Public Information Notice No. 05/52

Public Information Notice: IMF Executive Board Discusses Review of the Conditionality Guidelines

April 15, 2005

On March 25, 2005, the Executive Board of the International Monetary Fund (IMF) discussed a staff paper covering the review of conditionality guidelines adopted by the IMF in 2002.

Background

The latest review of IMF conditionality is part of a process of continuing assessments that are undertaken by the staff and the Executive Board of the institution and its policies. Conditionality links the approval or continuation of financing provided by the IMF to the implementation of specific elements of economic policy by the country receiving the financing. It provides safeguards to the IMF that its resources will be used to help countries solve their balance of payments problems and will be repaid, and assurances to the country that it will continue to receive financing provided that it continues to implement the policies envisaged under the program supported by the IMF.

New conditionality guidelines were adopted at the culmination of the 2000-02 conditionality review, replacing previous guidelines that dated back to 1979. The new guidelines emphasize national ownership of policies, parsimony in conditions, tailoring of policies to member circumstances, coordination with other multilateral institutions, and clarity in the specification of conditions. The new guidelines had been foreshadowed by an "interim guidance note on streamlining structural conditionality," which was adopted in September 2000. In assessing experience with the new policy, Directors contrasted the 2001-04 period with the pre-2001 experience.

At the time of the 2000-02 conditionality review, Directors recommended that, in the next conditionality review, the staff should address broader issues of program design in addition to the application of the conditionality guidelines. Program design issues were discussed by the Executive Board on December 17, 2004 (see Public Information Notice No. 05/16), while this review focuses on the main elements of the guidelines, with the exception of coordination with the World Bank which was discussed by the IMF Executive Board in early 2004 (Public Information Notice No. 04/36).

Executive Board Assessment

Executive Directors welcomed the comprehensive staff paper made available for the review of the experience with the new Guidelines on Conditionality adopted in 2002. They noted that conditionality is intended to ensure that Fund resources are provided to members to assist them in resolving their balance of payments problems in a manner that is consistent with the Articles of Agreement and that establishes adequate safeguards for the temporary use of the Fund's resources. Directors agreed that the implementation of the new guidelines has delivered positive results overall. They recognized that this review has come at an early stage of experience with the new guidelines, and that further evidence, in particular on economic outcomes, will be needed before definitive conclusions can be drawn. Nevertheless, it is timely to undertake an interim stocktaking, and highlight a number of preliminary findings focusing on structural conditionality and on how programs are developed. Directors have identified a number of areas where the guidelines introduced changes in the pursuit of national ownership, parsimony, and clarity, and where further progress is required. The staff will draw on their views and suggestions in applying the conditionality guidelines.

Directors welcomed the streamlining of the breadth of coverage of structural conditionality, in line with the requirement that such conditions be deemed "critical" to the goals of Fund-supported programs. They observed that structural conditionality has shifted away from non-core areas, which are less likely to be critical; that it tends to cover fewer areas than previously; and that it is more strongly linked to initial economic conditions.

Directors noted the major decline in conditionality on growth- and efficiency-related reforms, in GRA-supported and especially in PRGF-supported programs—notwithstanding the latter's explicit growth objective. A number of Directors regretted that streamlining conditionality may have led Fund-supported programs to focus on near-term results, at the expense of growth-and efficiency-related reforms and long-term objectives, which remain crucial for lasting program success. Other Directors were less concerned about the decline in supply-side conditionality, noting that in many instances a growth strategy is implicit in some aspects of quantitative conditionality and other structural reforms, and that since growth-enhancing measures take time to yield results, it is reasonable for the focus on criticality to reduce the scope for growth-specific conditionality. Directors noted that these issues often fall outside the areas of Fund competence and agreed that greater collaboration is needed with the World Bank and other donors to ensure that these areas are adequately addressed. In any event, conditionality on growth-and efficiency-related reforms will need to be monitored closely, and the implications in respect of economic outcomes studied.

Directors discussed what further scope exists to streamline the breadth of coverage. They agreed that the structural benchmark component of conditionality should be applied to reforms that are deemed critical, although a few Directors were sympathetic to the use of benchmarks for "less critical" conditions, especially given the complexity inherent in establishing criticality. A number of Directors considered that further progress is needed in operationalizing the concept of criticality, and ensuring its consistent implementation. To this end, Directors suggested a greater focus on the linkages between program goals and conditions, and recommended that the strategies underlying program conditionality should be specified and explained as clearly as possible in staff reports. This would help provide a transparent and consistent frame of reference to national authorities, as well as allow the Board to make better informed judgments. In this regard, Directors underscored the importance of requiring all staff reports to explain clearly the basis for deeming measures as critical, especially in non-core areas. As regards the definition of program objectives, some Directors stressed the importance of debt sustainability analysis in setting the broad framework for a program.

