I. Introduction

II. Surveillance and Global Financial Stability

A.Multilateral and Regional Surveillance
B. Enhancing the Content of Surveillance
C. Data Provision for Surveillance
D. Strengthening the Impact of Surveillance
E. Institution Building
F. Crisis Resolution
G. Trade

III. Fund Support for Low Income Countries

A. Overview
B. Strengthening the PRSP Approach
C. The Role of the Fund in the Medium Term
D. The Enhanced HIPC Initiative and Debt Sustainability
E. Encouraging International Support

IV. Use of Fund Resources

A. Program Design and Conditionality
B. The Fund's Financing Facilities
C. Financing the Fund and Mitigating Financial Risk

V. Voice, Representation, and Quotas

VI. The Fund as a Learning Institution

VII. Conclusion

Text Boxes
Box 1. Use of the Fund's Facilities
Box 2. IEO Evaluations—Common Themes

Tables
Table 1. Participation in Transparency, FSAP, and Standards and Codes Initiatives
Table 2. FSAP Participation
Table 3. HIPC Initiative: Committed Debt Relief and Outlook
Table 4. HIPC Initiative: Status of Commitments by the IMF
Table 5. Access Under Fund Arrangements By Year Of Approval, 1991-2004
Table 6. Current Financial Arrangements (GRA)
Table 7. Current Financial Arrangements (PRGF)
Table 8. IMF's Financial Resources and Liquidity Position, 2002 - Present

List of Acronyms

I. Introduction

1. The improved world economic environment since the 2003 Annual Meetings presents an opportunity for concerted and collaborative efforts among nations—and the risks facing countries make it important that this opportunity be seized. The U.S.-led global recovery is strengthening and broadening, if still uneven, and many emerging market economies have taken advantage of favorable market conditions to improve their debt profiles. The balance of risks has improved significantly since last September, and in the short run global growth may be higher than anticipated, although—as recent events underscore—geopolitical uncertainties and oil price volatility remain important concerns. But significant challenges and risks remain, including achieving an orderly reduction in global imbalances; addressing difficult medium-term fiscal situations in many countries; and managing the eventual transition toward higher interest rates.

2. The international community must take advantage of the recovery to work together to ensure that growth is sustained and broadened, and resilience increased. All countries have a role to play in this effort. Vulnerabilities associated with fiscal and financial sector weaknesses, large debts, and current account imbalances must be reduced, and room rebuilt to adjust policy in the event of unexpected shocks. Long-term growth fundamentals need to be reinforced and economies made more flexible through structural reform. Protectionist pressures must be resisted, and the medium-term gains to all from a successful completion of the Doha Round clearly recognized. Only in this way will a sustainable rise in standards of living be achieved, including—with the help also of stronger and better international support for low-income countries—for the most disadvantaged.

3. As emphasized by the IMFC at the 2003 Annual Meetings, the Fund must continue to adapt to the realities and challenges of an evolving global economic and financial system. We must focus on steady implementation of the various initiatives introduced over the last few years, while incorporating the lessons of experience, and remaining mindful of resource constraints. Key challenges include improving the tools we use to assess policy and conduct surveillance, including over the economic and financial system as a whole, helping members use the current relatively benign environment to reduce vulnerability and foster sustained growth; enhancing our instruments for engaging with our low-income members and playing our part in helping these countries make progress toward the Millennium Development Goals (MDGs), including by supporting efforts to raise finance on appropriate terms; and attuning our financing facilities better to the new environment of large-scale capital flows. We must also ensure that all these efforts are informed by continuous learning. The following sections describe the Fund's policy agenda in more detail.

II. Surveillance and Global Financial Stability

4. Surveillance is the Fund's foremost means of influencing countries' policies, to the benefit of all members. To make surveillance more effective, the Fund is seeking to sharpen its focus on key issues—notably global imbalances, vulnerabilities, and structural rigidities that impede growth and resilience—as well as its analytical tools. In addition, it is examining the modalities of its relationships with members with a view to maximizing the impact of surveillance. The range of recent surveillance-related initiatives is soon to be examined in the Biennial Surveillance Review (BSR). Efforts to help members build stronger institutions, including through technical assistance, are a natural counterpart to the policy advice provided under surveillance, and improved crisis resolution mechanisms are a necessary backstop for when crisis prevention fails.

A. Multilateral and Regional Surveillance

5. The Fund is working to strengthen its effectiveness as a global forum for discussion of economic interlinkages among countries:

• Multilateral surveillance has become more attentive to the cross-border impact of individual members' policies and to vulnerabilities. Executive Board discussions of the World Economic Outlook (WEO) and Global Financial Stability Report (GFSR) are key vehicles for addressing global issues.¹ Board discussions on World Economic and Market Developments (WEMD) have increased their coverage of emerging markets. The staff's contributions to all these discussions are increasingly informed by the high-frequency vulnerability exercise, introduced a few years ago, which allows a more systematic examination of key sources of vulnerability across countries.
  
  
• International capital market surveillance is benefiting from deepened cooperation with other international bodies. The Fund's participation in the Financial Stability Forum (FSF) allows it to contribute to a broad work agenda, and the Fund also liaises closely with such regulatory standard-setters as the Basel Committee on Banking Supervision and the International Organization of Securities Commissions (IOSCO).
  
  
• Surveillance of countries of systemic or regional importance is an important platform for discussion of policies to help reduce global imbalances and possible spillover effects to other countries.
  
  
• The Fund's approach to regional surveillance has also evolved. Surveillance of currency unions is becoming progressively more formal, with greater coordination between the discussions with regional institutions and those with individual members. The Fund is also increasing its participation in regional surveillance groups, aimed at enhanced regional cooperation and sharing of expertise; and bilateral surveillance is increasingly being carried out against the backdrop of the regional context.

B. Enhancing the Content of Surveillance

6. The Fund is improving its analytical tools for the early identification of vulnerabilities, including in the financial sector, and sharpening its focus on balance sheet weaknesses in a context of large and volatile international capital flows. The financial crises of the mid- to late-1990s pointed to the need to complement more systematically the Fund's traditional flow-based analysis with an examination of stocks and structures of assets and liabilities, and much recent work has focused on developing better ways of analyzing balance sheets, within and across sectors.

