I.   Introduction

1.   In March 2000, the Executive Board began a comprehensive review of the Fund’s nonconcessional financing facilities, with a discussion of the paper “Review of Fund Facilities—Preliminary Considerations.”¹

2.   That discussion revealed a rather wide consensus about the nature of the Fund’s financing role. A central theme in the discussion was the implications for the Fund of the growing importance of private capital markets. First, the volatility of these markets poses new challenges for members. The Board affirmed the importance of Fund support for members undergoing large-scale crises of capital market confidence, while stressing again the need to find better ways of stemming moral hazard. At the same time, Directors re-emphasized the importance of crisis prevention, and thought there might be room for the Fund’s financing facilities to better support members’ efforts in this area. Second, in calmer periods, private capital markets now provide financing to a larger number of countries than in the past—though still not by any means to all Fund members. In the Board’s view, some rethinking of the Fund’s financing role was warranted in this connection. While Directors saw a catalytic role for the Fund as appropriate, and underscored the benefits of Fund arrangements, both to the member involved and to the world at large, there was concern that access to Fund resources should not substitute for private financing. And while most Directors believed that certain balance of payments problems may take some time to resolve, and that it was appropriate for the Fund to assist members in these circumstances, there was also concern that members should not make unduly long use of the Fund’s resources.

3.   Directors welcomed the opportunity to revisit the Fund’s facilities, in light of both internal and external (see Box 1) proposals for reform.² As a first step, the Board eliminated a number of facilities that it considered no longer served a useful purpose, and agreed to streamline the Compensatory Financing Facility (CFF).³ As regards the remaining facilities, Directors called for a reexamination of the repurchase periods and rates of charge of stand-by arrangements and of the Extended Fund Facility (EFF), as well as the eligibility criteria and conditionality that apply to the EFF. Directors were also interested in exploring further the potential for using the facilities to encourage members’ efforts at crisis prevention, and, to this end, most favored additional experimentation with the design of the Contingent Credit Lines (CCL). There was also interest in strengthening procedures for post-program monitoring, as an element of the safeguards for Fund resources.

4.   The present paper seeks to follow up on these various issues. The focus this time is on what the previous paper termed “core” facilities—stand-by arrangements, the EFF, the Supplemental Reserve Facility (SRF), and the CCL.⁴ Annex I (taken from the previous paper) provides a description of these four facilities. Like the previous paper, the present paper does not consider the Poverty Reduction and Growth Facility (PRGF), which is financed by a separate trust fund administered by the Fund.

5.   The remainder of this paper is structured as follows. Chapter II outlines some stylized facts about the Fund’s financing operations—focusing on the duration of members’ balance of payments needs and on the use of the EFF—that are relevant to a reconsideration of the Fund’s facilities. Chapter III considers the modalities of stand-by arrangements and the EFF (particularly repurchase periods and rates of charge, but also the requirements of the EFF). This chapter seeks in particular to find ways to discourage members from unduly large or long use of Fund resources (for instance, when they have access to alternative financing from capital markets), while not preventing the use of Fund resources by countries in need. Chapter IV considers in more detail the CCL, and Chapter V, post-program monitoring. Chapter VI suggests issues for discussion.

6.   The present paper is meant to provide a basis for a general discussion and to elicit from the Board clear guidance on the preferred modalities and, to the extent possible, the specific parameters of the modifications to be made to the various facilities. A follow-up paper, planned for discussion in September, would deal with remaining details and with related issues, and propose decisions.

II.   Balance of Payments Needs and Structural Conditionality:
Recent Experience Under Fund Arrangements

7.   The Fund’s facilities are intended to provide financial support on maturities broadly appropriate to the balance of payments need faced by the member, and based on adequate action to resolve that need. Whether they do so or not in practice must be an important ingredient in any reconsideration of the modalities of the facilities. Drawing on data on Fund arrangements in the 1990s, the present chapter will explore empirically two questions: (i) the extent to which the duration of members’ balance of payments (BOP) needs differs from case to case and whether this duration is predictable at the outset of an arrangement; and (ii) whether use of the EFF has been consistent with the requirements of the facility as regards both BOP need and structural policy content. There are limitations to the usefulness of the data employed in this analysis (discussed below and in Annex II), and their use here focuses on identifying a few stylized facts.

A.   Balance of Payments Needs—Differences and Predictability

8.   The analysis of BOP need remains essential to the design of Fund facilities despite the deepening of international financial markets. In most nonprecautionary Fund arrangements, and not least because not all members have access to capital markets, Fund purchases and other associated official financing still play a material role in supporting the balance of payments, in that the adjustments required in the absence of such financing would be excessive. However, with the strengthening and widening access of members to international financial markets, there are increasingly cases where the financing provided under a Fund arrangement may take second place to the signals provided to the market by that arrangement regarding the strength of policies, and the authorities’ commitment to their implementation. It is widely recognized that the increased volume and sensitivity of capital flows increases the immediacy of the costs of poor policies, but it also increases the potential for BOP needs to be resolved more quickly than expected. Thus, the frequency of cases where members could convert their arrangement to a precautionary status, and also perhaps be in a position to repurchase Fund resources earlier, may have increased significantly from the situation some time ago.⁵

9.   In the array of Fund facilities, each facility is aimed at a different type—including different expected durations—of BOP need; and there are only limited mechanisms in place to adapt, or encourage members to adapt, the period of use of Fund resources to the actual duration of needs. Underlying the present design are three important implicit assumptions: (i) the duration of BOP needs differs across members; (ii) this duration is reasonably predictable at the outset of an arrangement; and (iii) the likelihood that the actual duration of need will turn out to be significantly shorter than expected is reasonably low. This section explores evidence relating to each of these assumptions in turn. The analysis is detailed in Annex II, with key definitions and measurement issues noted in Box 2.

10.   Members’ actual balance of payments needs do differ, and there appears to be a tendency for them to be either very short or rather long (Figure 1, upper panel). Forty-five percent of members with nonprecautionary stand-by arrangements (SBAs) or extended arrangements (EAs) have an actual BOP need of a duration of 1 year or less,⁶ while 40 percent have longer-term BOP needs, of four years or more.⁷ There is no evidence of a “typical” need between the extremes of this spectrum.

11.   The duration of balance of payments needs is more often than not identified broadly correctly ex ante. In the majority of stand-by and extended arrangements where needs are projected to be of a medium-term nature (1-3 years), actual needs are relatively short, at 2 years or less (Figure 1, middle panel). Similarly, in arrangements where needs are projected to be 4 years or more, a majority do have longer-term needs, of 3 years or more (Figure 1, lower panel). The limited experience with the SRF (and SRF-type crises) also suggests that this type of BOP need is fairly distinct and recognizable.⁸

12.   Nonetheless, errors are often made in projecting the duration of needs—with many more cases where the actual needs are shorter rather than longer than projected. Partly reflecting considerable volatility of BOP needs (Annex II), some 30 percent of arrangements projected to have a need of 1-3 years display needs of 5 or more years in practice (Figure 1, middle panel); and where longer-term needs are projected, some 40 percent of needs last 1 year or less (Figure 1, lower panel). Roughly 60 percent of needs turn out to be shorter than projected, and only 15 percent longer than projected. The large proportion of very short needs (paragraph 10) plays an important part in this result.⁹

13.   In sum, members’ balance of payments needs cover a wide range; it is difficult, but not impossible, to predict their durations; and the actual duration of needs often turns out to be shorter than projected. The implications of these facts for the design of the Fund’s facilities will be taken up in Chapter III.

B.   Use of the EFF

14.   The EFF is intended to support members facing relatively long-term balance of payments difficulties and implementing policies required to correct structural imbalances (Box 3). For the Fund to use the EFF to good effect, it must be the case that (i) the Fund grants access to the EFF only where it projects a relatively long duration of BOP needs; (ii) when it grants access to the EFF, the duration of BOP needs does generally turn out to be relatively long; and (iii) appropriate policy changes are made to resolve the member’s structural problems. This section explores each of these premises in turn.

15.   For nonprecautionary arrangements, the Fund does appear to be restricting the use of the EFF to members that are projected to experience relatively long-term balance of payments difficulties. Among members with nonprecautionary arrangements, the needs of those granted access to the EFF are projected to decline more slowly than the needs of those granted a stand-by arrangement (Annex II, Figure 1, upper panels). Thus, while about half of SBAs have projected needs of 3 years or less, this is the case in only 2 of the 22 nonprecautionary extended arrangements in the sample (Figure 2, upper panel). At the same time, not all members with projected longer-term needs are granted access to the EFF; in many of these cases, follow-up arrangements were likely foreseen from the outset.¹⁰

16.   The precautionary use of the EFF is an important exception to the finding that the Fund generally restricts use of the EFF to members projected to experience longer-term balance of payments difficulties. There have been eight initially precautionary extended arrangements since the EFF was created in 1974, half of them between 1996 and 1999. Although a “potential long-term need” is conceivable, it is likely to be rare (Box 3), and past precautionary extended arrangements were generally not justified by reference to this type of need. Staff reports for such arrangements have typically placed considerable emphasis on the strength of the structural reform program, and comparatively little emphasis on the nature of the potential BOP need.

17.   The Fund appears to have had only limited success in targeting (nonprecautionary) extended arrangements to members actually experiencing relatively long-term balance of payments needs. The actual needs of members using the EFF are in general longer than those of members with SBAs (Figure 2, lower panel); for instance, fewer extended arrangements (17 percent) than SBAs (36 percent) turn out to have no actual BOP need. However, the duration of actual BOP needs under stand-by and extended arrangements is much more similar than the duration of projected needs (e.g., needs are resolved within three years or less in some 50 percent of EAs, compared with 60 percent of SBAs). The difficulty in projecting BOP need durations under the EFF may partly reflect the unpredictable timing of the effects of the fundamental structural reform programs that qualify for EFF support (see below). At the same time, the finding raises the question whether the Fund could not do better at projecting the durations of BOP difficulties in these cases.

18.   The Fund appears in general to require stronger structural action under extended than stand-by arrangements—although the latter have often also had substantial structural content. Over the period 1996-99, the median number of programmed structural measures that were subject to formal conditionality in extended arrangements (18 per year) was double the median number (9) in stand-by arrangements (Table 1).¹¹ The mean numbers of structural measures in the two types of arrangements were much closer, reflecting some outliers with very strong structural conditionality among SBAs. This pattern is broadly what one would expect to find if the Fund is tailoring program content to the country’s difficulties, since countries using the EFF must have serious structural problems, but countries with short-term BOP problems may also require strong structural measures (e.g., in the financial sector). It is also, however, consistent with the possibility that the Fund is choosing to grant stand-by or extended arrangements at least in part based on the strength of the member’s structural reform program, separately from the issue of the likely duration of the BOP problem.

19.   In sum, the record suggests that the Fund does indeed require strong structural programs for use of the EFF, but that there may be room to better ensure that only members with relatively long projected BOP needs have access to the facility.Chapter III, Section B (iv) will discuss the possible future operation of the EFF in this light.

III.   Terms of Fund Financing

20.   The present chapter considers the modalities of Fund financing. The approach is guided by the Board’s discussion in March, as well as by the stylized facts presented in Chapter II. The focus is on stand-by arrangements and the EFF, as the terms of the SRF are considered by the Board to be broadly appropriate¹² and the CCL will be discussed in more detail in Chapter IV. Nonetheless, the interaction between the various facilities will be touched on where relevant.¹³

21.   By way of preamble, it is useful to set out the main objectives to be pursued in the design of the Fund’s facilities. These can be described as follows.¹⁴ The facilities:

• must support members’ efforts to adjust to balance of payments difficulties without measures detrimental to national or international prosperity;

• must give members confidence that Fund support will be available for this purpose;

• must ensure that the Fund’s resources are adequately safeguarded; and

• should ensure that members do not rely excessively on (continued) use of the Fund’s resources, as a substitute either for adjustment or for other financing, or to maintain higher levels of reserves than necessary.

22.   In addition, the facilities potentially have an important role to play in encouraging members to pursue sound policies, even if they do not face immediate balance of payments difficulties, thus contributing to the prevention of financial crises.

