitoring its conditionality. ("See Annex I of "Strengthening IMF-World Bank Collaboration on Country Programs and Conditionality—Progress Report"" - http://www.imf.org/external/np/pdr/cond/2002/eng/collab/coll.htm, 2002 for a more detailed discussion).