7. The most general example of the increasing emphasis on stock variables is the so-called balance sheet approach (BSA), which involves interlinked sectoral balance sheets and can be used to help gauge exposure to interest rate, exchange rate, and rollover risks.² Recent staff reports for Article IV consultations with Thailand and Peru provide examples of application of the BSA, and similar work has begun for several more members. Balance sheet issues feature prominently in surveillance of advanced economies—for instance, the implications of potential changes in housing prices for household debt and mortgage lending. In several emerging market economies corporate sector balance sheets have been analyzed in some detail, while a chapter in the current WEO analyzes the risks posed by credit booms. While the BSA provides a useful analytical framework for the study of vulnerabilities, its data requirements and resource costs are high.

8. Much has been done to improve the analysis of vulnerabilities in official sector balance sheets. The Fund is implementing a common framework for more rigorous assessments of public and external debt sustainability (DSA).³ Additional work is underway to examine how the structure of public debt, and balance sheet mismatches more generally, can contribute to financial crises, and how these factors should affect judgments of reserve adequacy.

9. In recognition of the key role played by the financial sector in the generation and transmission of vulnerabilities, financial sector surveillance continues to evolve:

• The Fund-Bank Financial Sector Assessment Program (FSAP) is being streamlined. The FSAP remains the key tool for in-depth analysis of financial sector weaknesses at the country level. Consistent with the recommendations of the 2003 Board review,⁴ and with a view to releasing resources for other vehicles of financial sector surveillance, the number of FSAPs has been reduced by about a quarter, to some 18 per year, and their scope streamlined, with more selective preparation of Reports on the Observance of Standards and Codes (ROSCs).
  
  
• The coverage of financial sector issues in surveillance is being improved. Financial sector surveillance is now a core area of Article IV surveillance, and a guidance note on financial sector surveillance in Article IV consultations is in preparation.
  
  
• Continued efforts are underway to promote the compilation and use of key Financial Soundness Indicators (FSIs). The core and encouraged sets of FSIs, which were reviewed by the Board last year,⁵ are used to assess the soundness of both financial institutions and their corporate and household counterparts. A FSI compilation guide will be finalized in mid-2004, and a coordinated compilation exercise involving 60 countries will be initiated shortly, with the aim of compiling at least a core set of FSIs for each country as of end-2005.

10. The Fund has continued to seek ways not only to help members reduce vulnerabilities, but also, within the framework of its mandate, to help them promote growth. These two strands of work are in any case closely related, as a failure to grow may sooner or later jeopardize external and public debt sustainability. The forthcoming BSR will seek to shed light on the institutional underpinnings of growth in low-income countries and elsewhere, and a planned Board seminar on the investment climate will provide further analysis of these issues. In addition, the Board has discussed fiscal policy and accounting issues related to public investment, with a view to finding ways to narrow infrastructure gaps and protect investment when fiscal adjustment is required.⁶ Directors emphasized the importance of ensuring that borrowing is consistent with macroeconomic stability and debt sustainability, and the need for rigorous cost-benefit analysis of projects. They stressed that infrastructure investment should be accommodated to the extent possible within these constraints. The primary focus of analysis should remain the overall fiscal balance and gross public debt, but appropriate attention should be paid to current and cyclically-adjusted balances. In addition, the operations of commercially-run public enterprises should be excluded from fiscal indicators and targets. Preliminary criteria put forward by the staff for identifying such public enterprises were broadly endorsed, and will be studied further. Public-private partnerships (PPPs) were viewed as having the potential to attract private capital to infrastructure investment and to secure efficiency gains in asset building and service provision. At the same time, their appropriate role must be carefully assessed, and their fiscal risks transparently reflected in the government's accounts. Some pilot country studies will be undertaken, in conjunction with the World Bank and regional multilateral development banks, to refine these proposals and to develop an implementation strategy.

11. The Fund also continues to search for ways to make its work more incisive in its traditional core areas of exchange rate, monetary, and fiscal policy. Two areas have recently been the subject of special attention in this regard. In November, the Executive Board held a discussion on exchange rate arrangements, suggesting that the "bipolar" view of exchange rates—under which rates should be either fixed or freely floating—needed to be nuanced by recognizing that the benefits of exchange rate flexibility increase with economic and institutional development, and emphasizing again the importance of the consistency of macroeconomic and structural policies with the chosen exchange rate regime.⁷ In addition, the implications for surveillance of the Independent Evaluation Office (IEO) report on fiscal adjustment in Fund-supported programs were taken up in an action plan recently discussed by the Board, which sought in particular to ensure that, in countries where structural and institutional fiscal reform is a priority, surveillance pay appropriate attention to this area.⁸

C. Data Provision for Surveillance

12. Because a sine qua non of all surveillance is comprehensive and timely statistical data, the framework for members' provision of data to the Fund for surveillance has been reviewed and refined.⁹ Steady progress continues to be made in both data provision to, and data dissemination by, the Fund. The Board considered that the current framework for data provision should be essentially preserved and its implementation strengthened. Improvements in data capacity will benefit both low-income and small member countries—where significant data weaknesses continue to hamper effective policy formulation and surveillance—and emerging and advanced economies facing changing data needs arising from the need to monitor developing threats to stability. The Board also urged that increased attention be paid to data quality in staff reports and to consistency among data sets published by the Fund.

13. While the Fund continues to rely mainly on members' cooperation in providing data, it has also clarified the legal basis for such provision. The recent Board decision on Article VIII, Section 5 augments the categories of data that members are required to provide, in line with the Fund's evolving surveillance needs, and further strengthens the procedures associated with remedial actions when data are not provided.¹⁰ The decision also limits the circumstances under which Article VIII, Section 5 may be applied in the context of performance criteria, to avoid a proliferation of minor cases whose pursuit would not be in the interest of the Fund.