A.   A Single Facility?

23.   This chapter begins by exploring whether a single facility could serve the Fund’s purposes. Although in the previous discussion most Directors considered that the overall structure of facilities was broadly appropriate to the diversity of circumstances facing members—and is indeed broadly the one that would be invented if it did not exist—a few raised the question whether a single facility might not be simpler and preferable.

24.   The apparent simplicity and transparency of a single facility for all Fund members seeking support in the GRA is attractive, but the approach also suffers from serious drawbacks. Because it would eliminate the Fund’s discretion in choosing to grant a member access to one facility or another, a single facility might be thought to serve uniformity of treatment. However, uniformity of treatment refers to similarly situated members; thus, when one considers what terms would be appropriate for such a facility, it becomes clear that there are difficulties with the same treatment of members with different types of BOP problems:

• If the duration of members’ balance of payments needs differs, a single maturity is problematic. The longer the repurchase period of the facility, the greater the risk that the Fund’s resources would remain outstanding for longer than is required by a member. At the same time, the shorter the repurchase period, the greater the risk that a member would continue to need balance of payments support while Fund repurchases would be coming due. In the latter case, the problem could be resolved by successive arrangements, but this approach would fall short of providing reasonable assurance to members that the financing they seek to support sustained adjustment efforts would be available. Moreover, the approach would imply a departure from a central principle of Fund financing, namely that a Fund-supported program should resolve the member’s problem and enable repurchases.

• There may also be drawbacks to a single rate of charge, if members’ balance of payments needs differ. There is a case—exemplified, for instance, by the existing terms of the SRF—for higher rates of charge in some cases, reflecting the differing balance of payments needs of members in different circumstances and the different incentives facing them.

• Of course, these drawbacks of a single facility are based on the premise that members’ different circumstances can be identified exante. Chapter II above suggests that this is often a difficult but not impossible task.¹⁵

• A single facility with uniform charges would also do little to strengthen crisis prevention. While the facility could be provided on a precautionary basis as support against risk to the balance of payments, members with “first class” policies may not wish to have precautionary arrangements as these may be perceived to be associated with lesser quality policies. Nor would it be possible to grant more advantageous terms to members with especially strong policies (as may be necessary, in comparison with the SRF, to make the CCL a more useful preventive instrument).

25.   Alternatively, one could conceive of a single facility under which the Board would have flexibility to tailor the modalities of each individual arrangement to the different circumstances members face. However, such a “flexi-facility” would have to be based on clear rules. In order to safeguard uniformity of treatment and provide guidance for choosing one set of modalities from a large number of alternatives in a given country case, a flexi-facility would need to be rules-based, relating specific modalities to members’ specific circumstances. In its overall design, therefore, a system of such rules may in the end look very much like the present structure of facilities.

B.   The Present Structure of Core Facilities

26.   The present structure of facilities consists of a set of rules that attempts to tailor the modalities of financing to the type of balance of payments need and, to some degree, the quality of preexisting policies:¹⁶ the SRF for short-term capital account-driven crisis; the CCL for countries with “first class” policies and no immediate BOP need, but vulnerable to large and sudden shifts in financial flows arising from contagion; stand-by arrangements for short- to medium-term BOP problems; extended arrangements for medium- to longer-term BOP problems; and precautionary arrangements for countries with no immediate BOP need but, typically, some financial imbalances and risk to the balance of payments.

27.   This structure attempts to find the right balance between different objectives (paragraphs 21-22). It provides for relatively long repurchase periods where appropriate, thus delivering the assurance sought by members requiring such support, and for shorter repurchase periods in other circumstances, thus helping to ensure that members in a position to repay quickly do so; yet, with only three maturities, it does not require very fine judgments on BOP needs (the difficulty of which was emphasized in Chapter II). It allows for a special mechanism adapted for prevention purposes. Finally, it is relatively simple to understand and operate.

28.   There is nevertheless scope for refining the terms and conditions of Fund facilities, particularly in light of the concern raised in the earlier Board discussion that members may be relying unduly on use of Fund resources. This concern is reinforced by the evidence presented in Chapter II, which suggests that it is not uncommon for members’ balance of payments problems to resolve themselves faster than anticipated. The rate of charge and repurchase periods are crucial modalities in this regard, and they will be taken up in the following sections. The policy on early repurchases linked to balance of payments improvements will also be touched on, and the chapter concludes with a discussion of the requirements of the EFF. Policies on access and conditionality can also be important in determining the extent and length of use of Fund resources by members, and reviews of these policies will be integrated into the Board’s broad discussion of facilities at a later stage.

29.   The effect on the Fund's income of modifications to the terms and conditions of Fund facilities is difficult to predict. The modifications to the rate of charge and repurchase periods discussed below would be aimed at deterring unduly long or large use of Fund resources. If these modifications were successful, Fund credit outstanding would be lower. It is quite possible that the combined effect of surcharges on Fund credit and shorter repurchase periods would result in a loss of net income to the Fund. In any case, the net effects cannot be identified with confidence. Thus, it would not be meaningful to focus on the gross income that might be generated from surcharges over the basic rate of charge.¹⁷

(i)   The rate of charge

30.   A key element in the incentive structure is the cost of Fund lending. The rate of charge on GRA resources is substantially lower than the cost of borrowing from other sources available to most members.¹⁸ As noted in the earlier paper, there are sound reasons for maintaining a relatively low basic rate of charge, not least because of the positive externalities associated with the pursuit of sound economic policies under Fund arrangements. At the same time, the relatively low cost of Fund lending may act as an incentive for members to make larger purchases and keep them outstanding for longer than may be needed. This is particularly pertinent in the context of increasingly widespread access by member countries to private capital markets. However, it is also relevant in the case of members without such access, which may base key decisions—including about their level of reserves—on relatively low rates. Experience with the SRF suggests that the rate of charge is indeed effective in influencing members’ decisions to repay.¹⁹

31.   A case could be made for a uniform increase in the rate of charge. A higher rate of charge would make the use of Fund resources relatively less attractive, and should lead members to rely more heavily on alternative sources of financing, including financial markets. A uniform increase would also be simple to understand and administer, and is attractive on these grounds alone. However, a uniform increase would bear equally on all countries in all circumstances and may not be the best way of ensuring that the cost of Fund lending provides the right incentives at the margin.

32.   A better solution may be to introduce graduation into the rate of charge. Three broad approaches are possible, all involving the introduction of a surcharge over the basic rate of charge.

33.   A surcharge increasing with the time resources have been outstanding would aim primarily at discouraging long use of Fund resources (Figure 3). Such a surcharge would provide increasing incentives to repurchase as time goes on. The rationale would be that the likelihood of an improvement in the member’s ability to repurchase increases over time (assuming good policy implementation), including through a recovery of access to and a reduction in costs of alternative sources of financing. A time-based surcharge could provide incentives in support of the temporary use of Fund resources. There would be two basic design options (see Annex III):

(a)   The first option would be a surcharge linked to purchases under each specific arrangement (and rising with time elapsed either since the purchase, or since the first purchase under the arrangement).²⁰ This option would be relatively simple to understand and administer, and would provide clear incentives for advance repurchases. Given the positive externalities of Fund lending, a case could be made that members should have access to resources at the relatively low basic rate of charge for an initial period with the surcharge starting only at, for example, the time when the first repurchases begin to fall due. ²¹ This option may not, however, significantly strengthen the disincentives for prolonged use, as members would again have access to Fund resources at the basic rate of charge under each new arrangement, and could avoid an increase in the rate of charge through successive arrangements that effectively refinanced the (now) more costly purchases under earlier arrangements.²²

(b)   The second option would be time-based graduation across successive arrangements. This option would avoid the incentives for refinancing, as a member’s cost of borrowing would return to the basic rate of charge only after the member had extinguished its obligations to the Fund. This system could be particularly effective at discouraging prolonged use, but may be considered demanding in that it would, as a rule, price all purchases under a new arrangement at the highest surcharge under a prior arrangement, as long as there is any Fund credit outstanding.²³ Modifications to this rule to ease this effect result quickly in complex systems with significantly reduced incentives against prolonged use.²⁴

34.   Under either option, the Fund would have to decide whether a time-based surcharge should apply to both stand-by and extended arrangements, and whether the same schedule should apply to both. Applying the same schedule to both would have the appeal of simplicity, and would also ensure that the rate of charge would not affect members’ decisions to request use of one or the other facility. However, since the EFF is targeted to members with weaker balance of payments positions likely to take a longer time to correct (and especially with a tightening of the application of the requirements of the EFF, see Section (iv) below), there would also be a case for less steep graduation under the EFF than under stand-by arrangements.

35.   A surcharge increasing with the level of Fund credit outstanding would be aimed mainly at discouraging large use.²⁵ The rationale behind this approach would be that the Fund is more concerned about additional use of its resources when a member’s use of Fund resources is already high than when it is low. Such a surcharge would provide both disincentives to purchase and incentives to repurchase, at higher levels of credit outstanding. It would thereby also create some disincentives for long use, which tends to be accompanied by a higher level of use of Fund resources.

36.   For credit outstanding above the cumulative limit under the credit tranches and the EFF, there is a case for a surcharge in line with that under the SRF, which also provides large access. This would imply a surcharge of 300 basis points on credit outstanding in excess of 300 percent of quota.²⁶

37.   Below this level of Fund credit, the parameters for a graduation schedule based on amounts outstanding might be chosen with one of two objectives in mind (Box 4):

• A focus on members that have made repeated use of Fund resources and that therefore tend to have higher credit outstanding would suggest a graduated surcharge starting at a relatively low level of credit outstanding. This would also allow for a more gradual increase in the surcharge and thus reduce the discontinuities arising from larger steps. However, a low starting point may in practice cover most borrowing members and would therefore suffer from similar drawbacks as a uniform increase in the rate of charge. As shown in Figure 4, the current distribution of members according to Fund credit outstanding is concentrated at low levels of use, with most members having outstanding Fund credit of less than 50 percent of quota.

• Alternatively, the graduated surcharge could be aimed more specifically at countries with large Fund credit outstanding and large arrangements. The latter could be a concern especially as regards members with access to capital markets, and more so to the extent that—as many Directors considered desirable at the previous discussion—the Fund wishes to continue to experiment with large precautionary arrangements.²⁷ This would suggest a larger surcharge beginning at a higher level of credit outstanding, which would aim at making Fund resources less attractive for large users, and thus providing, at high levels of credit outstanding, incentives not to purchase and, if purchases are made, to repurchase rapidly. In these circumstances, a surcharge can also be justified from the point of view of the allocation of limited Fund resources.

38.   A system of charges graduated with level of Fund credit outstanding, while simple to apply, would raise difficult questions of transition. It would not seem reasonable to apply such a system immediately to all members with Fund credit outstanding. The staff therefore sees a strong case for a transitional period to allow countries with existing Fund credit sufficient time to adjust to the new incentive structure.

39.   Combining the two approaches—based on time and Fund credit outstanding—is intuitively appealing as a means of discouraging both long and large use, but suffers from a number of drawbacks. Such a system (illustrated in Figure 5) would entail a matrix of charges associated with time and amount of resources outstanding, and may considerably complicate the structure of charges relative to the present, simple system or any of the alternatives. A combined system would be particularly complicated, though richest in its incentive structure, if the option of a time-based surcharge linked across arrangements were combined with the option of a broad-based surcharge on the level of Fund credit (see footnote 24).

40.   In sum, a system of graduated surcharges could provide strong incentives to support the temporary and revolving character of Fund resources:

• It is tempting to use the rate of charge to achieve a multiplicity of objectives, but it is important to keep the system as simple as possible. An unduly complex system may pose problems to member countries in understanding and managing their Fund obligations. In any case, a system that is difficult to understand probably does not provide the right incentives, or pass the test of transparency.

• Tackling the problem of excessively long use of Fund resources through graduated charges is appealing but limited in scope in the context of a single Fund arrangement. It is less straightforward in the context of successive arrangements and different facilities, and can quickly become complex. In any case, the Fund has other instruments with which it can address the problem of excessive length of use—repurchase periods (see below), as regards use under a single arrangement, and policies relating to conditionality and access, as regards repeated arrangements.

