Public Information Notice No. 08/43

Public Information Notice: IMF Executive Board Discusses the Fund's Engagement in Fragile States and Post-Conflict Countries -- A Review of Experience

April 1, 2008

On March 24, 2008, the Executive Board of the International Monetary Fund (IMF) discussed the Fund's Engagement in Fragile States and Post-Conflict Countries—A Review of Experience; Issues and Options.

Background

The international community has stepped up efforts to devise a broad and coordinated approach to engaging more effectively with fragile states (including post-conflict countries), whose economic and social performance is substantially impaired by their weak governance, limited administrative capacity, persistent social tensions, and a tendency to conflict and political instability.

The Fund has been engaged in some form in almost all fragile states to improve economic management and performance, although it has not adopted a specific and differentiated policy toward them. To better attune the Fund's engagement in fragile states, the Fund's Medium-Term Strategy (MTS) proposed incorporating greater flexibility in program design in fragile states (including post-conflict countries), while focusing on the Fund's core areas of competence.

A review of the Fund's engagement in fragile states indicates that it has been broadly effective. Macroeconomic performance improved in fragile states that implemented the reforms designed with the Fund, or recommended by it. Fund financing in these states also generally led to increased net external financing, and in almost all cases, facilitated access to debt relief. However, the review also reveals certain gaps in the Fund's engagement that have significant implications for some fragile states.

Against this backdrop, the present discussion considered options for a more systematic, graduated approach that could improve the coherence of the Fund's engagement. The thrust of the approach would be a medium-term framework that explicitly adjusts Fund policy advice and monitoring, capacity building, signaling, and financial assistance to a country's evolving capacity to formulate and implement macroeconomic policy, and that builds on the country's commitment to reform.

The discussion focused on a proposal for an "Economic Recovery Assistance Program" (ERAP), which combines the modes of the Fund's present engagement with fragile states into a consistent medium-term policy framework, and expands the financing options available for fragile states that are not in a post-conflict situation. The ERAP would support the implementation of economic reforms of progressively rising ambition, and would set out a trajectory for alleviating the country's capacity weaknesses through the provision of Fund technical assistance that is closely coordinated with other providers, culminating in the restored ability of the fragile state to manage its economy effectively.

The ERAP would be available in two phases over a period of five years. The first phase would be a non-financing phase, emphasizing capacity building and macroeconomic policy support. Once sufficient implementation capacity has been established, and provided a balance-of-payments financing need exists, the country could enter the second phase, which would provide Fund financial support (the "Economic Recovery Financial Assistance" —ERFA), to any eligible low-income fragile state under modalities similar to those under the Fund's existing Emergency Post-Conflict Assistance (EPCA). It is proposed that financial support to fragile states under the ERFA be on concessional, possibly PRGF, terms, and that, for HIPC-eligible fragile states, performance under the ERFA would count toward the decision point track record under the enhanced HIPC Initiative.

To give a clear and transparent signal of the Fund's commitment to provide sustained structured support, the Board would formally endorse the economic program supported under the ERAP and the staff's assessments of progress throughout the program.

Executive Board Assessment

Executive Directors welcomed the review of the Fund's engagement with fragile states and post-conflict countries. This engagement has been broadly effective, but with certain gaps. Many Directors pointed in this regard to the fact that to secure external financing or debt relief, some non-post-conflict fragile states may have pursued a Fund-supported program of upper credit tranche (UCT) standard, which had proven too challenging for them because of capacity constraints. Also, these Directors stressed that the Fund's financial engagement could have helped catalyze more donor support, in part because it offered donors a clear perspective on the member's economic situation over the medium term, and on the expected outcome of the Fund's engagement.

Directors generally agreed that there is scope to improve the Fund's capacity to assist low-income fragile states, with many Directors seeing merit in a graduated, flexible, medium-term programmatic approach. Fund support to fragile states should be tailored to their evolving macroeconomic prospects and implementation capacities, contribute to the concerted international effort to address their needs, and adhere strictly to the Fund's mandate. Some Directors also emphasized in this regard that many of the challenges in fragile states are typically developmental ones which should be taken up under the lead of the World Bank, regional development banks, and donors. Directors stressed that the Fund should focus on helping fragile states rebuild their institutional capacity to fully utilize macroeconomic policy advice and to implement basic economic reforms. While Directors recognized that donor coordination would not be the Fund's responsibility, there was agreement that the Fund's engagement could help catalyze international financial support for the country and deal with arrears, and lay the groundwork for debt relief. The Fund's technical assistance to and engagement with fragile states should be carefully calibrated and coordinated with that of donors and other international institutions. In this regard, some Directors noted the leading role of the United Nations and the World Bank.