D. Strengthening the Impact of Surveillance

14. Surveillance is merely a means to an end—better policies—and the Fund is working to increase its impact. This is no easy task, nor is it clear how success should be measured. The forthcoming BSR will review the modalities of surveillance from this perspective. The Fund's work in this area has pursued several objectives:

• Since policy decisions are of course in the hands of members, the Fund must strive to be as persuasive as possible. A recurring theme of the IEO's work has also been that the Fund needs to speak clearly and to understand fully the constraints on member countries' ability to take certain actions. Recent efforts have focused on: increasing the use of cross-country experiences; systematic discussions with members regarding the effectiveness of past surveillance; enhanced dialogue with parliamentarians, trade unions, and civil society; an increased emphasis, both in staff reports and in multilateral surveillance discussions, on political realities which can impede policy implementation (for example, in the chapter in the current WEO on political impediments to structural reforms in industrial countries); and efforts to sharpen, in an evenhanded manner, the candor of judgments.
  
  
• The Fund also continues to seek to provide a fresh perspective in surveillance in program countries, to ensure that it steps back and takes stock of experience and of the medium-term challenges faced by countries with which it is intensively engaged. In particular, guidance on the timing of Article IV consultations seeks to ensure that surveillance feeds directly into more thoughtful program design.
  
  
• In addition, the Fund continues to move toward greater transparency. There has truly been a revolution in this area over the last decade. Although tensions with candor remain, these developments have not only made the Fund more accountable and facilitated better risk assessments by borrowers and creditors, but have also contributed to broader domestic policy debates. Publication of all use of Fund resources and post-program monitoring staff reports is now presumed (though still voluntary). From July 2004, this policy will also apply to Article IV staff reports and related documents. Publication rates for Fund documents continue to rise: more than two thirds of country reports are now published, along with most country policy intention documents and Fund policy papers. The Fund has also recently started to release the weekly calendar of Executive Board meetings.

E. Institution Building

15. International standards and codes, and their assessments, play an important part in providing a sound information base for financial flows and for preventing buildups of vulnerabilities. The coverage of data, fiscal, monetary, financial sector, and corporate sector ROSCs continues to rise. Recent review and development work in this area has focused on:

• Monetary institutions. The recent review of the monetary and financial transparency code found a generally high level of observance by member countries.¹¹ Examples of good transparency practices identified during the review are being used to strengthen the Supporting Document to the Code of Good Practices on Transparency in Monetary and Financial Policies.
  
  
• Corporate insolvency and creditor rights. The Fund is collaborating closely with World Bank and United Nations Commission on International Trade Law (UNCITRAL) staff with a view to merging the Bank's Principles and Guidelines for Effective Insolvency and Creditor Rights Systems and UNCITRAL's Legislative Guide on Insolvency Law into a single standard that can be used for ROSC assessments.

16. The Fund actively supports institution building in the financial sector:

• FSAPs. These include recommended action plans with a significant focus on institution building, including through improving countries' observance of international financial sector standards and codes of best practice. The Fund is working with the World Bank to deepen the coverage of development issues in FSAPs, and has stepped up its research and policy advice in areas such as the development of securities and derivatives markets. Work is also being done to strengthen the links between the FSAP and other Fund and World Bank financial sector work, especially follow-up technical assistance (TA). The new Basel capital agreement will also be a focus of both FSAPs and TA, although either the old or the new standard may be emphasized, depending on country circumstances.
  
  
• Combating abuse of the financial sector. The Executive Board has endorsed Offshore Financial Center (OFC) assessments and Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) assessments as core areas of Fund work in the financial sector. In November the Board endorsed regular monitoring of OFCs; 41 of the 44 countries and territories contacted in the context of the OFC program have undergone an initial assessment.¹² These will be updated in 4-5 years' time, with interim risk-focused assessments triggered by specific concerns carried out as needed. In March, in reviewing the 12-month pilot AML/CFT program, the Board endorsed (i) the Financial Action Task Force (FATF) 40 plus 8 recommendations as the new, expanded standard for AML/CFT assessments, and (ii) the Fund and the World Bank becoming fully accountable for AML/CFT assessments.¹³ All FSAPs will include an AML/CFT assessment, prepared either by the Fund/Bank or the FATF/FATF-Style Regional Bodies.
  

17. Technical assistance (TA) has a central role to play in efforts to help build institutional capacity in support of macroeconomic stability and sustainable growth:

• In its recent review of TA, the Board pointed to progress in pursuing a strategic focus and enhancing effectiveness, as well as to remaining challenges in these areas.¹⁴ With this in mind, and with the help of the forthcoming IEO review of TA, the Fund will continue to emphasize prioritization; results-based evaluation of TA; increased ownership and better coordination with other TA providers; and flexibility so that the TA program remains appropriately tuned to the evolving needs of the membership.
  
  
• The importance of regional approaches for delivering Fund TA and training, in particular through regional TA centers, has continued to grow. There are currently two regional centers in Africa, one in the Pacific, and one in the Caribbean. Early assessments of experience suggest that the regional approach has enhanced efficiency and quality, and facilitated close alignment with local priorities. A full review of one of the centers has been carried out, and evaluations of the other three are due to be completed by the end of the year. Preparations are advancing for a fifth regional center in the Middle East.

F. Crisis Resolution

18. Crisis prevention efforts notwithstanding, countries will sometimes incur debt-servicing difficulties, and the Fund continues to work toward improving crisis resolution mechanisms.¹⁵ Market-driven and voluntary means are clearly the preferred strategy for engaging private creditors and resolving debt problems. In the event a sovereign default cannot be avoided, the Fund's involvement in supporting the member's adjustment program will continue to be guided by its policy on lending into arrears.

19. The Fund is taking an active role in promoting the inclusion of collective action clauses (CACs) in international bond issues in all markets, through increased dialogue with emerging market issuers and private market participants. Progress in this area is reflected in the inclusion of such clauses by an increasing number of emerging market countries (now 18 in all) in their international sovereign bonds issued under New York law, where they have hitherto not been the market standard. There is no evidence that issue prices included a premium for CACs. In addition, five industrial countries have included CACs in their sovereign bonds issued in foreign jurisdictions.

20. Progress toward a voluntary Code of Conduct—which would outline standards of behavior and responsibilities for debtors and their private creditors—has been limited, but work continues. Efforts to formulate a Code, initially led by the Banque de France and the Institute for International Finance, have now been taken up by the G-20, in which the Fund participates. A technical working group including Brazil, Korea, and Mexico has been established to work further with other G-20 members and private sector representatives to prepare a draft Code for broader consideration.