• Graduation with amounts outstanding is a straightforward approach, reflects the Fund’s concern over levels of use of its resources, does not suffer from the drawbacks of graduation with time, and partially addresses the issue of long use. The implementation would need to be phased in to allow countries with current Fund credit sufficient time to adjust to the new incentive structure.

41.   If the Board wished to proceed with the graduation of charges, the decisions that would need to be made concern:

• The choice between a system of surcharges based on time or the level of Fund credit, or both; and, in the case of a time-based surcharge, the choice between the two basic design options; and

• A range of quantitative parameters on which the system could be benchmarked, including, in particular, starting points, graduation intervals, and ceilings.

42.   Executive Board decisions affecting charges require a 70 percent majority of the total voting power.

(ii)   Repurchase periods

43.   The motivation for revisiting repurchase periods is the concern that members may not be making repurchases as rapidly as they might. As noted by the Board in March, the growing number of members with access to capital markets may be able to resolve balance of payments problems more rapidly than in the past, since adjustment should bear fruit quickly for them, through the intermediary of better market access. In any case, as noted in Chapter II, significant numbers of members see their balance of payments improve quickly, during and following an arrangement.

44.   There is inevitably a degree of arbitrariness in the Fund’s repurchase periods. As noted in Chapter II, there is no “typical” duration of balance of payments need, and in any case—especially given the volatility of BOP needs—the elimination of a BOP need does not necessarily imply that the member is in a position to repurchase. The choice of specific repurchase periods is thus essentially a matter of judgment, and the different options described below are predicated primarily on the general concerns described above, rather than on arguments about why a specific repurchase period would be “optimal.”

45.   The discussion below focuses on stand-by and extended arrangements:

• There was agreement at the earlier Board discussion that the maturity structure of the SRF, with early repurchase expectations at 1 - 1½ years and repurchase obligations at 2 – 2½ years, is broadly appropriate. (The maturity structure of the CCL is discussed in Chapter IV below.)

• For a stand-by arrangement, a repurchase period of 5 years, implying full repurchases 6½ years from the beginning of a 1½ year stand-by arrangement (the average length of stand-bys in the second half of the 1990s), may be too long.

• Similarly, for longer-term BOP needs, a repurchase period of 10 years, and full repurchase in 13 years from the beginning of a 3-year extended arrangement, may also be too long.

46.   A straightforward option would be to shorten the schedules of repurchase obligations under both stand-by and extended arrangements. For example, repurchases under a stand-by could fall due, say, 2 - 3½ years after the date of purchase. Thus, a member’s obligations stemming from a 1½ year arrangement would be repaid within 5 years of the first purchase.²⁸ The repurchase period of the EFF could revert to its original 8 years, or even perhaps 7 years, with repurchases falling due, say, 4 – 7 years after each purchase.²⁹ This would still imply repayment within 10 years of the beginning of a 3-year extended arrangement.

47.   Executive Board decisions to shorten repurchase obligations require an 85 percent majority of the total voting power.

48.   Given the uncertainty regarding the duration of balance of payments needs, an alternative approach would be to include in arrangements repurchase expectations that would establish a time-based expectation of repurchase ahead of the obligation date (as in the SRF and CCL).³⁰ The member would be expected to repurchase at the earlier dates but could, if it so desired, request the Board to extend these expectations, up to the obligation dates. The approach would differ from the Fund’s early repurchase policy based on balance of payments improvements (see Section (iii) below) in that repurchase expectations would arise at specific dates, rather than being formed depending on members’ circumstances. Moreover, it would put the burden of proof on the member to establish that its balance of payments position had not sufficiently strengthened to permit an early repurchase, instead of putting the burden of proof on the Fund to establish the reverse.

49.   This approach would bring several benefits:

• It would provide greater assurance to the Fund that a member would begin making repayments should an early recovery in its balance of payments materialize;

• It would maintain a strong assurance to the member that Fund support will be available for the period for which it is needed. That assurance would be slightly reduced, compared with the present system, in that there would always be some risk that the Fund and the member would differ as to the strength of the balance of payments. However, the assurance of continued Fund support would be much greater than if repurchase obligations were shortened, in which case the member would have to reach understandings on a new arrangement in order to benefit from the continued use of Fund resources.

50.   It is important to recognize that introducing repurchase expectations into arrangements would not in itself be a means of extending the period covered by conditionality. Under the approach presented here, the Board’s determination whether to grant the member’s request for an extension of the early repurchase expectations would be based exclusively on the member’s balance of payments position, and not on the quality of the member’s policies.³¹

51.   At the same time, the approach is not without drawbacks. In particular, it would complicate the structure of facilities, and thereby also members’ decision-making.

52.   Introducing this form of repurchase expectations would seem most useful in the case of the EFF, where the risk of a period of unwarranted use of Fund resources is greatest. Repurchase expectations could, for instance, begin at 4 ½ years, with semiannual repurchases and with full repurchase expected to be completed at 7 years. Thus, as may befit members that need to engage in deep-seated reform efforts for several years but whose efforts may bear fruit reasonably quickly, the period before repurchases begin would remain unchanged but repurchases thereafter would be accelerated. If repurchase expectations were introduced only into the EFF, and if the Fund used the EFF more sparingly than in the past (see Section (iv) below), any associated increase in complexity of the Fund’s facilities should be relatively minor.³²

53.   Repurchase expectations could also be introduced into stand-by arrangements. Repurchase expectations could, for instance, begin at 2¼ years, with full repayment expected to be completed at 4 years. This would advance the time at which repurchases begin without increasing the individual repurchases. There is no necessary incongruity between a schedule of repurchase expectations of 2¼ - 4 years on the one hand, and the maximum length of stand-by arrangements of 3 years on the other: long stand-by arrangements are typically expected to become precautionary in the later years, and if the member still had a balance of payments need it could request an extension of the expectations.³³ However, the introduction of repurchase expectations into stand-by arrangements could bring some increase in the complexity of the facilities.

54.   If repurchase expectations were introduced, a decision would have to be made as to whether the member could request an extension of the expectations only at one point in time, or at any time while a purchase was outstanding. Under the former approach, the member would need to make the request before the first repurchase expectation falls due, and the Board would then determine whether the member should adhere to the schedule of expectations or obligations. That determination by the Board would be final, and any subsequent deterioration in the member’s balance of payments would be addressed, if necessary, through a further arrangement. Under the alternative approach, the member could, say, meet the first few repurchase expectations, and then (and at any time) request an extension of the remaining expectations should its position deteriorate. The staff would lean toward the latter approach, so as to avoid creating an incentive for members to request an extension of the expectations by way of “insurance,” only because they know it will not be possible at a later date.

55.   Executive Board decisions to introduce repurchase expectations into arrangements require a simple majority of the votes cast.

(iii)   The early repurchase policy

56.   With strengthened price incentives, changes in repurchase periods, and/or the introduction of time-based repurchase expectations, the Fund’s early repurchase policy based on balance of payments improvements would tend to serve as a further backstop, rather than a primary inducement to early repurchase. Under the early repurchase policy, repurchase expectations can be formed by the Fund at any time while Fund resources are outstanding, based on the member’s balance of payments strength, with the objective of ensuring that members repay the Fund ahead of the relevant repurchase obligations as their balance of payments position improves.³⁴ The current policy, however, does not work very well, in part because it relies heavily on the level of and change in members’ gross reserves—a crude indicator of BOP strength and to a great extent under the member’s own control (and more so in a world of fluid capital markets). Another issue relates to the difficulty of bringing to bear judgments on members’ potential (and hence unobserved) access to alternative sources of finance, in a way that does not create either undue uncertainty for the member or risks to uniformity of treatment.³⁵ A staff paper is scheduled for September that will consider some possibilities in this area, but the staff doubts that likely improvements can have more than a marginal impact.

(iv)   Conditions for use of the EFF

57.   In line with the earlier discussion and as argued further above, there is a case for the Fund to retain a longer maturity facility. But it is important to ensure that the relevant facility—the EFF—is used only in appropriate cases. Box 3 above sets out the requirements of the EFF.

58.   It is incumbent on the Fund to ensure that the EFF is used only in appropriate cases. Some of the changes discussed above could reduce the incentives for members to seek use of the EFF, and it should also be possible to eliminate a common misunderstanding—that the EFF confers a stronger “seal of approval” than a SBA. Nonetheless, the facility will retain, from members’ point of view, at least the advantage of longer maturity relative to stand-by arrangements.

59.   The discussion in Chapter II suggests a need to apply the requirements of the EFF Decision in a more rigorous manner. In particular, the Fund has had only limited success in targeting the EFF to members whose BOP needs actually turn out to be relatively long-term. It has been more successful at requiring strong structural programs in extended arrangements, and indeed may have targeted the EFF based in part on this consideration, rather than on a careful analysis of the likely duration of the BOP difficulties.

60.   There is a strong case for examining more rigorously the likely duration of the balance of payments difficulties when a member requests use of the EFF. The staff would expect that a more thorough analysis, in line with the existing requirements of the EFF Decision, would result in fewer extended arrangements being approved than hitherto, because a number of members would be found not to have the relatively long-term balance of payments difficulties required to qualify for the EFF:

• The EFF would be unlikely to be used on a precautionary basis. A member seeking a precautionary arrangement (notwithstanding the consistency of precautionary arrangements with the 1974 EFF Decision) faces only a potential need for Fund resources, and only in rare circumstances would a potential need likely turn out to be prolonged (see Box 3).

• The EFF would probably not be used by members with well-established access to capital markets. Such countries are not likely to suffer from the problems described in the EFF Decision—severe payment imbalances, or slow growth and an inherently weak balance of payments. Moreover, even when such members lose access to capital markets, their balance of payments difficulties are likely to be of relatively short duration: in the majority of cases, access is likely to be re-established within a relatively short time span with the implementation of corrective measures and restoration of confidence.

• The experience of transition economies suggests that not all require longer-term balance of payments support. Indeed, many of these countries, after the steady implementation of strong structural reform, have gained meaningful access to capital markets within only a few years.

• Rather, the main candidates for the EFF would be countries with balance of payments difficulties that are demonstrably of a longer-term nature, or that face the combination of a large structural reform agenda and related balance of payments needs of a longer-term nature. The former category might include, for instance, countries “graduating” from PRGF eligibility, and the latter some of the remaining poorer transition countries that are not PRGF-eligible.

61.   A more restrictive approach to the EFF is likely to lead to substantially reduced use of the facility. Under these circumstances, the stand-by arrangement would again become by far the main channel for Fund financial support.

IV.   The Contingent Credit Lines

62.   At its previous discussion, the Board noted that the CCL had not attracted the interest of members since it was created in April 1999, and most Directors favored additional experimentation with the design of this facility. The present chapter examines the CCL in some detail, focusing in particular (but not exclusively) on areas identified by the Board for possible modification at the last discussion. Concerns expressed by members on the CCL are summarized in Annex IV.

63.   The CCL does not appear currently to offer members sufficient advantages compared with other Fund facilities. If members prefer to use other facilities, the Fund may be missing an opportunity to encourage the first-class policies that would enable a member to qualify for the CCL. A redesign of the CCL should thus be guided, at least in part, by better “positioning” of the CCL relative to the SRF, on the one hand, and precautionary arrangements, on the other hand.

64.   The CCL “competes” with the SRF in that members that do not have a commitment under the CCL can request access to the SRF should a crisis hit. The CCL features, however, what members may perceive to be a relatively high cost (the commitment fee), without providing more advantageous or obviously more secure access to Fund resources (since the rate of charge is the same on CCL and SRF resources, and since the Fund retains the discretion to ask for policy changes in the CCL activation review).

65.   In addition, the CCL “competes” with precautionary arrangements—although a comparison between the two is more complex than between the CCL and the SRF: ³⁶

• For members, there should be several advantages to the CCL, compared with precautionary arrangements. First, the CCL is designed to provide a strong signal of “first class” policies to markets. Its prequalification requirements are designed in part to set apart members that have such policies. Second, the CCL provides a member immediate access, in the event of activation, to a substantial level of funding. In the case of a precautionary arrangement, even with high access (which has generally been the exception), the member would normally take a relatively long period to build up the ability to purchase an equivalent amount. Thus, the CCL effectively rewards members for performance prior to the arrangement, while a precautionary arrangement rewards a member for performance during an arrangement.

