Public Information Notice No. 02/26

Public Information Notice: IMF Board Discusses Modalities of Conditionality

March 8, 2002

On January 28, 2002, the Executive Board of the International Monetary Fund (IMF) conducted further discussions on the modalities of conditionality as part of an ongoing review of conditionality attached by the IMF to the use of its financial resources.

Background

The IMF is currently engaged in a process of reviewing the conditions attached to its financing. The aim is to ensure that conditionality in Fund-supported programs is designed and applied in a way that reinforces national ownership and sustained implementation of country economic reforms. To this end, the current review emphasizes the need to focus conditionality on those policies that are critical to achieving the macroeconomic objectives of the programs supported by the Fund and to establish a clearer division of labor with other international institutions, especially the World Bank. The process was initiated by Managing Director Horst Köhler shortly after taking up his position in May 2000 and the Executive Board discussed a series of earlier papers on this topic in March 2001 (see Public Information Notice No. 01/28), in July 2001 (see Public Information Notice No. 01/92), and in November 2001 (see Public Information Notice No. 01/125).

Executive Board Assessment

In the context of the discussion of the modalities of conditionality in January 2002, Directors considered proposals for greater use of outcomes-based conditionality and floating-tranche disbursements, and reviewed the use of various tools of conditionality, including performance criteria, prior actions, and program reviews guided by indicative targets and structural benchmarks. Directors stressed the need to apply the modalities of conditionality flexibly and to take into account country- and program-specific circumstances, consistent with the objective of enhancing the effectiveness of Fund conditionality through streamlining, focusing, and enhanced ownership.

Outcomes-Based Conditionality and Floating Tranches

Directors broadly welcomed proposals to base IMF conditionality to a somewhat greater degree on outcomes rather than on the implementation of specified actions by the authorities. Outcomes-based conditionality would give the authorities greater flexibility and accountability in choosing how to achieve the desired results, which would enhance national ownership of policy programs and reduce the degree of detail with which the IMF monitors the implementation of reforms. Directors noted, however, that the scope for outcomes-based conditionality is likely to be limited by the need for timely disbursements and for avoiding inappropriate policy actions. Moreover, when conditionality is specified on outcomes rather than actions, the authorities are exposed to the risk that the desired results may not be achieved notwithstanding their own best efforts. Some Directors also cautioned against a weakening of program focus on critical aspects of institution building. Greater application of outcomes-based conditionality would therefore have to be handled with care and moderation and on a case-by-case basis, to avoid its potential disadvantages. In cases where a long time period is needed to achieve the final outcome, some intermediate outcomes on which disbursement will be based may be agreed between the authorities and the Fund. A range of views was expressed on the scope for moving toward greater use of outcomes-based conditionality, in view of these potential disadvantages, but, on balance, Directors agreed that some shift in this direction would be feasible and desirable, where appropriate, particularly in the context of Poverty Reduction and Growth Facility and Extended Fund Facility arrangements, given their medium-term focus on structural reforms. In this connection, many Directors stressed that the Fund should stand ready, in particular in cases where administrative capacity is weak, to advise countries on a range of available policy options and implementation plans so as to enable them to make informed choices.

Directors discussed proposals for some of the Fund's financing to be provided in floating tranches linked to the implementation of specified structural reforms. The Fund has already used floating tranches in some specific circumstances: in supporting debt restructuring under the Brady Plan in the late 1980s and in triggering completion point assistance under the Highly Indebted Poor Countries Initiative. Directors noted that greater use of floating tranches could enhance ownership by giving the authorities greater flexibility in choosing the timetable on which reforms—particularly structural reforms—are implemented. Floating tranches would, however, not be suitable for measures that must be implemented on an agreed timetable to achieve macroeconomic or external stabilization. Some Directors also felt that having multiple disbursement mechanisms would unduly complicate Fund programs. In any case, with the streamlining of conditionality to concentrate on macro-critical measures, Directors expected that the scope for using floating tranches will remain limited in the IMF's work.

Tools of Conditionality

Directors generally agreed that the existing conditionality toolkit remains appropriate, with each of the tools serving a distinct and essential role. At the same time, they noted that, in some instances, the inappropriate use of the tools of conditionality may be symptomatic of deeper weaknesses in program design, ownership, and selectivity, which need to be addressed more directly rather than by restructuring the toolkit.