21. Work also continues on a number of other crisis resolution issues. The Board has held a seminar on developments in litigation against sovereigns and the possible implications for countries' efforts to reach agreement with their creditors on sovereign debt restructuring. While it is premature to draw firm conclusions, staff will continue to monitor developments in this area. In addition, the Board will shortly have an opportunity to discuss linkages between banking sector vulnerabilities and sovereign debt distress.

G. Trade

22. The Fund will continue to press for the successful conclusion of the Doha Development Round, and, together with the World Bank, has urged participants from both developed and developing nations to make this a priority. Late last year, the Managing Director and the President of the World Bank sent a letter to heads of state and government, as well as trade and finance ministers, stressing the importance of pressing forward with the Doha Round. The letter emphasized the need for meaningful liberalization of agricultural trade, a willingness of all countries to take on substantive obligations to liberalize trade, and flexibility in areas that may result in heavy regulatory burdens on poor countries.

23. The Fund itself is doing its part to support an open international trading system:

• In its surveillance and policy advice more generally, the Fund points to the benefits of trade liberalization, both to individual countries and to the world economy as a whole.
  
  
• The Board has also recently approved a new financing policy, the Trade Integration Mechanism (TIM), aimed at mitigating concerns that countries might find it hard to cope with temporary balance of payments shortfalls resulting from the implementation of World Trade Organization (WTO) agreements or non-discriminatory trade liberalization by other countries.¹⁶ Under the new policy, the Fund has spelled out that it is prepared to provide access to its resources, within its existing facilities, to help meet a balance of payments need associated with the net effect of specified trade measures taken by other countries, and to augment such access if the effect was larger than anticipated.

III. Fund Support for Low Income Countries

24. The Monterrey Consensus and the establishment of the Millennium Development Goals (MDGs) represent a unique opportunity for low income countries to accelerate their progress. The Fund has a crucial role to play in this endeavor—supporting and encouraging sound policies through providing advice and assessments in its areas of expertise, making available suitably tailored financial support, assisting with the development of vehicles for the coordination of donor efforts, and advising both recipient countries and donors on financing options consistent with longer-term debt sustainability.

A. Overview

25. The international community must reaffirm its commitment to the steadfast implementation of the comprehensive strategy expressed in the Monterrey Consensus. There are signs that this two-pillar approach, involving a commitment to sound economic policies and good governance by low-income countries, together with better and stronger support from the international community, is beginning to bear fruit. There has been broad progress toward macroeconomic stability and growth in low-income countries, and aid volumes have begun to reverse their decline of the last decade. The task, however, is great, and the MDGs will be difficult to achieve even with a major effort. Much more will have to be done by all parties if low-income countries are to make decisive progress and to achieve the high and sustained growth needed to reduce poverty; and a strong policy effort in aid-receiving countries will have to be met by an equally significant increase in aid, on appropriate terms, from donors.

26. The Fund is a partner in this effort. Through its surveillance, technical assistance and, where necessary, financial support, the Fund will continue to assist its low-income members in establishing and maintaining macroeconomic and financial frameworks that can support sustained growth and poverty reduction without either overtaxing absorption capacity or leading to unsustainable indebtedness; identifying and managing macroeconomic risks and vulnerabilities; and strengthening institutions and policies that underpin sound macroeconomic management.

B. Strengthening the PRSP Approach

27. Together with other multilateral and bilateral partners, the Fund is working to ensure that the Poverty Reduction Strategy Paper (PRSP) process provides an operational tool for implementing and coordinating efforts to foster growth, poverty reduction, and progress toward the MDGs. Emerging challenges in implementation include the need for better prioritization of policies and objectives, improved donor alignment and harmonization, and strengthened public expenditure management and budgetary processes. In support of these objectives the Fund is taking a number of measures:

• The Fund is working to ensure that PRGF arrangements are coordinated with country budgets and PRSP cycles, to ensure macroeconomic policy-making moves in concert with national and donor decisions on poverty-reduction initiatives.
  
  
• Progress has been made with Bank-Fund collaboration on country programs and conditionality (see paragraph 39). However, there remains scope for improvement, and Fund staff will work to monitor performance closely and deal with emerging issues of mutual concern through a reinvigorated Joint Implementation Committee.
  
  
• The Fund is intensifying its efforts to incorporate available Poverty and Social Impact Analysis (PSIA) into the design of PRGF-supported programs. A small group (four staff) will be set up shortly within a division of the Fiscal Affairs Department to assist area departments in this connection.
  
  
• Fund staff is pressing for fuller inclusion of trade policy considerations in PRSPs, including through the Integrated Framework for Trade-Related Technical Assistance, a cooperative interagency effort supported by bilateral donors, as well as regional conferences with development and trade officials.

The next Bank-Fund PRSP progress report will be completed prior to the 2004 Annual Meetings. This will be informed by the forthcoming IEO report on the PRSP/PRGF, and will propose ways to sharpen the focus of PRSPs so as to provide a better link to the MDGs and a better operational basis for policy choice and donor coordination.

C. The Role of the Fund in the Medium Term

28. In the medium term, the Fund will continue to focus on helping low-income members face the macroeconomic challenges inherent in the development process. To strengthen the Fund's macroeconomic policy input, a review of PRGF-supported program design will soon get underway, drawing in part on the work of the IEO. This will focus on how macroeconomic frameworks can support sustained growth and poverty reduction, and on creating an environment conducive to stronger private sector growth. In particular, the Fund needs to help countries strengthen debt management, deal with the absorption of large aid inflows, cope with exogenous shocks, build strong institutions, and create an enabling environment—including regulatory, legal, and tax—for private investment. We intend to devote additional human and other resources to work on low-income countries, particularly for Africa, as a high near-term priority.

29. Technical assistance remains a key element in the Fund's strategy to help low-income countries build domestic capacity and strengthen institutions. The resource-intensive nature of this work presents special challenges. In line with the recent review of TA (see paragraph 17), the Fund will aim to enhance the effectiveness of its TA to low-income countries by relying on complementary support and on coordinating its TA interventions with the large-scale projects funded by many bilateral and multilateral donor agencies.

