Public Information Notice No. 01/28

Public Information Notice: IMF Executive Board Discusses Conditionality

March 21, 2001

On March 7, 2001, the Executive Board of the International Monetary Fund (IMF) discussed conditionality in Fund-Supported programs, in the light of experience over the past decade.¹

Background

The IMF provides financing to a member country that needs it, provided that the country is implementing an adequate program of policy adjustments in response to its external imbalances. Conditionality is intended to give the country confidence that it will continue to receive IMF financing as long as it implements the policies envisaged under the program, while providing safeguards for the Fund's resources by ensuring that the financing is provided only if needed policy adjustments are under way.

Conditionality has evolved substantially over the history of the Fund. Until the 1980s, policy conditions were primarily limited to macroeconomic variables such as those related to domestic credit creation and the fiscal deficit. But starting in the late 1980s, there was a major broadening of the scope of conditionality. In part, this reflected an increasing emphasis on growth as an objective of Fund-supported programs, together with a growing involvement in countries where severe structural problems were impeding the achievement of a sustainable balance of payments position. As a result, Fund conditionality came increasingly to be attached to structural reforms, including those intended to strengthen fiscal institutions, to build a sound financial sector, and to increase the efficiency of the economy more generally.

The expansion of conditionality has raised a number of issues. In particular, it has raised concerns that excessively broad and detailed conditionality may undermine the national ownership of a policy program, which is essential for successful program implementation. Moreover, extensive conditionality may strain the country's administrative capacity, thus undermining the implementation of those policies that are truly essential.

The Managing Director of the IMF has therefore given high priority to streamlining and focusing the Fund's conditionality and strengthening national ownership. The International Monetary and Financial Committee welcomed this emphasis at its September 2000 meeting.

Such streamlining involves a number of steps. The Managing Director issued an Interim Guidance Note on Streamlining Structural Conditionality to staff in September 2000. Fund staff have begun putting the principles established in this note into practice in new and existing Fund arrangements. The Executive Board discussion on March 7 is another stage in this process. This discussion of the principles and issues related to conditionality was based on a set of papers prepared by staff, which examine the experience with structural conditionality and the policy issues associated with streamlining. Following this discussion, the Board agreed to post the papers on the IMF website and invite comments from outside the institution. A seminar will be held at IMF Headquarters, at a date to be announced, to provide an opportunity to hear the views of outside experts and country officials. In the period ahead, the Executive Board will return to discuss conditionality again in light of comments received from outside the institution as well as of a staff paper reviewing the experience with application of the Interim Guidance Note. The end result will be a review of the Fund's formal guidelines on conditionality with a view to bringing them into line with current realities and giving due emphasis to the need for streamlining.

Executive Board Assessment

Executive Directors discussed the general principles and issues related to conditionality against the background of the experience of the past several years. This discussion is an important step in our review of policies in this area. It has identified a number of aspects on which there is already broad consensus in the Board, and others that the Board will need to consider further in the period ahead. The basic aim is to streamline and focus conditionality. This would give greater scope for national ownership while ensuring that the essential objectives of Fund-supported programs, consistent with the purposes of the Fund—including safeguarding Fund resources and their revolving character—are achieved.

Areas of Consensus

Directors agreed that conditionality remains indispensable. The Fund's financing is intended to support a member country's policy program, with adjustment policies and financing together forming an integrated response to the country's economic difficulties. For the country, conditionality provides assurances that it will continue to receive the Fund's financing subject to the continued implementation of the policies envisaged under the program; while for the Fund, it provides safeguards that successive tranches of financing are delivered only if key policy objectives remain attainable. Directors reviewed the major expansion of conditionality, particularly in the structural area, over the past several years. This expansion was, in part, a reflection of the increasing emphasis on growth as a policy objective, driven by the view that demand management alone is inadequate to address the pressing economic problems of member countries. Moreover, the Fund had been intensively supporting countries facing increasingly varied economic situations, including low-income and transition countries, in which the correction of sometimes massive structural distortions and weaknesses in governance was viewed as fundamental to addressing macroeconomic and external imbalances. More recently, the Fund had supported programs to deal with capital account crises stemming in large part from structural weaknesses in financial sectors, and addressing these weaknesses had been an essential element of the policy response, intended both to achieve a sound medium-term position and to help restore market confidence.

Directors also recognized that the broadening scope of Fund programs had been accompanied by changes in the way the Fund monitors policy implementation. In particular, the Fund relied increasingly on program reviews in monitoring policy performance. Structural benchmarks were extensively used to map out steps in the implementation of particular structural policies. Prior actions—policy actions taken by the authorities before approval of a Fund arrangement or before the completion of a program review—had also become an increasingly important element in program monitoring.