• At the same time, there are several reasons why members may prefer precautionary arrangements. First, the rate of charge on CCL resources is much higher. Second, the CCL has a much shorter repurchase period. Third, under a precautionary arrangement, the member is assured resources in the event of need, as long as its program stays on track (there is no further review by the Fund). The current design of the CCL does not provide a similar assurance. Finally, a precautionary arrangement permits purchases to be made for any balance of payments need, whereas a CCL can be activated only for a contagion-driven crisis.

66.   The advantages and disadvantages of the CCL relative to other facilities point to a number of aspects that should be re-examined if the CCL is to become a more effective preventive device. This chapter will look, successively, at the Fund’s discretion in the activation review, the rate of charge, the commitment fee, the repurchase period, and the conditions for activation. It will also examine other concerns raised by members, including the issues of market reaction and of how members might exit from the CCL, and will consider whether the existing requirements for private sector involvement in countries making use of the CCL are appropriate.

67.   The changes to the CCL proposed in this chapter must be viewed as experimental. The present discussion of the CCL would constitute the review of the CCL that must be completed by end-August, 2000.³⁷ The intention would be, at the next Board discussion in September, to amend the CCL in a number of relatively straightforward ways, with a view to finding out, over the coming months, whether, with these changes, it can become a useful instrument. The CCL already incorporates a sunset clause, so that it will expire on May 4, 2001, absent any action by the Board. The staff would expect that the Board would review experience with the facility once again by that date.

A.   The Fund’s Discretion in the Activation Review

68.   At the previous discussion, many Directors thought it worth considering the possibility of reducing the Fund’s discretion in the activation review. The Fund currently retains significant discretion to ask for policy changes, should a crisis hit, before substantial resources under the CCL are made available to the member.

69.   While the Fund’s discretion in the activation review strengthens the safeguards for its resources, it plays an important part in diluting the usefulness of the CCL to members, and potentially also its signaling impact. The Fund retained this discretion because it is impossible to predict the exact avenue through which contagion could strike, and because policy changes may be required, should a crisis occur, in order to address it effectively and to safeguard the Fund’s resources. At the same time, the Fund’s discretion may considerably dilute the confidence members and markets have in the actual availability of CCL resources. While this may to some extent be a teething problem—there is no experience yet with how the Fund would respond to an activation request—it is nonetheless the case that there can be no assurance of the availability of Fund resources if the Fund retains the right to ask for additional policy action at the time of the activation review. Members may thus prefer to rely on their ability to request a commitment under the SRF should a crisis hit, and markets may question the signal the Fund seeks to give by granting members access to the CCL.

70.   The staff believes it is important, if the CCL is to become a useful instrument, to allow for greater automaticity upon activation. Greater automaticity should be possible without undue erosion of the safeguards for Fund resources, because members with arrangements with CCL resources are members with a demonstrated track record of good policies, and the Fund could thus have some confidence that they will make any policy adjustments required.

71.   The staff would propose allowing for greater automaticity of the first drawing on activation by limiting the scope of the activation review. Currently the Fund verifies, in the activation review, that “(i) the member is experiencing exceptional balance of payments difficulties due to a large short-term financing need resulting from a sudden and disruptive loss of market confidence reflected in pressure on the capital account and the member’s reserves; (ii) these difficulties are judged to be largely beyond the member’s control and to be primarily from adverse developments in international capital markets consequent upon developments in one or several other countries; (iii) up to the time of the crisis, the member has successfully implemented the economic program that it had presented to the Board as a basis for its access to CCL resources; and (iv) the member is committed to adjusting policies to deal with any real economic impact from contagion.” ³⁸ Under this proposal the scope of the activation review would be limited to verifying conditions (i)-(iii), and the member would be given the strong benefit of the doubt as to condition (iv).³⁹

72.   The amount available upon completion of the activation review would be specified at the time of approval of the commitment under the CCL. The decision on an arrangement with CCL resources would specify, in addition to the first purchase, the purchase on activation (with the rest to be phased on activation). The purchase on activation would likely need to be substantial in order to make the CCL useful to members, and to put the weight of the Fund’s financing behind its seal of approval. It could be a uniform equivalent to, say, 100 percent of quota (the annual access limit under the credit tranches, and hence the maximum annual purchases a country could accumulate under a precautionary stand-by arrangement), or some fixed fraction (perhaps a third) of the total amount available under the arrangement. Alternatively, there could be a presumption that the purchase would be, say, equivalent to 100 percent of quota or one third of the total amount available under the arrangement, with flexibility for the Board to depart from this if the circumstances warranted. The phasing of the remainder of the resources, and the associated conditionality, would be specified at the time of the activation review, and it could be determined at that time that the purchase on completion of the activation review would be larger than the purchase originally specified.

73.   An Executive Board decision amending the scope of the CCL activation review would require a simple majority of the votes cast.

B.   The Rate of Charge

74.   At the previous discussion, many Directors also thought it worth considering the possibility of lowering the rate of charge on CCL resources. The CCL rate of charge is currently identical to the SRF rate—incorporating a surcharge of 300 basis points over the basic GRA rate of charge for one year from the date of the first purchase under the facility, rising by 50 basis points every six months up to a maximum of 500 basis points. Arguments for a relatively high rate of charge on CCL resources are based primarily on the incentives that such high charges would provide for advance repurchases—this is all the more important because the crisis would be expected to be particularly short-lived. At the same time, there are strong arguments for a lower rate of charge on CCL than on SRF resources. As emphasized above, members currently have little incentive to seek to qualify for the CCL rather than rely on the use of the SRF should the need arise, and positive externalities associated with decreasing the likelihood of crisis are thereby foregone.

75.   The staff would see a case for a significant reduction in the starting rate of charge on CCL resources, but also for maintaining the graduation of the rate with time, as in the SRF:

• While there are both advantages and drawbacks to the CCL compared with precautionary arrangements (paragraph 65), it is possible to argue that, in order to prevent a bias against the CCL, the charges on an arrangement with CCL resources should be broadly in line with those under an equivalent stand-by arrangement, at least at the point of drawing. The cost of stand-by arrangements will depend on the Executive Board’s eventual decision on charges. For example, if the cost of an arrangement with CCL resources of 300 percent of quota (the bottom of the range of access expected for an arrangement with CCL resources) were equated with the cost of a stand-by arrangement of equivalent size, the surcharge on CCL resources would be 150-200 basis points if the Fund adopted one of the two graduation schemes shown in Box 4.⁴⁰ The staff suggests that the decision on the rate of charge on CCL resources be taken in the context of overall decisions on charges, at the time of the follow-up paper in September, with a view to broadly aligning the cost of an arrangement with CCL resources with that of a hypothetical stand-by arrangement of equal size.

• At the same time, there is a strong case for having the rate of charge on the CCL rise with time, in order to strengthen incentives for repurchase as the crisis recedes. Maintaining the same graduation with time as in the SRF should not undermine the financial attractiveness of the CCL compared with the SRF, as the rate on CCL resources would be consistently lower than would be the rate on SRF resources over the same period. And while graduation with time might bias members somewhat toward precautionary stand-by arrangements, it would begin (as in the SRF) only after a year, and hence may not feature very prominently in the decisions of members for which a crisis itself—and still more a long-lived one—is only a remote possibility.

76.   Executive Board decisions about the rate of charge on the CCL require a 70 percent majority of the total voting power.

C.   The Commitment Fee

77.   There is also a case for lowering the commitment fee on the CCL. The Fund levies an annual commitment fee of ¼ percent on the amount available for purchase. The fee is uniform for all arrangements. The commitment fee is refunded to the extent that purchases are made under the arrangement. As the ex ante probability of purchases under arrangements with CCL resources would be lower, a case could be made that the commitment fee should also be lower as it is less likely to be refunded.⁴¹

78.   There are good reasons not to waive the commitment fee entirely. First, the Fund’s commitment fee is already low compared to other financial institutions.⁴² Second, the basic financial rationale for charging a commitment fee for contingent credits also holds for the Fund—that is, to cover the cost of establishing and monitoring the credit line and setting aside financial resources over a period of time—and the Fund incurs significant costs in such operations. The staff would therefore propose to maintain the principle of a commitment fee but reduce it by half, to 1/8 percent.

79.   Executive Board decisions about the CCL commitment fee require a 70 percent majority of the total voting power.

D.   Repurchase Periods

80.   The staff would propose to keep the repurchase periods of the CCL unchanged. Members with first-class policies that are affected by contagion are likely to experience short-lived balance of payments difficulties—probably shorter even than those typically financed under the SRF. Thus there could be a case for making the CCL repurchase period the shortest in the array of Fund facilities. This may, however, bias members against the CCL not only in comparison with precautionary stand-by arrangements, but even in comparison with the SRF, and would probably represent excessive fine-tuning in a world of uncertainty. On balance, the staff believes that it is reasonable to keep CCL repurchase periods aligned with those of the SRF, at least for the time being.

E.   Conditions for Activation

81.   Some members have noted, as a disadvantage of the CCL, that an arrangement with CCL resources can be activated only if there is a contagion-driven crisis.⁴³ Compared with the condition for purchases under other arrangements—that the member should have a balance of payments need—this condition incorporates two restrictions, namely that there be a crisis of capital market confidence, and that it be driven by contagion. This section examines the rationale for each of these restrictions in turn.

82.   There is good reason why the activation review under the CCL should be completed only in the context of a crisis. From the Fund’s point of view, there is a strong case for ensuring that the potentially large amounts of resources provided under the CCL are used only in crisis cases, where extremely sharp and rapid adjustment would otherwise be needed. Moreover, from the point of view of members, the fact that CCL resources are not available outside the context of a crisis may not be a great drawback of the facility, since members with first-class policies would not expect to have to draw on the Fund absent a crisis.

83.   It is less clear that the conditions for activation of the CCL should remain limited to contagion-driven crises, to the exclusion of other exogenous events that may temporarily disrupt a country’s access to capital markets. These narrow conditions for activation may bias members toward precautionary arrangements. While members with “first-class” policies would not expect to draw on the Fund absent a crisis, and would not expect to be subject to a self-generated crisis, they may still suffer from shocks to capital market confidence generated by exogenous events other than contagion.

84.   While recognizing the difficulty of identifying contagion, the staff would propose to keep contagion as a necessary condition for activation. The CCL Decision defines “contagion”as “circumstances that are largely beyond the control of the member and that stem primarily from adverse developments in international capital markets consequent upon developments in other countries.” Beyond this, the main non-contagion exogenous events that might trigger crises would be political ones. Any political event that triggers a severe market reaction—presumably, because markets perceive risks for the continued good conduct of policies—may well imply risk for Fund resources.

85.   This construct implies that a member with an arrangement with CCL resources that is hit by a non-contagion exogenous shock would need to revert to the SRF, even if its policies are still first class. Such a move would carry clear financial costs for the member if the rate of charge on the CCL is lower than on the SRF. Nonetheless, the member in this case would be no worse off than if the CCL had not existed at all.

F.   Market Reaction

86.   Important concerns that members have expressed about the CCL relate to the possible market reaction to a request for an arrangement with CCL resources:

• Members are concerned that markets may interpret a request for an arrangement with CCL resources as a sign of weakness, not of strength;

• In particular, some members are concerned about the stigma they see attached to any form of arrangement with the Fund;

• Concern over market reaction is compounded by the fact that, since the CCL has not yet been used, members do not know what kind of club they would be joining.

87.   These problems may be to some extent, or even entirely, teething problems. If a pattern became established whereby only members with truly first-class policies were granted access to the CCL, members’ concerns about clubs and stigma should fade, and the experience of these members could demonstrate that concerns about adverse market reaction to an arrangement with CCL resources are unfounded. Indeed, there could be positive externalities if a number of members were to request and be granted access to the CCL at about the same time. The staff would not suggest attempting to create a club by certifying members as eligible for the CCL, which would confer on the Fund some of the characteristics of a rating agency.