30. In addition to its policy advice, surveillance, and TA work, the Fund will continue, where necessary, to support low-income countries financially, carefully calibrating its financing to the country's circumstances. To this end, and mindful also of the large number of PRGF-eligible countries that are long-term users of Fund resources,¹⁷ the Executive Board has conducted a review of instruments and financing for low-income countries, and has endorsed the following proposals:¹⁸

• To support the efficient use of PRGF financing for members with continuing needs for Fund financing, establishing PRGF access norms for the third and subsequent arrangements, and strengthening Fund policy and guidelines on the blended use of PRGF/GRA resources. For countries with limited need for Fund financing, establishing a standard low access level for PRGF arrangements;
  
  
• Further work on a strengthened process of surveillance for those countries that do not need Fund financing.
  
  
• Extending Post-Program Monitoring to members with outstanding PRGF loans of 100 percent of quota or more;
  
  
• Modifying the policy on emergency assistance for members emerging from conflict to allow a longer time for transition to regular Fund lending, through programs of longer duration and more tapered access.

31. Low-income countries are particularly vulnerable to exogenous shocks—such as natural disasters and commodity price changes—that can have a significant negative impact on growth, macroeconomic stability, debt sustainability, and poverty. The Fund advises on policies that would help countries prepare for such events, and provides financial support where appropriate. The Board has endorsed the following proposals:

• Establishing explicit principles for augmenting PRGF arrangements;
  
  
• Introducing a subsidy for emergency assistance for natural disasters;
  
  
• Further work on a vehicle that would enable lending on PRGF terms in arrangements with the program design and duration of a stand-by arrangement. This could provide suitably rapid and concessional assistance to respond to shocks in circumstances where a comprehensive three-year PRGF arrangement may not be appropriate.

32. The Board also had an initial discussion of the potential magnitude of the financial resources required to support the Fund's continued involvement in low-income countries, and of various options for financing. Most Directors agreed that a financing capacity on the order of SDR 0.8-1.2 billion annually would provide a reasonable basis for PRGF lending operations during 2006-2010. Nearly all Directors agreed that the three financing options that would rely solely on the resources in the Reserve Account of the PRGF Trust—self-sustained PRGF, sun-setting PRGF, and grants—would be insufficient to meet the projected financing needs. Most instead supported the option that would allow a self-sustained PRGF to begin operations in 2006, while supplementing its lending capacity with new bilateral loans. This option would meet the projected financing requirements in 2006-10 and allow for the continuation of self-sustained PRGF operations beyond 2010 at a significant level. The staff will prepare a follow-up paper with more detailed information on the projected financing requirements and propose a decision for the consideration of the Executive Board later in 2004.

D. The Enhanced HIPC Initiative and Debt Sustainability

33. Progress continues to be made in implementing the enhanced HIPC Initiative and reducing the debt burdens of poor countries, although challenges remain. The Fund is supporting this process by helping countries move toward HIPC Initiative milestones.

• As of April 15, three additional countries have reached the completion point (Guyana, Nicaragua, Niger) since the 2003 Annual Meetings, taking the total to eleven out of the 27 countries that have reached the decision point. The Boards of the Fund and the World Bank will also soon review the completion point documents for Ethiopia, which may be eligible for additional debt relief, and for Senegal. The 27 countries that have reached the decision point account for 85 percent, in net present value terms, of the total expected relief for the 34 HIPCs for which data are available.
  
  
• The Executive Boards of the Fund and World Bank will consider later in the year options for addressing the sunset clause of the HIPC Initiative, currently scheduled for end-2004. There are 11 countries (9 in Africa) that may require HIPC relief but have not yet reached the decision point, most of which are suffering from the effects of conflicts, have protracted arrears to the Fund and World Bank, or both.
  
  
• The three protracted arrears cases—Liberia, Somalia, and Sudan—have been in arrears to the Fund, the World Bank, and other creditors for two decades. To date, no provision has been made for the HIPC grant resources that would be needed for these countries, once they clear their arrears. Given the magnitude of their debt problems, achieving debt sustainability will require substantial additional resources from the international community. The mobilization of these resources could soon become a matter of urgency.

34. We are also working to help low-income countries ensure their external debt remains sustainable even as they pursue their development objectives, especially the MDGs. The Fund staff, in collaboration with World Bank staff, has developed a debt sustainability framework for low-income countries, which combines two main elements: a template for analyzing the debt dynamics under baseline assumptions and in the face of plausible shocks; and the development of indicative thresholds for debt-burden indicators that depend on the quality of the country's policies and institutions.¹⁹ Following an initial discussion of this framework by the two Boards, staff are undertaking further work on the framework, especially on the indicative thresholds and on the operational implications for the Fund and for other international financial institutions and donors, for Board consideration before the Annual Meetings. In the interim, Fund staff are beginning to apply the debt dynamics template in the Article IV context, in close consultation with World Bank staff. In many countries debt sustainability analysis is likely to show that additional borrowing, even on concessional terms, needed to meet the MDGs would be incompatible with debt sustainability, and hence point to the availability of donor grants as a key issue. Both low-income countries and donors will need to face up to their respective responsibilities in these instances.

E. Encouraging International Support

35. Sound domestic policies in low-income countries need to be matched by more support from the international community if the MDGs are to be met. More financial support is crucial, and this must be on the right terms if future debt distress is to be avoided. In addition, support includes strengthening international trade by improving market access for developing countries' exports and reducing trade-distorting subsidies in advanced economies. Reductions in barriers to trade between developing countries can also make a large contribution.

36. The Fund is working in a number of areas related to enhancing financial support for low income countries, and is intensifying its collaboration with the UN system, aimed at developing a comprehensive response to the international MDG effort:

• To enhance aid predictability and effectiveness, the Fund is engaged with the Organization for Economic Cooperation and Development (OECD)'s Development Assistance Committee (DAC) and the multilateral development banks on donor harmonization and alignment. It is also helping donors and national authorities in the field develop more coordinated and streamlined frameworks for disbursing aid. Efforts, joint with the World Bank, to strengthen the capacity of Public Expenditure Management systems to track poverty-reducing public spending could contribute to such streamlining by simplifying reporting to donors.
  