Directors noted that the increasing scope and detail of conditionality in the structural area raised a number of issues. While some Directors observed that, by and large, the Fund's conditionality had remained concentrated on its core areas of responsibility, others noted that the application of some conditionality outside these areas gave rise to concerns that the Fund was overstepping its mandate and expertise. They also took note of concerns that Fund-supported programs sometimes short-circuited national decision-making processes and failed to take adequate account of the authorities' ability to muster public support for the policies envisaged, as well as their administrative capacity to implement these policies. Considering that national ownership was essential to the successful and sustained implementation of a program of economic policies, Directors underscored the importance of avoiding ill-focused or unduly intrusive conditionality that could detract from ownership. Concerns were also raised regarding the consistency of the application of conditionality with the Fund's existing guidelines, including with respect to uniformity of treatment across the membership. Directors also noted that the boundaries of conditionality had become blurred, due to the increasing use of structural benchmarks and the use of Letters of Intent (LOIs) to set out the authorities' overall reform programs. This made it more difficult for both the Fund and outsiders to ascertain on exactly which policy measures the Fund's financing is conditional.

In light of these considerations, Directors agreed that there was a need to streamline and focus the Fund's conditionality. The aim of streamlining should be to leave the maximum possible scope for countries to make their own policy choices, while ensuring that the Fund's financing is provided only if those policies that are essential to the purposes of the Fund continue to be implemented. A few Directors noted that this exercise should not be seen as a quantitative one, with the sole purpose of reducing the number of conditions in Fund programs, but with the aim of ensuring that conditionality is appropriately targeted in light of the circumstances of the country.

Directors therefore supported the broad thrust of the Interim Guidance Note on Streamlining Structural Conditionality issued by the Managing Director in September 2000. This note states that structural reforms that are critical to the achievement of a program's macroeconomic objectives will generally have to be covered by Fund conditionality; however, a more focused and parsimonious application of conditionality is envisaged for structural reforms that are relevant—but not critical—to the program's macroeconomic objectives. While these principles would need to be interpreted carefully on a case-by-case basis, they would shift the presumption of coverage from one of comprehensiveness to one of parsimony—thus requiring a stronger burden of proof for the inclusion of specific structural measures as conditions in an arrangement, particularly where these measures are outside the Fund's core areas. It was also agreed that the appropriate coverage and content of conditionality are likely to differ, depending on countries' circumstances, as well as between programs supported by different Fund facilities.

Directors also agreed that a clear division of labor and enhanced cooperation with the World Bank and other agencies was an important element of streamlining. They welcomed the progress that had been made in this direction with regard to countries supported by the Poverty Reduction and Growth Facility, and looked forward to further steps, with the support of shareholders of both institutions, that would make this coordination framework fully effective. Directors also noted that work was now underway in the World Bank that would facilitate more effective cooperation with regard to middle income countries.

Directors noted that the role of program reviews had changed importantly in the past two decades, with reviews now being used for both forward- and backward-looking assessments of economic policies. They considered this change to be appropriate: first, it reflected the increased uncertainty of macroeconomic relationships in a world of volatile global capital markets which had made it more difficult to specify macroeconomic performance criteria for more than a brief period ahead; and second, structural policies, which had become much more prevalent, were less amenable to assessment in terms of simple quantified performance criteria. At the same time, Directors underscored the importance of ensuring that the increasing prevalence of reviews does not unduly weaken assurances to member countries regarding the conditions under which they will continue to have access to the Fund's resources.

Directors also noted that structural benchmarks had become an increasingly important tool of conditionality. They agreed that benchmarks were useful in tracking progress in implementing structural reforms that take time to come to fruition. As such, benchmarks did not constitute formal conditions for Fund financing, but were a tool of program monitoring helping inform Board assessments of the implementation of structural policies in the context of program reviews and providing some assurance to the authorities by helping clarify the basis on which these assessments would be made. At the same time, Directors saw a need for structural benchmarks to be used more sparingly, by limiting each benchmark to an important and representative step toward a policy outcome. This would also help avoid the impression of micromanagement.

Directors agreed that Letters of Intent (LOIs) should make a clearer distinction between the authorities' overall policy program and the part of that program that is subject to the Fund's conditionality. They agreed that the LOI should either focus only on those aspects of policy covered by conditionality or, in cases in which the authorities wish to use the LOI to present their broad policy agenda, should indicate clearly which elements of the program constitute Fund conditionality. Directors also agreed that only measures covered by conditionality should be included in matrices in LOIs.

Some Directors also stressed that ownership depended importantly on the process by which programs were negotiated. This process should, to the fullest extent possible, allow the authorities to consider various policy alternatives with a view to ensuring that the program reflected the circumstances and priorities of the country itself.