G.   Exit

88.   Another concern members have expressed with regard to the CCL relates to the manner in which, once they have entered into an arrangement with CCL resources, they might exit from this type of arrangement. The CCL was designed so that one of its main advantages would be the announcement effect of having policies certified as first class. This feature, however, brings with it the question of how a member might exit without creating the reverse of the announcement effect and unsettling financial markets. While there is no presumption that a commitment of CCL resources will be followed by another, the very fact that the facility is intended for members with first-class policies, in an environment of relative calm in financial markets, may leave markets wondering what has changed to warrant exit.

89.   It is difficult to judge how much of an impediment the question of exit is to the usefulness of the CCL. The difficulty could be diminished if members indicated at the time of approval of a commitment under the CCL that they intend to avail themselves of the facility only for a limited period—say, one or two years—thus effectively announcing their exit in advance.⁴⁴ Further, the difficulty is one that is found to some extent in Fund arrangements in general, although it is magnified in the CCL by the fact that the facility is meant specifically for members with first-class policies (members wishing to exit from other arrangements can claim that their situation has improved and that they no longer need the Fund’s support or protection). Moreover, this difficulty, too, may to some extent represent a teething problem: should a few members be granted access to the CCL and subsequently exit, their experience may demonstrate that exit is possible without a negative market reaction. Removing some of the drawbacks to the CCL discussed above should allow a further period of experimentation with the facility that may reveal whether the question of exit represents a minor or fundamental barrier to the functioning of the CCL.

H.   Links to Private Sector Involvement

90.   Issues relating to private sector involvement in the CCL have arisen, at least implicitly, in the various discussions the Executive Board has had on private sector involvement (PSI) in the resolution of crises. In particular, proposals whereby more concerted means of securing PSI would be mandatory above a certain level of access to Fund resources could have important implications for the CCL.

91.   The staff considers it important to maintain the CCL’s original requirements for involving the private sector—i.e., the requirement that the member should have in place, or be making credible efforts toward putting in place, appropriate (ex ante) arrangements to involve the private sector.⁴⁵ As emphasized in the previous paper, the CCL clearly raises issues of moral hazard, and greater automaticity in the availability of resources would intensify this concern. The demanding eligibility criteria—including the PSI requirement—are key to mitigating that risk.

92.   At the same time, it would not seem appropriate to make (ex ante or ex post) PSI mandatory for the CCL. Ex ante PSI is limited by the state of development of the various instruments (enumerated in the CCL Summing Up) and prevailing market conditions, and the Fund cannot strengthen its requirements further without running ahead of market developments. Mandating concerted PSI (that is, any form of requirement that in the event of a CCL activation, private creditors will be forced to participate, regardless of the original contractual terms) would likely negate entirely, from the point of view of members, any potential benefits. The countries that would be eligible for the CCL would also be countries that have, and use regularly and substantially, access to capital markets. The use of concerted techniques to secure PSI by countries that could otherwise have strong prospects for a rapid resumption of access would make the CCL unattractive. Moreover, this might lead the CCL to be perceived by markets as signaling a member’s intention to use concerted PSI as a first resort during periods of difficulty, thereby damaging the prospects for market access during normal times.

V.   Post-Program Monitoring

93.   The aims of stronger post-program monitoring (PPM), as advocated by a number of Directors, would be to provide additional safeguards for Fund resources, and to promote closer monitoring of the member’s policies and progress than would be expected under the normal surveillance procedures. At present, upon expiration of an arrangement, staff contacts with the member typically remain quite intensive, but the member’s situation is generally formally reviewed by the Board only on the occasion of the annual Article IV consultations. A strengthened policy could provide a better early warning system of cases where, following completion or expiration of an arrangement, bad policies might lead to problems in repaying the Fund or put at risk the achievements of the arrangement, and a mechanism for bringing this to the attention of the authorities and the Board and stimulating action to improve the situation.⁴⁶

94.   A possible procedure for stronger PPM would involve members being subject to more frequent consultation with the Fund, with a particular focus on macroeconomic and structural policies that have a bearing on external viability. To this end, the member would engage in discussions with the staff on its policies, including a quantified macroeconomic framework. The staff would then report formally to the Board on the member’s policies, the consistency of the proposed macroeconomic framework with the objective of medium-term viability, and the implications for the member’s capacity to repay the Fund. There could be two Board discussions a year. One of these might coincide with the Article IV consultation, and the other could be based on a short staff report covering recent economic developments and the discussions with the authorities on the macroeconomic framework.⁴⁷ Descriptions of developments between discussions could also be given periodically at country matters meetings if necessary. The Board may wish to consider whether there should be either voluntary or mandatory Press Information Notices (PINs) at the conclusion of PPM discussions, or whether PPM staff reports should be published. The staff would suggest that these possibilities be considered in the context of the Board’s discussion of the forthcoming paper on Transparency and the Fund.

95.   This practice would be based on, and give better-specified content to, the existing consultation clauses in all arrangements, under which members are expected to consult with the Fund, at the request of the Managing Director, concerning their balance of payments policies, as long as purchases remain outstanding. While these procedures would resemble some forms of intensive surveillance and assistance to members, they would have a different motivation—namely, safeguarding the Fund’s resources.

96.   Since resource constraints would preclude a universal application of intensive post-program monitoring, the staff would suggest that the emphasis should be on (a) countries with relatively high outstanding use of Fund resources; and (b) countries where the risks appear highest that the member could encounter difficulties in repaying the Fund:

• Emphasis on (a) would suggest that the criterion for deciding whether a member should be monitored should be outstanding Fund credit, in percent of quota.⁴⁸ PPM consultations would continue as long as the member’s outstanding Fund credit remained above the threshold, and would cease when credit fell below this threshold, unless called for on some other count (see below). A threshold of, say, 100 percent, beyond which members would be automatically subject to post-program monitoring, would correspond to the limit in Article V, Section 3 (b)(iii) on Fund holdings of member’s currencies, and has also traditionally been considered (e.g., in analyses of prolonged use) as an indicator of relatively intensive use of Fund resources.⁴⁹

• Among other things, emphasis on (b) would suggest that if the Board decides, as suggested above, to introduce early repurchase expectations into arrangements, post- program monitoring should be required in cases where the member requests an extension of the period of early repurchase expectations: a request for more time to repay the Fund on grounds of continued balance of payments difficulties would seem to imply greater risk that external viability will not be secured. However, the staff would suggest that the Board also retain discretion to initiate similar consultations with any member that it believes is particularly vulnerable to balance of payments difficulties.⁵⁰

97.   The primary function of PPM would be as an early warning system of policies which could call into question the member’s progress toward external viability. Therefore, the staff would recommend that failure to cooperate in PPM—which would essentially consist of a refusal to provide relevant information and/or to hold discussions with the staff—be subject to some sanctions, specifically that such failure to cooperate should be taken into account in any future discussions on a new arrangement.⁵¹ However, based on experience with Article IV consultations, this would be expected to occur very rarely, if ever. The staff does not think that sanctions are either necessary or desirable in cases where PPM takes place but reveals serious differences of view between the authorities and the Fund on the adequacy of policies.⁵² The alerting of the member’s authorities and of the Board to the differences of view, and the discussion of the member’s policies in the Executive Board, should be sufficient to assure the Fund that its concerns are being given serious consideration.

98.   The above proposals for PPM could be implemented as soon as the Board decided to do so. In particular, PPM could be implemented for members that currently have Fund credit outstanding above a certain threshold. There would be no retroactivity involved, as these members are already expected, as reflected in the consultation clauses in their arrangements, to consult with the Fund, at the Managing Director’s request, as long as purchases are outstanding.

99.   Experience with PPM could be reviewed in about 18 months.

VI.   Issues for Discussion

100.   Directors may wish to comment on the following issues:

The overall structure of facilities

• Do Directors agree that a limited set of facilities serves the Fund’s purposes better than a single facility? Do Directors believe that the broad structure of the Fund’s core facilities is appropriate—with the stand-by arrangement the central facility, complemented by the SRF, the CCL, and the EFF?

Charges

• Do Directors believe that the Fund should be making more use of the rate of charge in order to discourage members from making unduly large or long use of Fund resources?

• If so, would Directors favor (a) a uniform increase in the rate of charge on the credit tranches and the EFF, (b) graduation of the rate of charge with time, or (c) graduation with Fund credit outstanding? If Directors favor (b)—graduation with time—do they think the surcharge should be linked to purchases under each arrangement separately, or across arrangements? If Directors favor (c)—graduation with the level of Fund credit outstanding—do they favor a broad-based surcharge or a surcharge on especially high levels of Fund credit?

• What broad parameters would Directors have in mind for an increase in, or a graduation schedule for, the rate of charge (including in the latter case starting points, graduation intervals, and possible ceilings)?

Repurchase periods

• Are Directors interested in shortening repurchase obligations? If so, are they interested in doing this under the EFF, stand-by arrangements, or both?

• Are Directors interested in making wider use of the system used in the SRF and CCL, whereby repurchase expectations fall due before the respective obligations? If so, are they interested in this for the EFF, for stand-by arrangements, or for both? Would they favor a system where members can request an extension of a repurchase expectation only before the first expectation falls due, or at any time while resources under the arrangement remain outstanding?

The EFF

• Do Directors agree that the requirements of the EFF—in particular, the requirement for a relatively long-term balance of payments need—should be applied more rigorously? Do they agree that such application is likely to result in the EFF being used more sparingly, perhaps primarily by graduating PRGF countries and early transition economies, with little use either by countries with capital market access or on a precautionary basis?

The CCL

• Do Directors agree that the Fund’s discretion in the activation review should be reduced? Do they agree that the scope of the activation review should be limited by giving the strong benefit of the doubt to the member as to whether it is committed to adjusting policies as needed, and that an arrangement with CCL resources should specify the amount of the purchase on activation? If so, do they favor a rule or a presumption that the purchase on activation should be for the equivalent of a set percentage (perhaps 100 percent) of the member’s quota, or a fixed fraction (perhaps a third) of the total amount available under the arrangement?

• Do Directors agree that the initial rate of charge on the CCL should be reduced? Would they wish, as suggested above, to broadly align the initial rate of charge on an arrangement with CCL resources with the rate of charge on a hypothetical stand-by arrangement of 300 percent of quota? Do Directors agree that the rate of charge under the CCL should continue to rise with time, at the same pace as the rate of charge under the SRF?

• Do Directors agree that the commitment fee on the CCL should be reduced? To what level? Would the suggested level of 1/8 percentage point be acceptable?

• Do Directors agree that it should remain the case that the CCL can be activated only if there is a crisis driven by “contagion”—namely, adverse developments in capital markets consequent upon developments in other countries?

• Do Directors agree that the CCL’s criteria for involving the private sector should remain unchanged?

Post-program monitoring

• Do Directors support the procedures for post-program monitoring outlined in Chapter V?

• Do Directors believe that post-program monitoring should apply to all members above a certain level of outstanding Fund credit? If so, would the suggested threshold of 100 percent of quota be acceptable?

• If repurchase expectations were introduced into stand-by and/or extended arrangements, do Directors believe that post-program monitoring should apply to members that have obtained an extension of the repurchase expectations?

The Fund’s Core Facilities

The Credit Tranche Policies - Stand-by Arrangements

Stand-by arrangements are available for any balance of payments need.

The length of stand-by arrangements is typically 12-18 months, although they range from a minimum of about six months (there is no legal minimum) to a maximum of three years.

For a member that has no Fund credit outstanding, the first 25 percent of quota access under a stand-by arrangement is subject to “first credit tranche conditionality.” The

Fund’s attitude to requests in the first credit tranche is a liberal one, while requests beyond this require substantial justification.

All stand-by arrangements beyond the first credit tranche feature phasing of purchases conditional on performance clauses (applying only to purchases beyond the first credit tranche).¹

Access under stand-by arrangements (together with access under the Extended Fund Facility) is subject to limits of 100 percent of quota annually and 300 percent of quota cumulatively. The Fund may grant access beyond the limits in exceptional circumstances.