  
• The first Global Monitoring Report (GMR), prepared by the World Bank with input from Fund staff, addresses policies and actions in developed and developing countries needed to achieve the MDGs, and the related contribution of major agencies.²⁰ The GMR makes clear that, although progress has been made, achievement of the development goals will require all parties to scale up their actions in line with the principles and partnership established at Monterrey.
  
  
• The Fund staff is cooperating with the World Bank in the preparation of a report on Mobilizing Financing for Development, scheduled to be completed by the time of the Annual Meetings. This report will consider international financing facilities and other modalities to increase current official development aid.²¹

IV. Use of Fund Resources

37. The provision of financial support from its general resources remains a key responsibility of the Fund. In a context of large and volatile capital flows, the Fund continues to seek better ways of backstopping members' efforts to reduce their vulnerability and to recover from shocks. Well thought-out programs being critical both for members' prosperity and for the Fund's repayment prospects, program design and conditionality remain subject to almost continuous review, with a particularly wide-ranging stocktaking prominently on the agenda.

A. Program Design and Conditionality

38. The remainder of this year will feature a broad agenda of work in connection with the 2004 conditionality review, which will also look at a number of issues that have been highlighted in the IEO's work. In particular, the Fund will review:²²

• The macroeconomic objectives and achievements of programs, and an assessment of the use of financial programming and ways to incorporate other modeling and balance sheet approaches;
  
  
• The experience with key elements of policy, including fiscal, monetary, and structural policies;
  
  
• The implementation of the new conditionality guidelines, agreed in September 2002, and whether the effort to streamline, focus, and clarify conditionality has resulted in more successful programs with a higher degree of national ownership;
  
  
• Trade policy advice in Fund-supported programs.

39. Work already completed in this area includes the recent Board review of Bank-Fund collaboration, which found both progress and room for improvement.²³ The Board concluded that:

• The framework for collaboration, including on program design and conditionality, is working well, although there is scope for improvement and for continued learning from each other and for generalizing best practices across countries;
  
  
• There is need for a more consistent implementation of the agreed divisions of labor and for better collaboration on the coverage and consistency of conditionality.

In response to the issues raised, the Joint Implementation Committee (JIC) will be strengthened to facilitate Bank-Fund cooperation at the senior staff level, complementing existing coordination mechanisms between the two institutions' managements and staffs. The role of this committee will be expanded as necessary to cover middle- as well as low-income countries. The Fund and Bank will also explore ways to facilitate closer collaboration in analyzing thematic issues that feed into program design.

40. The Executive Board has also examined the lessons from Argentina's 2001-02 crisis.²⁴ The Board noted that the crisis reflected the interaction of several sources of vulnerability that were already present during the boom years of the 1990s: the public debt dynamics, the constraints on monetary policy imposed by the currency board, and a variety of structural and institutional factors. These vulnerabilities were not adequately taken into account in the design of Fund-supported programs during the 1990s; in particular, the fiscal policies pursued were, in hindsight, unsustainable, reflecting in part overoptimistic medium-term growth projections. The crisis also underscores the importance of ensuring that the exchange rate regime is supported by fully consistent macroeconomic and structural policies. Directors noted that Argentina's experience highlights once again the importance of breadth in the domestic ownership of key policies, as well as the need for strong and candid surveillance in countries with Fund-supported programs. The forthcoming IEO report on the Fund's role in Argentina should allow us to further refine and broaden the lessons learnt.

41. Action is underway to assimilate the lessons for program design from last year's IEO evaluation of fiscal adjustment in Fund-supported programs.²⁵ This work is directed at clarifying programs' analysis of the fiscal stance, including its links to growth; strengthening programs' focus on key structural and institutional fiscal reforms; and protecting critical social spending in program design.

42. In addition, the operational framework for ex post assessments for members with longer-term program engagements has now been established, and the first few assessments have been undertaken. About 27 ex post assessments are expected to be completed this year. These assessments were introduced as part of the response to concerns raised in the IEO's evaluation report on prolonged use of Fund resources. In addition to providing a fresh perspective on successes and failures under successive Fund-supported programs, they examine the rationale for continued Fund program engagement, suggest priorities, and, where appropriate, present an exit strategy.

B. The Fund's Financing Facilities

43. Following major changes to lending policies in recent years, the Fund has kept its facilities under review to ensure that they remain responsive to the changing global environment and the growing financial interdependence of members. The great majority of members that draw on Fund financing make use either of stand-by or extended arrangements within the normal access limits, or of the PRGF (see above) (Box 1). But the Fund also has other means through which it seeks to provide more appropriate support for members facing particular circumstances, and the Board has recently reviewed three of these—the Contingent Credit Lines, aimed at crisis prevention; the provisions for access in excess of the normal limits; and the Compensatory Financing Facility, intended to provide financing for certain types of temporary current account shocks.

44. Work continues on possible instruments through which the Fund could provide a precautionary line of defense against adverse capital market developments to members pursuing strong policies. This was the objective of the Contingent Credit Lines (CCL), which expired on November 30, 2003 without having been used.²⁶ The Fund will explore further the scope for adapting precautionary arrangements to crisis prevention, paying special attention to a number of concerns that have already been raised in this connection—including the potential impact of high-access precautionary arrangements on debtor and creditor behavior and on Fund liquidity, the appropriate circumstances for use of such arrangements, and ways of measuring potential balance of payments need.

45. The Board has reviewed the experience with the year-old framework for exceptional access to Fund resources, and agreed to keep this framework unchanged at this time. Directors noted that the criteria governing exceptional access in capital account crisis cases had helped to improve the clarity and predictability of the Fund's response to such crises, but also recognized that in rare circumstances—including for instance where members have large preexisting Fund credit outstanding—a need for exceptional access could arise in situations other than a capital account crisis. Similarly, while the strong presumption remains that exceptional access should be provided in the form of Supplemental Reserve Facility (SRF) resources, it was recognized that the SRF's maturity may sometimes be too short relative to the duration of the balance of payments need. The Board judged that the strengthened decision-making procedures for exceptional access cases—with early Board involvement and provision of additional information and documentation—have worked well. The Fund will conduct a general review of access to its resources by the end of 2004.