Directors noted that little streamlining has been achieved in terms of the aggregate numbers of structural conditions. A number of Directors therefore saw scope for further narrowing. At the same time, Directors agreed that numbers of structural conditions are at best a crude metric, and that in any event it is appropriate for conditionality in Fund-supported programs to cover all critical measures. Several Directors also noted that even more important than the numbers of conditions are the quality and mutual consistency of conditions.

Directors discussed the degree of detail in which conditions should be specified, given that the emphasis on clarity often gives rise to more detailed specification. Many Directors felt that conditions formulated at a high level of detail could be seen as unwelcome micromanagement, while some others emphasized that detailed specification has the advantage of providing helpful guideposts for the authorities, clarifying conditionality, and enhancing assurances of the timely availability of Fund resources. We will need to continue to balance these considerations on a case-by-case basis.

Directors considered how "aggregate conditionality" included in programs supported by the Fund and World Bank—a topic of considerable interest to borrowers and aid donors—has been evolving. Preliminary evidence suggests that such "aggregate conditionality" is on the decline. A number of Directors expressed concern over the possible emergence, as a consequence, of "gaps" in Bank-Fund conditionality, and noted that this further reinforces the importance of close collaboration between the two institutions. Most Directors were pleased that the sectoral coverage of the Fund's conditionality now appears largely unaffected by the presence or absence of a Bank-supported program. Instead, consistent with guidelines, Fund conditionality appears to be set on all measures critical to the success of the Fund-supported program. Directors reiterated the importance of effective Bank-Fund collaboration, with each institution taking the lead in its core areas.

Directors considered that major progress has been made in improving clarity in the identification of program conditions in members' program documents. They welcomed the routine inclusion of a separate table of program conditionality and the virtual disappearance of detailed policy matrices. In addition, Directors expressed satisfaction that the scope of program reviews is now quite well defined, and that new structural conditionality introduced at program reviews generally responds well to specific changes in circumstances.

In the area of program implementation, Directors noted that available evidence suggests mixed results. While the incidence of permanent program interruptions has fallen, the implementation of structural conditionality, and in particular the waiver rate for structural performance criteria, has not improved. In this regard, several Directors encouraged the inclusion of clearer justifications for waivers in staff reports. Directors acknowledged that the fraction of conditions that did not get implemented at all during the Fund-supported program ("the lapsed rate") has declined. This development is suggestive of the serious efforts being made to attach conditions only to measures that are indeed critical to achieving program goals.

At the same time, Directors noted that overly ambitious timetables appear to be a major reason for the high waiver rate. Accordingly, Directors encouraged realistic, but still appropriately ambitious, implementation timetables. While the authorities should be free to set demanding timetables where they consider them helpful, the staff should not press for overambitious timetables, not least because staff often faces serious constraints in forming an accurate judgment on implementation capacity. In this context, a number of Directors encouraged the staff to continue to explore the potential for using floating tranches in specific cases, despite their restrictive requirements, paying due regard to the incentives provided by a firm timetable.

On policy ownership, Directors considered that proper processes remain of great importance, and were encouraged to note the efforts being made by the staff in this respect. Directors recognized, however, that good processes alone do not guarantee effective ownership. Directors considered that the authorship of first drafts of letters of intent is a subsidiary question to the authorities' active involvement in the overall program design. To increase policy space and foster ownership, Directors encouraged staff to work with authorities to establish a common understanding of the nature of the problems facing the country and to develop alternative policy options. More fundamentally, Directors considered that improvements in the elaboration and presentation of clear strategies—which tailor conditionality to country circumstances and capacity, and clearly link conditions to program goals in the context of the authorities' broader objectives—can enhance program ownership and implementation.

In light of the difficulty in gauging ownership, some Directors saw a role for conditionality, especially prior actions, as a screening device. However, other Directors observed that higher numbers of prior actions did not bring subsequent program implementation up to the Fundwide average. This suggests that conditionality is not likely to improve performance when ownership is absent. Against this background, several Directors favored greater use of staff-monitored programs as a screening device because the evidence shows that, where staff-monitored programs were used, implementation of subsequent Fund-supported programs was comparable to the average implementation rate.

In concluding, Directors considered that substantial progress has been made in aligning practice with the new guidelines, although room for improvement remains. While it is premature to modify the guidelines, Fund staff will apply the insights from today's discussion to its operational activities, modifying the staff statement and the operational guidance note as warranted.

The 2004-05 conditionality review is now concluded. In view of the importance of the issue, Directors considered that the next review should be based on a larger body of evidence, and in particular it should take stock of economic outcomes. Accordingly, Directors agreed that, in lieu of the biennial review provided for under Paragraph 15 of the Conditionality Guidelines, the next review will be held no later than March 31, 2008. The staff will explore how it can help the Board monitor the application of the guidelines in the interim.