Issues Requiring Further Consideration

Directors discussed several important issues to which they will return in the period ahead. First, the approach to streamlining proposed in the Interim Guidance Note leaves open the question of where to draw the line between measures that are critical to program objectives and those that are relevant but not critical. Most Directors favored interpreting this criterion rather narrowly, while others, who favored a broader interpretation, expressed concern that some recent programs may have gone too far in eliminating conditionality related to important elements of structural reform. While it was agreed that this choice would inevitably involve considerable judgment on a case-by-case basis, a number of Directors saw a need to examine these issues more closely by drawing lessons from recent and upcoming cases.

A second issue on which further consideration is needed is application of the Fund's conditionality outside its core areas of responsibility and expertise. Here again, most Directors considered that any application of conditionality in such areas should be limited to measures that are critical to a program's achievement of its macroeconomic objectives. Other Directors, however, were of the view that measures that were relevant to these objectives might also be included. Directors agreed that care would need to be taken to ensure that the authorities received adequate advice—from the World Bank or other agencies—to guide implementation of any measure outside the Fund's core areas to be included under Fund conditionality. Limiting the Fund's conditionality to its core areas while ensuring that measures that are critical to program objectives are carried out would also require further progress in developing a framework for coordination with the World Bank and other agencies.

Third, Directors noted a number of issues of program design that are important in a broader context of the application of the Fund's conditionality. In particular, they saw a need for further consideration of issues regarding the pace and sequencing of structural reforms, and the need to work continuously to adapt conditionality to the actual implementation capacity of the country. They also saw a need to consider the lessons of implementation in various structural areas. A few Directors also stressed that the international economic environment, including the reactions of market participants, had an important influence on the results achieved by members' policies, and that this influence needed to be taken into account in designing conditionality.

A fourth issue raised is the extent to which the Fund should and could be more selective in providing financing in support of programs suffering from weak country ownership. Since conditionality cannot compensate for a lack of program ownership, Directors agreed that the Fund should seek to limit its financing in such cases. A number of Directors noted, however, that this principle is difficult to apply, because the costs for the country of holding back Fund support may be large and because of the difficulty of assessing the level and breadth of ownership. In this connection, it was suggested that prior actions could be a helpful tool to test country ownership, especially in cases where past performance had been weak. Directors also stressed that the Fund needed to continue to participate in member countries' institution building efforts, including through technical assistance, as these efforts played a key role in strengthening the ability and willingness of countries to implement sound programs.

Fifth, a range of views was expressed on the scope for greater use of results-based conditionality, under which the Fund's financing would be provided only after certain key policy outcomes had been achieved. A number of Directors considered that this approach would have the merit of giving countries greater flexibility in choosing the best means of achieving desired results, and some saw the increased use of prior actions as already moving in this direction. At the same time, the point was made that a wholesale move to results-based conditionality would create tensions with the need to synchronize policy implementation with Fund financing, unless financing were significantly more back-loaded.

In this regard, Directors discussed the role of standards and codes in specifying desired policy outcomes in Fund-supported programs. They noted that standards and codes could be a useful element in program design and that the adherence of members to best practices in a number of areas could limit the need for specific conditionality to safeguard program objectives. They observed, however, that the application of standards and codes in Fund-supported programs would need to respect their voluntary nature.

Finally, Directors agreed that some aspects of the tools of conditionality would need to be considered further before completing their review of conditionality. These issues include the application of waivers of non-observance of performance criteria, the scope, content, and frequency of program reviews, the precise role of structural benchmarks, and the use of prior actions (particularly with regard to the need for transparency and uniformity of treatment).

Next Steps

Directors discussed steps to move forward in reviewing the Fund's conditionality. They agreed that the papers prepared by the staff would be made public soon after the meeting and comments invited from outside the Fund on the issues proposed. They also noted plans for seminars in which various outside commentators on conditionality would be invited to participate. Directors agreed to return to these issues again following the Spring meetings, taking account of the deliberations of the International Monetary and Financial Committee and input received from outside the Fund, as well as a staff review of the experience so far with the application of the Interim Guidance Note on Streamlining Structural Conditionality. In addition, real-time assessments of the application of these guidelines in the context of ongoing programs would provide an opportunity to review the rationale for the inclusion or exclusion of conditionality related to specific policy measures.

Directors also stressed the need for information regarding the application of conditionality to be provided regularly to the Board. While a number of Directors noted that the information on the numbers of conditions included in programs was not conclusive in itself, they agreed that on balance it would be useful for such information to be provided on an annual basis.

The eventual objective is to review the Fund's existing guidelines on conditionality to ensure that these reflect new realities and give due emphasis to the need for streamlining. Directors agreed that, pending the completion of this review, the Interim Guidance Note would continue to be applied. They also agreed that, as the review progresses, staff will move ahead on specific issues on which the Board has reached consensus.