Purchases under the credit tranche policies are subject to the rate of charge on GRA resources², and to repurchase obligations of 3¼ - 5 years from the date of purchase (eight quarterly installments). Stand-by arrangements are subject to a commitment fee of 25 basis points payable at the beginning of each 12-month period on the amount scheduled to become available over the next 12 months.

The Extended Fund Facility (EFF)

The EFF was established in 1974 with the purpose of providing medium-term assistance in particular to members with (a) an economy suffering serious payments imbalance relating to structural maladjustments in production and trade and where price and cost distortions have been widespread; or (b) an economy characterized by slow growth and an inherently weak balance of payments position which prevents pursuit of an active development policy.

The length of extended arrangements is typically three years, with a possibility of extension for a fourth year.

Extended arrangements are subject to phasing provisions similar to those under stand-by arrangements. The policy conditions necessary for Fund support through the EFF include implementation of structural reforms over an extended period.

Access to the EFF (together with access under the credit tranches) is subject to limits of 100 percent of quota annually and 300 percent of quota cumulatively. The Fund may grant access beyond the limits in exceptional circumstances.

Purchases under the EFF are subject to the rate of charge on GRA resources, and to repurchase obligations of 4½ - 10 years from the date of purchase (twelve semiannual installments). Extended arrangements are subject to a commitment fee of 25 basis points payable at the beginning of each 12-month period on the amount scheduled to become available over the next 12 months.

Supplemental Reserve Facility (SRF)

The purpose of the SRF is to provide assistance to members that are experiencing exceptional balance of payments difficulties due to a large short-term financing need resulting from a sudden and disruptive loss of confidence reflected in pressure on the capital account and the member’s reserves.

Access under the SRF is separate from the access limits under the credit tranches and the EFF, and the SRF is not subject to access limits of its own. SRF resources are, however, provided under stand-by or extended arrangements, in combination with credit tranche or EFF resources up to the annual or cumulative limit, whichever is binding.

Conditionality in an arrangement involving SRF resources is similar to that in a stand-by or extended arrangement.

SRF resources are subject to repurchase expectations at 1–1½ years from the date of purchase, and repurchase obligations at 2–2½ years from that date. The member may request an extension of the repurchase expectations by up to one year, but the Board may decide not to approve this request, and to turn unmet expectations into immediate obligations.

SRF resources are subject to a surcharge above the rate of charge on GRA resources. During the first year from the date of the first purchase under the facility, the surcharge is set at 300 basis points, and it rises by 50 basis points at the end of the first year, and every six months thereafter, up to a maximum of 500 basis points. SRF resources are subject to a commitment fee of 25 basis points payable at the beginning of each 12-month period on the amount scheduled to become available over the next 12 months.

Contingent Credit Lines (CCL)

The purpose of the CCL is to provide members with strong economic policies a precautionary line of defense which would be readily available against balance of payments problems that might arise from international financial contagion.

The CCL is subject to demanding eligibility criteria: (i) an absence of need for use of Fund resources from the outset, (ii) a positive assessment of policies by the Fund, taking

into account the extent of the member's adherence to internationally-accepted standards (in particular, the member must have subscribed to the Special Data Dissemination Standard and be making satisfactory progress toward meeting its requirements);

(iii) constructive relations with private creditors, with a view to facilitating appropriate involvement of the private sector, and satisfactory management of external vulnerability, and (iv) a satisfactory economic and financial program, which the member stands ready to adjust as needed.

As with the SRF, access under the CCL is separate from the access limits under the credit

tranches and the EFF. CCL resources are provided under stand-by arrangements, in combination with credit tranche resources up to the annual or cumulative limit, whichever is binding. Commitments under the CCL are expected to be in the range of 300-500 percent of quota.

Upon approval of an arrangement involving CCL resources, a small purchase is made available (but not expected to be drawn). Thereafter, phasing is left unspecified. If a crisis strikes, the member may request completion by the Board of an “activation review,” under which resources would be released and phasing and conditionality (similar to conditionality under the SRF) would be specified for the remainder of the resources. To complete the activation review, the Board must be satisfied that the member, having successfully implemented its program to date, is nevertheless severely affected by a crisis stemming from contagion, and that it intends to adjust policies as needed. If an activation review is not completed by a pre-specified date, a midterm review of the arrangement must be completed before a purchase associated with an activation review can be released.

CCL resources are subject to the same repurchase expectations and obligations (at 1-1½ years, and 2-2½ years, respectively, from the date of purchase), and the same rate of charge (incorporating a surcharge over the rate of charge on GRA resources that rises from 300 to 500 basis points), as SRF resources. CCL resources are subject to a commitment fee of 25 basis points payable at the beginning of each 12-month period on the amount scheduled to become available over the next 12 months.

Empirics of Balance of Payments Financing Needs

A.   Introduction

1.   This annex presents an analysis of the characteristics of the balance of payments (BOP) financing needs of members granted arrangements with the Fund. The analysis focuses on those features most relevant to a reconsideration of the modalities of stand-by arrangements (SBA) and extended arrangements (EA), which are respectively intended to address short- to medium-term (hereafter, “medium-term”) and longer-term balance of payments needs. The main issues covered in the analysis are:

• the characteristics of the projected BOP needs of members, and whether they correspond to the maturity of the Fund facility that members are granted;

• the distribution of the durations of members’ actual BOP needs, and whether they show a pattern consistent with the structure of Fund facilities; and

• the predictability of the duration of needs, especially the likelihood that needs prove to be either shorter or longer in duration than was expected.

The following sections discuss the definition of BOP needs, the characteristics of projected and actual BOP needs, and the predictability of the duration of needs, and provide details on data sources.

B.   Balance of Payments Needs Defined

2.   One of the conditions governing the use of the Fund’s general resources is that the “member represents that it has a need to make the purchase because of its balance of payments or its reserve position or developments in its reserves” (Article V, Section 3(b)(ii)). These criteria are independent, so a member with strong reserves could still request a purchase if it had a deficit in its overall balance of payments.¹ This analysis uses a definition of BOP financing need that covers both the overall balance of payments and shortfalls in reserves. It departs from the Fund’s standard definition of BOP need in that it puts sovereign market borrowing “above the line” in the overall balance (thus having it contribute to reduce, rather than fill, the financing need), in line with the Fund’s concern that members with access to capital markets should not unduly rely on Fund resources (see also paragraph 4 below).

Definition of BOP need: The magnitude of the BOP need is the amount of exceptional BOP financing required to achieve a suitable target level for foreign reserves.²

The need arises because the overall payments balance before exceptional financing—often referred to as the autonomous balance because it reflects current and capital account transactions that are made without regard to the state of the balance of payments—would either result in a fall in reserves, or would leave reserves at an undesirably low level. Arithmetically, the definition of BOP need is:

   Targeted change in reserves - Overall balance of autonomous transactions
= Targeted change in reserves - Change in reserves excl. exceptional financing
= Exceptional financing consistent with reserve target

A more detailed definition is provided in Table 1, which for example includes Fund repurchases as an outflow under autonomous transactions, because these are due regardless of the state of the overall balance of payments.

3.   Exceptional financing includes many sources aside from Fund purchases. There are other forms of borrowing to support the balance of payments, including non-project loans from the World Bank, e.g., Structural Adjustment Loans. The rescheduling of debt service is a major source of exceptional financing under many arrangements. In the BOP projections a financing “gap” may be included to represent the expectation of continued exceptional financing, but where no specific source of exceptional financing is yet identified with certainty. Indeed, financing gaps are included in the projections of some 60 percent of both SBAs and EAs. Given the broad coverage of exceptional financing, and therefore of potential financing needs, the analysis will report needs that are large relative to typical Fund financing.

4.   While borrowing from international financial markets by the authorities is included in the usual definition of exceptional financing (see Balance of Payments Manual, Fifth Edition), in this analysis it is treated as part of autonomous transactions. This approach allows shocks to members’ access to international financial markets—as reflected in their borrowing activity—to affect the actual BOP need, because the object is to better understand the duration of need for Fund (and other official) resources. However, there is some risk that actual borrowing takes less than full advantage of market opportunities, in which case the duration of the estimated need for official resources would be biased upward.

5.   The BOP need is affected by economic policies through both the balance on the external current account and the balance on the capital and financial accounts excluding exceptional financing. The BOP need most pertinent to this analysis is that which arises under sound economic policies given other shocks, because the Fund arrangement—and other associated exceptional financing—is designed to meet this need.³ If policies were stronger in the sense of increasing the (autonomous) overall balance, the actual needs would be smaller and shorter in duration than otherwise, and vice versa.

6.   In the analysis, the medium-term BOP projections from the original program document are used as the source for the targeted change in reserves. For most arrangements these projections will maintain a suitable level of reserves, but in some cases constraints on the availability of exceptional financing mean that projected reserves will remain rather low. If the opportunity arose, the reserve projections would be increased to a more comfortable level. In these cases the level of the underlying BOP need is understated by the use of the original reserve projections. This weakness in the data for this subset of arrangements, should, however, affect duration considerably less than the level of need, because there will be few additional cases where needs are eliminated earlier than otherwise due to the wide variance in the overall balance of payments relative to the magnitude of the understatement of the reserve target. This weakness, could, in any case only be avoided by adopting a rule to set the reserve targets, but such a rule would likely be inferior in most cases to the judgements reflected in program projections.

C.   Characteristics of Projected BOP Financing Needs

7.   There is substantial variation in the size and duration of projected BOP needs of members requesting a nonprecautionary arrangement, as shown in the lines representing each arrangement in Figure 1 (upper panels). Nevertheless, on average the needs of members seeking a SBA are projected to decline more quickly than those seeking an EA (see the lines labeled median). In precautionary arrangements, there was no projected BOP need as expected, except in a few cases that were projected to receive exceptional financing from other sources.

8.   As expected, extended arrangements show longer projected BOP need durations than stand-by arrangements. The duration of projected BOP needs is defined as the number of years before a zero need is found, implying that the targeted change in foreign reserves would be achieved without exceptional financing (Table 2, and text Figure 2, upper panel).⁴ For every duration below 5 years, the cumulative share of SBAs exceeds that of EAs. While some 49 percent of SBAs have projected BOP needs of 3 years or less (including the initial year of the program), this is the case in only 2 of the 22 EAs in the sample.

1/  All arrangements in the MONA database (1993-99) that were nonprecautionary at the outset, excluding four arrangements with incomplete medium-term BOP projections.
2/  Duration is assessed as the number of years before the projected need equals zero.

9.   Nonetheless, a large share of SBAs have projected needs beyond the time at which repurchases begin, with needs programmed to last for 4 years or more in half of SBAs.⁵ Of the 29 “longer-term need” SBAs expiring before the end of 1998, there was a follow-up arrangement within 18 months of the expiration of the SBA in some 90 percent of cases. Follow-up arrangements are therefore used significantly more often than nonprecautionary EAs (20 during this period) to address longer-term financing needs. The composition of follow-up arrangements indicates that these SBAs are commonly used to develop a track record of policy implementation before a longer duration arrangement, either an EA or an arrangement under the PRGF (Table 3).

D.   Characteristics of Actual BOP Needs

10.   To calculate a member’s actual BOP need, the data on the actual overall balance excluding exceptional financing are substituted for those of the projected overall balance.⁶ The actual need can therefore be negative if the actual overall balance was sufficiently higher than projected, such that reserves would rise more than targeted even in the absence of exceptional financing. This outcome is not uncommon, as shown in Figure 1 (lower panels). Indeed, the median BOP need of SBAs in the first year is close to zero, though it subsequently remains at modest positive levels. The median for EAs shows an interesting pattern of a positive need in the first year, followed by signs of success in the second year as needs under most EAs fall and the median need approaches zero, but a return to positive needs on average in the third and fourth years of the arrangement. However, the small sample of EAs suggests some uncertainty about whether this characterization is reliable.