Against this background, many Directors welcomed the initiative to improve the framework for the Fund's involvement in fragile states, in particular for countries that had not recently experienced a conflict and had not been eligible for Emergency Post-Conflict Assistance (EPCA). A number of other Directors, however, considered that the necessary improvements could be achieved in the context of the Fund's existing toolkit of technical assistance, surveillance, assessment letters, Staff-Monitored Programs (SMPs) and EPCA. They saw no need for new instruments. Some Directors also cautioned that in the current budget environment, new initiatives and tasks should be considered very carefully.

Directors noted that, according to the proposal, the ERAP could be available to all low-income fragile states, without affecting their eligibility for other Fund facilities or programs. The EPCA would be intended mainly for non-low-income post-conflict states. Eligibility for the ERAP should be based on general characteristics of state fragility rather than on a formal list of countries. The ERAP would have two phases, with the first providing for technical assistance and capacity building support from the Fund, but no financing. The second phase would allow for financing with a limited but well-focused conditionality in anticipation of further strengthening economic performance and policy implementation aimed at graduating to a UCT-standard Fund-supported program as soon as possible. There would be flexibility to allow a member to enter the ERAP at the first or second stage, depending on its implementation capacity, and to progress more rapidly through the stages in step with progress in capacity building and successful program implementation.

A range of views was expressed on the main elements of the ERAP. Many Directors saw the first phase as a useful precursor to the provision of future Fund financing, although some cautioned that the first phase should not be too long, or unduly delay the Fund's financial assistance. However, a number of other Directors considered that existing tools, such as an SMP, serve the same purpose, and recalled that the Board abolished the "signaling" SMP. Accordingly, they saw little added value in establishing this no-financing phase, and cautioned that a new signaling instrument could risk confusion, send potentially conflicting signals, and undermine the efficiency of existing signaling instruments, including assessment letters.

Many Directors saw merit in and supported the proposal that under the ERAP's second phase—the Economic Recovery Financial Assistance (ERFA) phase—fragile states could request Fund financial assistance, provided there is sufficient implementation capacity and a clear balance of payments financing need. However, a number of other Directors questioned the need for a separate financial instrument for fragile states. They pointed out that the Fund does not provide grant financing, that its loans are less concessional than those of many donors, and that financing for development should be left to institutions with developmental mandates. A few Directors also expressed concern that the new instrument would not meet the standard of an UCT program.

Those Directors who supported the ERAP's second phase considered that financing under the ERFA should be provided with modalities similar to those of EPCA, but on concessional terms, such as those extended under the PRGF. They generally favored the proposal that the ERFA be designed as a new window in the PRGF-ESF Trust. Amongst Directors who saw no need for new instruments, there was some interest in considering whether the time horizon and concessionality of EPCA financing for low-income countries could be adjusted by integrating it into the PRGF-ESF Trust.

Many Directors also agreed that the Fund should apply its policy on lending into arrears under the proposed ERFA with the same flexibility that is currently applied in the context of EPCA. These Directors also agreed that, on a case-by-case basis, successful implementation of the ERFA-supported program could count toward the decision point track record under the enhanced HIPC Initiative, although achievement of the completion point would continue to require satisfactory performance under a UCT-standard Fund-supported program.

Directors supporting the proposed ERAP concurred that Board endorsement of the member's economic program in the context of semi-annual reviews would strengthen the signal emanating from the Fund's engagement and help to generate additional donor financing, by indicating the Fund's commitment to provide capacity-building and policy support, and to monitor regularly the member's progress through the ERAP. Board endorsement would also indicate that the member was continuing to strengthen its implementation capacity and economic performance so as to transition to a UCT-standard Fund-supported program within the envisaged timeframe. However, a few Directors considered that Board review of a program that did not involve financing would be a poor use of Board time, and doubted that such a review would generate additional donor financing.

Based on this discussion, Management will return to the Board with a follow-up paper, taking into account views and suggestions expressed today by Directors. Directors welcomed the staff's intention to seek the views of donors and potential recipients, on the need for, and possible features of, any new instrument. A number of Directors expressed strong reservations about labeling countries as "fragile states". Despite use of the term by other institutions, they feared it might carry an unwarranted stigma. Staff will work on alternative terminology, as well as on criteria for qualifying countries for the proposed type of Fund support.