Box 1. Use of the Fund's Facilities The pattern of use of the Fund's financial facilities reflects the changing needs of its membership. Large balance of payments needs of a few members have meant the continued use of arrangements with exceptional access since the crises of the mid- to late-1990s (chart). There were four such arrangements in place as of March 12, 2004, out of a total of 16 under the GRA, and compared with 38 under the PRGF Developments in Fund Credit in the GRA 1980-Jan 2004 (Top 5 debtors in percent of total credit) Concentration of GRA credit among a small number of members has been a consistent characteristic of the Fund's exposure through time. However, the financial crises of the mid-1990s saw a sharp increase in concentration, and there has been another spike since 2000 (see chart). As of January 2004, credit to the three largest borrowers exceeded an unprecedented 70 percent of total credit. In comparison, 16 debtors accounted for 70 percent of credit outstanding in 1980. This increased concentration principally reflects exceptional access by Argentina, Brazil, and Turkey during 2001-2003.

46. The Executive Board has agreed that the Compensatory Financing Facility (CFF) should be retained for the moment, despite its lack of use in recent years.²⁷ However, the new proposals for instruments to help address shocks in low-income countries are likely to fulfill some of the functions of this facility, and many Directors suggested that the CFF be eliminated following its next review in three years, absent evidence of a clear demand for the facility.

C. Financing the Fund and Mitigating Financial Risk

47. To fulfill its mandate, the Fund needs to preserve an adequate financial base. Alongside its surveillance work, technical assistance, and special forms of financial support for low-income members, it must be able to meet the legitimate financial needs of members who turn to the General Resources Account. In this regard, respect by all members of the Fund's preferred creditor status is fundamental to the Fund's role in the international financial system. Mitigating financial risk at the Fund rests heavily on rigorous implementation of the policies governing the use of Fund resources, including the framework for exceptional access, ensuring that the Fund supports only policy packages that will create the basis for repayment. In this connection, it is also important that the terms of use of Fund resources include incentives for members to repay the Fund as their balance of payments improves. Other elements needed to ensure that the Fund remains in a position to help its members financially include an adequate level and pace of accumulation of precautionary balances, along with careful management of the Fund's liquidity.

48. Given the unique and cooperative nature of the Fund, judgment must necessarily underpin decisions on the level of precautionary balances. The Executive Board recently reconfirmed as broadly appropriate the decision taken in 2002 for a target level of precautionary balances of some SDR 10 billion.²⁸ However, the adequacy of the level of precautionary balances and the pace of their accumulation will be kept under close review. Credit risk to the Fund stems mainly from large arrangements with middle-income countries, and sound risk management requires the Fund to be prepared for the possibility of payments disruptions, which could arise from the increase and concentration of its outstanding credit. In order to help guide decision making, Fund staff will explore further the possible use of credit risk models and will seek to provide more in-depth scenario analysis of the financial impact on the Fund—and explicit recognition of the costs for borrowers and creditors—of overdue obligations to the Fund.

49. The Fund's liquidity is adequate to meet the near-term projected needs of its members, with the forward commitment capacity (FCC), the main measure of the Fund's liquidity, standing at SDR 56 billion at end-February 2004. Recent large arrangements continue to have a significant impact on the Fund's liquidity. Continued monitoring of the Fund's liquidity position will be important given the risks to a sustained recovery and the need for the Fund to have adequate resources to fulfill its responsibilities.

V. Voice, Representation, and Quotas

50. The Fund's effectiveness as a cooperative institution depends on all members having appropriate voice and representation, and working together in a spirit of respect, trust, and consensus-building. Efforts have been made, within the current framework of voting power, to enhance the capacity of Executive Directors from developing and transition countries to participate effectively in decision making in the Fund, including by addressing staffing and other constraints faced by Directors with large multi-country constituencies.

51. Representation of members in the Fund depends critically on the distribution of quotas, which was last discussed by the Executive Board in July last year.²⁹ The Board noted that significant adjustments in quota shares have tended to take place in the context of general quota increases. Most Directors saw merit in a package of measures that would include a general quota increase with a relatively large selective element allocated by means of a new quota formula; ad hoc increases aimed at addressing the clearest cases of out-of-lineness; and an increase in basic votes specifically aimed at correcting the erosion of voting power of the smallest members. Given the Fund's satisfactory liquidity position, however, the Board has not seen a need to press forward with a quota increase at present. The Fund staff is continuing work on quota-related topics, including updating the data used in quota formulas.

52. Further progress on the issue of voice and representation will require broader consensus among the Fund's shareholders than currently exists, and continued strong efforts are needed to build agreement in this area. As part of the effort to seek a consensus among shareholders, the Chairman of the Development Committee (DC) has circulated a proposal for a roadmap on procedures and next steps in this area to the Committee members. The Boards of the Fund and World Bank are scheduled to produce a report on all aspects of the voice issue for consideration by the DC at the 2004 Annual Meetings.

VI. The Fund as a Learning Institution

53. The ever-changing world economy puts a high premium on the capacity to learn, and hence on the testing of judgments against both new evidence and alternative points of view. The Fund has always engaged in substantial dialogue with its members and in research and review-based learning, with periodic reviews of surveillance and conditionality, reviews of specific policies, and assessments of country experiences in surveillance, program design, and now ex post assessments. It has also recently engaged in much greater outreach and dialogue on both country and Fund policies, and in a more open exchange of views with other institutions, country authorities, academia, NGOs, and other members of civil society.

54. The establishment of the Independent Evaluation Office (IEO) has added an additional dimension to the learning process by providing regular independent assessments of the Fund's work. To date, the IEO has produced three reports, on prolonged use of Fund resources, the role of the Fund in three capital account crises, and fiscal adjustment in IMF-supported programs.³⁰ These reports have, in some cases, raised new issues and, in others, added impetus to work already underway. Box 2 provides a summary of common themes in IEO reports to date.

55. As demonstrated in the preceding chapters, the IEO evaluations have certainly had an impact on the Fund's approach, and staff have also undertaken extensive work to operationalize specific IEO recommendations that have been endorsed by the Board. Follow-up and implementation has taken various forms:

• Changes in procedures. IEO recommendations have led in some cases to the establishment of new procedures, for example, in the case of ex post assessments. Such changes have tended to be made only in cases where the IEO has identified a need for major redirection of the staff's efforts, because they often have large resource implications and because a proliferation of universal formal requirements would risk making staff's work less focused and flexible.
  