11.   Given the volatility of the actual BOP needs from year to year, the analysis of the duration of actual BOP needs is sensitive to the criterion used to define the time at which the period of BOP need ends. Three criteria are compared to illustrate this sensitivity:

Thus, half of nonprecautionary SBAs would have an absence of BOP need in the first year of the program using the same criterion as for the projected need (criterion a.). However, only a quarter of these SBAs had no need in both the first and second years (criterion b.). In some cases the needs in the second year were small relative to the reserve gains in the first year, so this latter criterion may understate the frequency of arrangements with no BOP need in the initial years. Criterion c. is used in the analysis, so that only if the absence of need in the first year is outweighed by a high level of need in the following year does the duration of the member’s BOP need continue. While this criterion should reduce the extent to which estimates of need duration are affected by the timing of BOP transactions, a significant degree of uncertainty remains unavoidable considering the volatility of needs.

12.   While there are many cases with longer-term needs, it appears that cases of medium-term needs are outweighed by arrangements with very short-term needs, if any. The incidence of arrangements with either an absence of need or very short term needs (0-1 years) is high, at 45 percent overall, and about one half of SBAs (Table 4 and text Figure 1, top panel). A substantial share of EAs also have relatively short-term BOP needs, with 35 percent of needs ending after 2 years. There is also a concentration of needs estimated to last 4 years or more, accounting for 42 percent of all arrangements, and some 52 percent of EAs. However, there appears to be little evidence of a clustering of needs at a medium-term duration, with only 26 percent of arrangements showing needs of 1-3 years

E.   Predictability of BOP Needs

13.   From the data on projected and actual BOP needs, a sample of 59 arrangements was found with estimates of both actual and projected durations (text Figure 1, Table 5).⁸ The data were consolidated into two groups: arrangements in which a medium-term BOP need was projected (1-3 years), and arrangements in which a longer-term need was projected (4 or more years).⁹ The duration of BOP needs is fairly often identified broadly correctly. In the 73 percent of arrangements in which needs are projected to be of a medium-term nature, actual needs are relatively short, at 2 years or less. In arrangements in which longer-term needs are projected, 62 percent of actual needs have a duration of 3 or more years.

Stand-by Arrangements

Number

Share, percent

Cumulative share, percent

Extended Arrangements

Number

Share, percent

Cumulative share, percent

All Arrangements

Number

Share, percent

Cumulative share, percent

Source: MONA and WEO databases and staff reports.

1/  Includes a subset of arrangements in Table 2, with the first year of the arrangement 1996 or earlier.

2/  Duration is assessed as the number of years before (i) the actual need in one year is nonpositive, and
     (ii) the combined actual need for that year and the following year is also nonpositive.

14.   However, actual needs are frequently shorter than projected, in arrangements with both longer-term and medium-term projected needs. Where longer-term needs were projected, 37 percent of needs lasted 1 year or less; where medium-term needs were projected, one third of arrangements displayed no need in even the first year. Needs also sometimes last longer than expected, with needs of 5 or more years in practice found in some 27 percent of arrangements projected to have a need of 1-3 years—virtually all of which are SBAs.

F.   Data Sources and Variable Definitions

Projected BOP Needs

15.   Projected needs were calculated from the database on Monitoring of Fund Arrangements (MONA) covering arrangements in 1993-99, a total of 61 SBAs and 22 EAs (Table 6). ¹⁰ The MONA record for the originating Board document is the source of data for each arrangement.¹¹ Exceptional financing in the MONA database includes the following (MONA variable name in brackets):

     Use of Fund Credit, net (BAFLI)
+   Other BOP Support (BEF_O)
+   Changes in External Payments Arrears (BAR)
+   Rescheduling Contracted Before Program (BDRPT)
+   Projected New Rescheduling (BDRPR)
+   Programmed Financing Gap (BEF_G)

This coverage appears appropriate relative to the definition in Table 1, though the use of Fund credit must be adjusted to exclude repurchases. Projected BOP needs were calculated as follows:

Projected BOP Need = - BAFA - (BO - REP)

Where: BAFA = Programmed change in gross reserves (- indicates an increase) (MONA)
  BO = Overall balance before exceptional financing (MONA)
  REP = Scheduled repurchase to the Fund, which is calculated as
BAFLI – originally scheduled purchases from MONA¹²

Actual BOP Needs

16.   Actual needs were calculated for the subset of the above arrangements beginning in 1996 or earlier using MONA, WEO, and IFS data.¹³ Data for EAs from 1990-92, prior to the MONA database, were entered to expand the sample of EAs to a still small 12, while data on 47 SBAs are available. Actual BOP needs were calculated as follows (using WEO variable names).

Actual BOP Need = -BAFA – (OB_WEO – REP_IFS)

Where: BAFA = Programmed change in gross reserves (- indicates an increase) (MONA)
  REP_IFS = Actual repurchases (IFS), being the annual sum of quarterly
  repurchases in SDRs converted to U.S. dollars at the quarterly average US$/SDR rate
  OB_WEO = Overall balance before exceptional financing (WEO)

OB_WEO = BCA + BKFA – BE – BFUND + BOP

Where: BCA = Balance on the current account
  BFKA = Balance on the capital and financial account, inc. exceptional financing
  BE = Exceptional financing
  BFUND = Fund credit, net
  BOP = Net errors and omissions

17.   The WEO database definition of exceptional financing is consistent with the MONA database except with respect to the inclusion of other multilateral BOP support loans. These loans are included under exceptional financing in the MONA data (i.e., BEF_O), but they are not separately identified in WEO data.¹⁴ This is the main reason why the calculated actual BOP needs are not strictly comparable with the projected BOP needs from the MONA database. Thus there is reason to expect that the WEO measures of exceptional financing would be smaller than estimates generated under a MONA classification, and the overall balance (OB_WEO) would be larger, resulting in a lower financing need. Again, this weakness in the data should affect duration substantially less than it affects the level of need, because there will be few additional cases where needs are eliminated due to the wide variance in the overall balance of payments.In any case, an examination of those arrangements where data on multilateral financing was available—from records of subseqent program documents in the MONA database—suggests that the cases where this financing was significant were already often estimated to have longer-term actual BOP needs, so the magnitude of any downward bias in estimated durations would appear to be limited in practice.

Time-Based Graduation of the Rate of Charge

There are two basic design options for time-based graduated surcharges on the rate of charge, namely to graduate charges within an arrangement or across arrangements. It would also be possible to combine elements of both basic options. Annex Figure 1 provides a simplified representation.¹

1.   Graduation within an arrangement

Under the first option (Annex Figure 1, Panel 1), the surcharge (relative to the basic rate of charge) would start out at zero, and would rise the more time had elapsed under the arrangement (either since the purchase, or since the first purchase under the arrangement). Under a subsequent arrangement, the surcharge would again start at zero, and again rise with time elapsed under that arrangement. For each arrangement, the surcharge would continue to rise until the associated purchases were repaid.²

This system would provide incentives to repurchase (rising over time). It would not provide disincentives to purchase, even for members that have had Fund credit outstanding for a relatively long time, as members would have access to Fund resources at the basic rate of charge under each new arrangement. At the same time, because the savings from repurchases would be relatively high and the cost of purchases relatively low, the system would create incentives for members to seek to refinance repurchases with new arrangements.

2.   Graduation across arrangements

Under the most straightforward variant of the second option (Annex Figure 1, Panel 2), the surcharge under a single arrangement would operate as under the previous option. However, if a new arrangement started while there was still credit outstanding from the previous arrangement, the surcharge would continue to rise from the level it had reached under the previous arrangement, instead of starting again at zero. Thus all credit outstanding would be subject to the same surcharge, which would continue to rise from the point at which Fund credit was first extended until all credit is repaid.

This system would impose a relatively high surcharge on new purchases for members that have had Fund credit outstanding for a relatively long time. This can be seen as an advantage (in that it would create disincentives for prolonged use), but also as a disadvantage (in that it would not allow members in need to use the Fund’s resources at relatively low cost, if they have had any credit outstanding up to that point). It would also provide strong incentives to repurchase in advance, especially by members that have had Fund credit outstanding for a relatively long time. The system would create discontinuities in that the surcharge would return to zero only after the member had repaid all its outstanding obligations to the Fund, no matter how small remaining obligations might be.³

Modifications to this system aimed at permitting members to make use of relatively low-cost Fund resources for an initial period of time, even if they already have Fund credit outstanding, yield a third option (Annex Figure 1, Panel 3), which combines some of the elements of the two options described above. Under this option, a surcharge, starting at zero and rising over time, applies to each successive “segment” of Fund credit (as it does to arrangements or purchases under the first option), but the surcharge on each segment continues to rise across arrangements (as in the second option).⁴ This pattern is achieved by stipulating that, for the purpose of determining the rate of charge, the most recent (and hence lowest-cost) obligations are extinguished first—a stipulation that adds complexity to the system.⁵

Like the first option, this option would not provide disincentives for purchases, including for members that have had Fund credit outstanding for some time (as in the first system, new purchases would start out at the basic rate of charge). The option would largely avoid the problem of refinancing, which otherwise arises under the first option, by ensuring that repurchases cancel out only the most recent and lowest-priced obligations (which would not be much more costly than new purchases). By the same token, the system would not create strong incentives to repurchase at the margin. Its main outcome would be to raise the average cost of Fund credit for prolonged users.

Members’ Views on the CCL

Members have conveyed various reasons for their lack of interest in the CCL to the staff:

• Uncertainty as to the market’s reaction to being part of the “CCL club” along with the risk that it would be regarded as a sign of weakness rather than strength.

• The perception that if a country planned in any event to implement good policies, then it has little to gain from requesting access to the CCL, given that in the event of a crisis the Fund has shown that it can move remarkably quickly. This is especially true for countries with the requisite track record to be eligible for the CCL.

• The perceived stigma of having any sort of Fund arrangement.

• The current relatively calm state of markets and the difficulty of explaining any eventual exit from the CCL.

• The lack of automaticity, i.e., the fear that markets would likely discount the resources the Fund would actually disburse in the event of a crisis, since they could depend on the country reaching agreement with the Fund on added conditionality.

• The rate of charge, currently the same as for SRF resources.

• The commitment fee, which seems onerous given that the resources will probably not be used.

• The narrow definition of the circumstances in which the CCL could be activated.

¹ EBS/00/37, March 2, 2000 (hereafter RoF I); and “Summing Up by the Chairman – Review of Fund Facilities—Preliminary Considerations, EBM/00/27,” BUFF/00/41, March 24, 2000 (hereafter Summing Up – RoF I). (Both of these documents are also available on the Fund’s website).

² Like the previous paper and for presentational simplicity, this paper refers generically to the Fund’s various policies on the use of its resources as “facilities,” even though this term normally refers to those policies on the use of Fund resources that are outside the credit tranches (see RoF I, paragraph 3).

³ The policies on Fund support for commercial bank debt and debt service reduction operations and currency stabilization funds were eliminated on April 13, 2000. This followed the elimination of the contingency element of the Compensatory and Contingency Financing Facility and the Buffer Stock Financing Facility on February 15, 2000, and the expiration of the Y2K facility on March 31, 2000. A paper proposing specific amendments to the CFF will be circulated to the Board shortly, for approval on a lapse of time basis.

⁴ See RoF I, Chapter I, for a full description of the existing facilities in the General Resources Account (GRA) and their terms. Following the recent streamlining of facilities, “non-core” facilities now consist of the first credit tranche, emergency assistance for natural disasters, emergency assistance for post-conflict cases, and the Compensatory Financing Facility.

⁵ A precautionary arrangement is one in which the member has expressed its intention not to make purchases. This statement is not a binding commitment and an arrangement retains its character as an instrument to provide a member with an assurance of access to Fund resources should the need arise (subject to meeting the specified conditions). The Fund does not challenge a representation of need should a member request a purchase and, if all the conditions prescribed in the arrangement have been met, the Fund will meet the purchase request. Nonetheless, there are ex post remedies available to the Fund if it determines that a purchase was requested in the absence of actual balance of payments need.