Directors discussed the Fund's policy in granting waivers of non-observance of performance criteria. They noted that waivers lend an indispensable element of flexibility in applying performance criteria, enabling a program to be adapted successfully in the face of unavoidable uncertainties about macroeconomic relationships and shocks, particularly those beyond the control of the authorities. At the same time, they observed that waivers are often an indication of poor policy implementation and/or a lack of realism in program design, including failure to take account of limited implementation capacity. In this light, Directors expressed concern that, over the past several years, there had been an increase in the overall numbers of waivers and a significantly higher incidence of waivers for structural performance criteria. Directors believed that waivers should become less frequent as conditionality is focused on measures that are critical to program objectives, and ownership is strengthened, while stressing the need to preserve the flexibility that waivers provide in adapting programs to changing circumstances. Several Directors cautioned, however, against the presumption that fewer waivers would be granted in the future, particularly in the current environment of increased uncertainty. Directors stressed the need to adhere more closely to the existing policy that, in cases of significant policy slippages, waivers should be granted only if appropriate corrective action has been taken to achieve the objectives of the program.

Directors agreed that prior actions serve an important purpose in underpinning the upfront execution of urgent and critical reform measures, putting in place necessary conditions for successful program implementation, especially in cases where Fund financial assistance is frontloaded. At the same time, Directors broadly agreed that, like other forms of conditionality, the use of prior actions should be streamlined and focused on those measures needed for programs to achieve their objectives. Directors expressed a range of views about the increasing use of prior actions, especially as signals of the authorities' commitment to implement the program in cases where past performance has been unsatisfactory. Many Directors noted that experience points to only limited usefulness of prior actions in this respect, and expressed concern about the strain that large numbers of prior actions place on countries' implementation capacity. These Directors were in favor of more strictly adhering to the existing policy that prior actions should be used sparingly. Directors considered that greater selectivity, including some period of successful implementation before committing IMF financing, would, in some cases, be the preferred course of action to address instances of past poor performance. At the same time, many Directors considered that, in cases that are less clear-cut, prior actions remain essential tools to demonstrate country ownership and commitment to reform.

A few Directors suggested establishing a threshold for the number of prior actions per program. While considering the importance of not overloading program with prior actions, on balance, however, Directors were of the view that the number of prior actions is not as important as to how effectively they contribute to a high quality economic program.

Directors also discussed the procedures by which the Board is informed of prior actions envisaged in programs currently being discussed with the authorities. They noted that a timely dialogue between Executive Directors and staff could be helpful, particularly in cases in which some prior actions may be contentious. They therefore asked management and staff to make more systematic use of existing informal procedures to keep the Board abreast of possible prior actions.

Directors noted the key role played by program reviews in the assessment of policy implementation, particularly in establishing the forward-looking viability of the program and in monitoring aspects of structural reform for which performance criteria are a less effective monitoring tool. This role has increased in recent years, in large part as a result of greater uncertainties about macroeconomic developments as well as the increasing importance of structural reforms. Directors envisaged that reviews could become even more important as the use of other forms of conditionality—performance criteria and prior actions—is streamlined, while stressing that this evolution should go hand in hand with a clear delineation of the scope of program reviews. Some Directors cautioned against using program reviews to escalate conditionality, and emphasized that performance criteria should remain the primary basis for decisions about disbursements under the program. Directors noted that the frequency of reviews had crept upward in recent years. In general, they reaffirmed the existing policy that reviews should normally be semiannual, while acknowledging that, in certain cases, there may be reasons for more frequent reviews—notably in crisis cases, given the rapid pace of changing events and the scale of Fund resources committed. Several Directors stressed that, in cases where reviews are delayed, even though performance criteria have been observed, it is important that the reasons for the delay are clearly understood by the parties involved, and that the Executive Board is informed.

To improve clarity and transparency, Directors stressed the importance of ensuring that the nature and boundaries of the Fund's conditionality are presented clearly in all Fund documents. In this connection, they welcomed the proposal to include in all staff reports on the use of Fund resources a single standardized table showing all the elements of conditionality that will be applied in a given case. Some Directors also expressed interest in periodic reviews of the application of conditionality.

Next Steps

As the next step in a series of discussions that have taken place over the past year, the Executive Board will distill the lessons from the review of conditionality, including from real-time assessments of the coverage of conditionality in each country case. The outcome of the January 28, 2002 discussion of the modalities of conditionality, as well as of the other discussions forming part of the conditionality review, will factor into the Fund's reassessment of its Guidelines on Conditionality, which is tentatively scheduled to take place by the time of the 2002 Annual Meetings.

In parallel to the present review of conditionality, Directors encouraged staff to continue with work reviewing the program design to determine whether improvements are warranted and feasible based on experience with IMF-supported programs under various circumstances. They saw such work as essential in bringing analysis and experience to bear in enhancing the success of Fund-supported programs. In this connection, Directors also noted the importance of further progress with the operationalization of IMF-World Bank cooperation on program design.