  
• Incorporation of lessons into regular reviews. For instance, the IEO's analysis of the need for better signaling arrangements formed a basis of the staff's work last year on ways of signaling assessments of members' policies,³¹ and some of the results of the IEO report on fiscal adjustment will figure prominently in this year's conditionality review.
  
  
• Dissemination of lessons among staff. The permeation of lessons learned into established work procedures is key to the successful implementation of recommendations. Some of the shortcomings identified by the IEO could be remedied by generalizing what is already best practice within the Fund. However, time constraints and information overload often inhibit staff from remaining current on all Fund-wide initiatives, reviews, and evaluations: the IEO itself pointed out, in its first evaluation, that the Fund seemed to have been quite good at identifying lessons, but less effective at ensuring that they were fully absorbed into its everyday operations.³² Follow-up thus often involves important dissemination efforts—through seminars, guidance notes to staff, website postings, and the regular dialogue between area departments and review departments; and management and the Board reinforce these efforts through feedback on the staff's work. Over time, a priority will be to enhance internal dissemination mechanisms.

VII. Conclusion

56. The Fund continues to adapt to a changing world economy, while keeping its core functions under review. Implementation of the various new initiatives of the last few years remains a priority, and the broad reviews of both surveillance and conditionality currently on the agenda should help in identifying additional efforts needed in this respect.

57. Although our priorities must evolve with changing realities and with experience, it is clear that certain issues will require our sustained attention. Several stand out: efforts, primarily in surveillance, to help members confront structural and fiscal challenges, including high debt; the design of facilities to backstop members' efforts to reduce vulnerability to unstable capital flows while safeguarding Fund resources; and the nexus of Millennium Development Goals, debt sustainability, and donor harmonization in low-income countries. Continued efforts will be required in these areas at least over the next 1-2 years.

58. While the Fund will continue to work to improve its policy advice and its modalities for relating to its members, the onus of action to align policies better with the common goals of financial stability and sustainable growth is with member countries. Progress on the Doha Round is only the most obvious example of an area where joint action is needed. Ultimately, the policies that drive the world economy are those that individual countries, large and small, put in place. With thoughtful and far-sighted action by all concerned, supported by an improved framework for the Fund's work, the world economy could be entering a period of sustained growth, to the benefit of all.

Source: Fund staff estimates.

¹/ This table does not include territories, special administrative regions (SARs), and monetary unions except for ROSCs, which include thirteen completed and published modules for Hong Kong SAR of China and the Euro Area.
²/ The regional groupings are based on the composition of World Economic Outlook (WEO) groups.
³/ The SDDS was established in 1996 to guide countries that have, or might seek, access to international capital markets in the dissemination of economic and financial data to the public. Table includes subscribers in full observance only.
⁴/ The GDDS was established in 1997 to encourage members to improve data quality, provide a framework for evaluating needs for data improvement and setting priorities in this respect, and guide members in the dissemination to the public of comprehensive, timely, accessible, and reliable economic, financial, and socio-demographic statistics.
⁵/ The number of members that published at least one such document.
⁶/ The number of members for which at least one ROSC module has been completed. ROSC modules not derived from an FSAP are considered completed once they have been circulated to Directors, and in the case of Bank-led modules, sent in their final form to the authorities. ROSC modules derived from an FSAP are considered completed only after the FSSA has been discussed by the Executive Board.
⁷/ The number of modules reflects if a member has had more than one full assessment for the same standard. On an exceptional basis, one FSSA-derived preliminary assessment is included.

¹/ An FSAP is defined as completed when the Fund Board has discussed the FSSA and all finalized documents have been transmitted to the authorities
²/ Completion postponed.

Sources: HIPC country documents; and World Bank and IMF staff estimates.

¹/ Committed debt relief under the assumption of full participation of the creditors.
²/ The assistance under the enhanced HIPC Initiative includes "topping up", with the NPV calculated in the year of the completion point.
³/ Cote d'Ivoire reached its decision point under the original-HIPC Initiative in 1998, but did not reach its completion point under the original HIPC, nor has it reached its decision point under the enhanced HIPC. The amounts of debt relief shown are only indicative of debt relief under the original HIPC Initiative, based on a preliminary document issued.

¹ Includes interest on amounts committed under the Enhanced HIPC Initiative.
² Equivalent to the committed amount of US $22.5 million at decision point exchange rates (3/17/98).
³ Excludes commitment of additional enhanced HIPC assistance of SDR 10.93 million subject to receipt of satisfactory financing assurances from other creditors.
⁴ Amount committed is equivalent to the remaining balance of the total IMF HIPC assistance of SDR 337.9 million, after deducting SDR 109.6 million representing the concessional element associated with the disbursement of a PRGF loan following the DRC's clearance of arrears to the IMF on June 12, 2002.
⁵ Excludes commitment of additional enhanced HIPC assistance of SDR 9.664 million subject to receipt of satisfactory financing assurances from other creditors.

Sources: Executive Board documents, and information provided by the Finance Department.

¹/ Reflects amounts and duration at the time arrangements were approved; excludes potential access under external contingency mechanisms and other augmentations.
²/ Access expressed in terms of quotas of: Eighth General Review of Quotas through October, 1992; Ninth General Review of Quotas through January 1999; 11th General Review of Quotas through January 2003, and 12th Review of Quotas thereafter. From November 1992 to October 1994, annual access limits were set at 68 percent of Ninth General Review quotas, and since then the access limit of 100 percent of quota has been in effect.
³/ Including first credit tranche arrangements.
⁴/ Total access for 3-year arrangement.
⁵/ Access under SAF in 1994 (Sierra Leone) and 1995 (Zambia) was accumulated under the Rights Accumulation Program.

¹ Amount agreed includes a fully drawn commitment under the SRF of SDR 7,610 million.
² Amount agreed and undrawn balance exclude SDR 257.4 million not drawn under the SRF. Uruguay's SRF
was canceled on 8/8/02.