⁶ Where a BOP need disappears quickly, an arrangement may turn precautionary (even when this was not expected originally), or reserve targets may be raised during the course of the arrangement, so that a BOP need again arises; the present analysis focuses on performance relative to the original targets only. Conservatism in program projections in the first year (where reserve targets constitute performance criteria) may contribute to the high frequency of arrangements with zero need, but only to a small extent; for the need to be zero, overperformance relative to reserve targets would have to be larger than all exceptional financing combined.

⁷ The volatility of BOP needs may lead to some understatement of the prevalence of long-term needs, though the criterion used to measure duration aims to limit this effect.

⁸ See the forthcoming paper on Program Financing, External Adjustment, and Macroeconomic Policies under High Capital Mobility.

⁹ A number of reasons why BOP needs may turn out to be short are noted in Box 2 and footnote 6—for instance, conservatism in program projections of market borrowing. An analysis of this question would be an important element of a review of conditionality, but is beyond the scope of the present paper.

¹⁰ The SBAs with relatively long projected needs were mostly used as a prelude to extended arrangements or arrangements under the PRGF (see Annex II).

¹¹ This analysis is based on information contained in the database on Monitoring of Fund Arrangements (MONA). The number of measures per annum is derived as the total number of measures over the period during which measures were fully specified, divided by the length of that period. The structural measures considered are only those subject to formal conditionality, i.e., prior actions, structural performance criteria, structural benchmarks, and conditions for completion of reviews. This definition was chosen because a count of all structural measures included in a program (for instance, in a structural policy matrix) would depend strongly on the level of disaggregation at which the measures were presented, and would give equal weight to measures considered to have widely varying importance. For the latter reason, the numbers presented here may still not tell the whole story; strong programs sometimes have just a few crucial structural measures. These measurement problems should be of minor importance in an aggregate comparison of SBAs and extended arrangements, but preclude a more disaggregated analysis.

¹² See Summing Up, RoF I.

¹³ “Non-core” facilities (see footnote 4) will not be considered. However, it should be noted that “non-core” facilities—especially those in the credit tranches, namely the first credit tranche and the two types of emergency assistance—could be affected by the changes proposed in this paper, depending on how these were implemented. Many consequential changes could be prevented, however, if this were desired, either by tailoring the changes to core facilities appropriately or, in the case of emergency assistance, by turning it into a special facility. In addition, if changes were made to the terms of the credit tranches, the Board might wish to reconsider the terms of the CFF, with an eye on the incentives members would face to make use of one or other of these facilities. These issues will be addressed in the follow-up paper.

¹⁴ The focus here, as in the remainder of the paper, is on actual use of Fund resources by members, rather than on arrangements per se. Many of the benefits of arrangements with the Fund—discipline on policy-making, positive externalities, catalytic effects—derive to some extent from the very existence of an arrangement (which may be precautionary) (see RoF I, pages 47-48). The present paper generally starts from the premise that an arrangement exists, and considers the terms and conditions that affect whether members use Fund resources in this context, and how quickly they repay.

¹⁵ Some of these drawbacks would also be alleviated if the Fund had a well-functioning policy linking early repurchase to balance of payments improvements. Such a policy would align early repurchase requirements with the observed (not projected) individual circumstances of members, and would reduce the need for ex ante distinctions. However, the staff strongly doubts that the policy could be made to work at the level of sophistication that would be required to make ex ante distinctions superfluous (see Section B (iii) below).

¹⁶ As noted above, this discussion abstracts from the “non-core” facilities in the GRA—the first credit tranche, emergency assistance for natural disasters and post-conflict cases, and the CFF—as well as from the PRGF.

¹⁷ All surcharges discussed in this paper are with reference to the current rate of charge on GRA resources. Related issues arising from the options considered in this paper on the rate of charge will be considered in the follow-up paper.

¹⁸ The basic rate of charge on GRA resources is the SDR interest rate (a weighted average of rates on short-term, high-quality financial instruments in France, Germany, Japan, the United Kingdom, and the United States), with a margin to achieve a target level of net income (see RoF I, Annex II, for a detailed description). Data on outstanding bonds issued by emerging markets indicate that the average spread faced by emerging market countries over the 1990s was some 300 basis points, and almost never dipped below 200 basis points. These spreads are relative to US Treasury bonds of equivalent, medium- to long-term maturity. The spread relative to three-month US Treasury bill interest rates, which enter into the calculation of the rate of charge on GRA resources, would normally be larger.

¹⁹ Members making use of SRF resources, which carry a surcharge of 300-500 basis points over the rate of charge on GRA resources, have in general made repurchases ahead of the dates of repurchase expectations.

²⁰ This type of graduation exists in the case of the SRF and CCL, where it starts from the date of the first purchase.

²¹ The timing of the first step increase of 50 basis points of the time-based surcharge under the SRF and CCL coincides with the timing of the first repurchase expectation (one year).

²² The possibility of refinancing is limited under the SRF and CCL, as SRF/CCL resources are available only under narrowly defined circumstances. More generally, the Fund could curtail access to its resources when members appear to be seeking refinancing. However, it might have difficulties in doing so in practice, and in doing so it might need to be more restrictive in granting precautionary arrangements, which may be desirable on other counts.

²³ The fact that the rate of charge rises as long as the member has any Fund credit outstanding, however small, would also create discontinuities that would complicate members’ decisions (essentially, the repayment of the last SDR outstanding would have an enormous impact on the rate of charge on new purchases).

²⁴ The system of graduation in effect prior to the unification of charges in 1981 was a variant of this option designed to avoid new Fund lending at the highest surcharge. This system applied new schedules of time-based graduation to each “segment” of Fund credit. A drawback of the system was that the determination of segments, their evolution over time, and thus their pricing was based on an attribution method that divorced segments from the actual schedule of purchases and repurchases.

²⁵ The level of credit outstanding would be defined as use of Fund resources in the GRA—including under stand-by and extended arrangements and under non-core facilities (first credit tranche, CFF, emergency assistance). It would not include use of Fund resources under the PRGF.

²⁶ It is assumed, for the purposes of this paper and in line with the Board’s previous discussion, that the rate of charge on the SRF will stay unchanged, with a surcharge above the basic rate of charge starting at 300 basis points and rising to 500 basis points.

²⁷ It could be argued that a surcharge should focus on providing incentives to repurchase rather than disincentives to purchase because the Fund has significantly more control over purchases (through access decisions) than repurchases (until the repurchase dates). However, the Fund’s control over access decisions does not provide full protection against unduly large purchases, since the decision to draw under a precautionary arrangement rests with the member (with some capacity for ex post challenge by the Fund) (see footnote 5).

²⁸ Consideration might be given to shortening the maximum length of a stand-by arrangement in this context, since balance of payments needs would not be expected to continue into the period when repayments fall due.

²⁹ The final repurchase period under the EFF was eight years when it was created in 1974; it was increased to ten years in 1979, in the wake of the second oil price shock.

³⁰ It would be possible both to shorten the schedules of repurchase obligations and to introduce repurchase expectations into arrangements (although with shorter repurchase obligations there would be less room to introduce repurchase expectations, and hence less to gain from them). For simplicity, the two options are discussed here as alternatives rather than as complementary approaches.

³¹ See Chapter V below for a discussion of post-program monitoring, including in cases where a member may have requested an extension of repurchase expectations.

³² This form of repurchase expectations exists under the SRF and the CCL, neither of which is expected to be frequently used.

³³ While three-year stand-by arrangements were rare in the past, they became more common with the Asian crisis. The crisis countries needed to implement structural reform measures that justified these longer arrangements, but it was expected that these arrangements would turn precautionary (which indeed is what happened in Thailand, Korea, and Brazil).

³⁴ See RoF I, Annex III, for further explanation of the early repurchase policy.

³⁵ The Fund also uses such judgments, for instance, in the determination of access levels under arrangements. However, because, once they have made purchases, members are committed to abide by the terms of the Fund’s early repurchase policy, it is especially important that this policy be sufficiently clear that members know what to expect.

³⁶ RoF I provides a more in-depth discussion of the relative roles and advantages of the CCL and precautionary arrangements (pages 42-44).

³⁷ The original deadline of May 5, 2000, was extended to end-August, 2000, on April 28, 2000.

³⁸ The Chairman’s Summing Up on Contingent Credit Lines, EBM/99/48, April 23, 1999.

³⁹ An alternative would be to increase substantially the amount available on approval of the commitment under the CCL. This approach, however, would allow the member to draw this amount for any balance of payments need, and not just for a contagion-driven crisis. It would also be closer to a traditional Fund arrangement, since some mechanism (presumably resembling traditional conditionality) would need to be instituted to ensure that the amount does not remain available if the member’s policies go off track.

⁴⁰ This calculation takes into account the fact that an arrangement with CCL resources will typically include credit tranche resources up to the equivalent of 100 percent of quota (since credit tranche resources are provided up to the annual or cumulative limit on access under the credit tranches).

⁴¹ The commitment fee is not refunded if an arrangement expires and is not fully drawn. Partial refunds are made when arrangements are canceled.

⁴² The typical commitment fee is one half to one percent.

⁴³ See conditions (i) and (ii) for the activation review, paragraph 71. The term “contagion” is used here as a convenient label to describe condition (ii) for the activation review.

⁴⁴ Indeed, with the CCL remaining, for the moment, an untested facility, it would not be surprising if a member wished to test it for a limited period, subject to a reconsideration of its costs and benefits at a later date.

⁴⁵ The CCL Summing Up states “a member should have in place, or demonstrate that it is making credible efforts toward putting in place, appropriate arrangements to involve the private sector. These might include, by way of example, (i) contingent private credit lines or similar arrangements, (ii) call options in debt instruments, (iii) terms and conditions in recent and forthcoming bond contracts that include provision for the adjustment of terms by qualified majorities, collective representation provisions, and sharing clauses, (iv) as they are developed, other debt instruments designed to provide efficient and appropriate insurance against shocks, (v) a framework for debtor-creditor discussions, (vi) effective debt management procedures, and (vii) strong domestic bankruptcy regimes.” (The Chairman’s Summing Up on Contingent Credit Lines, EBM/99/48, April 23, 1999.)

⁴⁶ The Board last discussed post-program monitoring on October 29, 1997. There was substantial support for some form of post-program monitoring, but a number of Directors were not convinced of the need for a new policy or the form it might take, and the discussion did not come to a conclusion.

⁴⁷ It would be possible—as it is with Article IV consultations—for the Board to conclude a PPM discussion on a lapse-of-time basis, if no major issues had arisen.

⁴⁸ Outstanding Fund credit would be defined as use of Fund resources in the GRA—including under stand-by and extended arrangements and under non-core facilities (first credit tranche, CFF, emergency assistance). Outstanding credit would not include use of Fund resources under the PRGF. Arrears cases would not be included, as they are subject to separate procedures. If a member exceeded the threshold of 100 percent of quota on account of an outright purchase (e.g., under the CFF), it would normally become subject to post-program monitoring based on the consultation clause in earlier arrangements (it is very unlikely, though not impossible, that the threshold of 100 percent of quota would be reached without a stand-by or extended arrangement). As of end-May, 2000, there were three members that had Fund credit outstanding (in the GRA) in excess of 100 percent of quota, and had no arrangement with the Fund.

⁴⁹ Under Article V, Section 3 (b)(iii), a member’s entitlement to use the Fund’s general resources is limited to an amount that would not cause the Fund’s holdings of the member’s currency to exceed 200 percent of its quota (i.e., Fund credit to exceed 100 percent of quota). Article V, Section 4 permits the Fund to waive this limitation for use of Fund resources above this level.

⁵⁰ Although there would be no automatic application of PPM in PRGF cases (see footnote 48), the Board would also have this discretion in these cases. PRGF arrangements include a consultation clause, similar to those in stand-by and extended arrangements, that calls for the member to consult with the Fund, at the request of the Managing Director, on economic and financial policies as long as obligations are outstanding.

⁵¹ More serious sanctions, such as triggering an early repurchase expectation or obligation, could be considered, but these could be counterproductive, raising the stakes in already strained discussions.

⁵² In this context, it is worth bearing in mind that if such differences of view on policies arose during an arrangement, the only consequence would be an interruption in the arrangement. There would be no question of early repurchase expectations or other sanctions being triggered.