Public Information Notice No. 03/146

Public Information Notice: IMF Concludes Discussion on the Review of Contingent Credit Lines

December 19, 2003

On November 26, 2003, the Executive Board of the International Monetary Fund concluded its review of the Contingent Credit Lines. The facility expired on its scheduled sunset date of November 30, 2003.

Background

As part of its response to financial market crises in Asia and elsewhere in 1997-98, the Fund introduced the Contingent Credit Lines (CCL) in the spring of 1999 to provide a precautionary line of defense for members with "first class" policies which may nevertheless be vulnerable to financial market crises.¹ The facility was intended to provide assurances of Fund financial support in the event of financial market pressures due to external events, and to reinforce the incentives for implementing sound policies. Under the facility, a member that met the demanding eligibility criteria could draw on a large pre-specified amount of resources if hit by a financial crisis due to factors outside of the member's control.

In the fall of 2000, several changes were made to the terms of the CCL to make it more attractive. These changes led to more automatic access to the first portion of the loan. In addition, the interest rate on the CCL was reduced relative to that applying to the Supplemental Reserve Facility, a facility used to support member countries that are already experiencing a crisis. The commitment fee was also reduced.

The CCL remained unused and, in March 2003, the Executive Board began a review of the facility.² It discussed a staff paper which reviewed the main reasons that member countries may not have found the CCL attractive, and set out several options for change. While there continued to be general support for the objectives of the CCL, there was not a broad consensus that redesigning the CCL along the lines proposed in the paper would enhance the facility's attractiveness. The Executive Board agreed that staff would explore the possibility of strengthening surveillance and improving existing Fund lending instruments to make them more effective in crisis prevention and to strengthen the Fund's capacity to respond quickly to the needs of members with strong policies.

In June 2003, the Executive Board discussed a staff paper that took a first look at possibilities to adapt an existing instrument-precautionary arrangements-to help in crisis prevention and achieve some of the objectives of the CCL.³ Precautionary arrangements are stand-by arrangements in which the country indicates its intention not to draw upon the Fund's resources unless economic circumstances deteriorate. Precautionary arrangements are quite common-there were 56 approved between 1987 and April 2003-and experience with them has generally been positive. They are typically used when balance of payments pressures are more likely to arise in the current account, though they have been used on occasion to help prevent capital account crises. The staff paper proposed several modifications designed to enhance the suitability of precautionary arrangements to crisis prevention. While there was interest in the proposed modifications, there was not sufficient support for them at that time.

In concluding the review of the CCL on November 26, 2003, the Board discussed a staff paper⁴ which outlined the issues examined thus far in the review and proposed several options to respond to the approaching sunset date for the CCL. The options included: (i) a brief extension of the expiration date for the CCL; (ii) further study of precautionary arrangements for crisis prevention; and (iii) an enhanced monitoring policy that would combine higher frequency surveillance with moderate access to Fund resources.

Executive Board Assessment

During their review of the Contingent Credit Lines (CCL), which began in March of this year, Directors have given extensive consideration to further modifications of the facility, as well as to alternative ways to achieve its objectives. Directors welcomed the opportunity today to review those proposals and discuss options for the way forward, including the further exploration of how precautionary arrangements could be structured to support members that might be subject to capital account shocks.

Most Directors have again taken the opportunity to express their broad support for the objectives of the CCL. The CCL was established in 1999 to help prevent the spread of financial crises by encouraging members to pursue strong economic policies and providing qualifying members with a precautionary line of defense against financial contagion. Directors noted that, despite the modification of the facility in 2000, the CCL has remained unused. Against this background, Directors considered the question of whether to allow the facility to expire as scheduled on November 30, or to agree to an extension of the CCL.

Many Directors considered that the CCL's sunset clause should be extended for a short period of time. These Directors expressed the view that the CCL should not be allowed to lapse before its design has been improved or alternative means have been found to achieve its objectives. They were concerned that expiration of the CCL now would seem to leave a gap in the Fund's toolkit for crisis prevention given remaining imperfections in the functioning of international capital markets, and might be misinterpreted as a weakening of the credibility of the Fund's commitment to help countries with good policies become more resilient to crises. A few of these Directors felt that the CCL instrument had provided an incentive to countries to pursue good policies, even if it has not been used.

A number of other Directors favored the expiration of the facility as scheduled. These Directors saw little prospect that the CCL would be used if extended-even if modified- and did not believe that its expiration would leave a gap in the Fund's toolkit for crisis prevention. Some of these Directors also reiterated their concerns about fundamental problems with the approach taken with the CCL.

In sum, while there is strong support among many Directors to extend the CCL, overall support among Directors for this approach falls well short of the 85 percent of votes necessary to extend the facility. The CCL will therefore expire on November 30, 2003, in accordance with the sunset clause built into the decision on the CCL.

Today's discussion highlighted a number of considerations that, in the view of many Directors, should help dispel possible concerns raised by the scheduled expiration of the CCL:

• First, as the Fund's record of helping members facing capital account crises shows, the Fund stands ready to move quickly and flexibly to approve the use of Fund resources and to adjust the level and the phasing of access to the member's need when conditions so require and permit;
  
  
• Second, the Fund's strengthened surveillance, support for greater transparency, and technical assistance operations are contributing to promoting sound policies, and helping to prevent crises more generally; and
  
  
• Third, recent innovations in the financial architecture, improvements in market differentiation across different borrowers, and stronger policy efforts by many emerging market countries seem to have lessened the threat of contagion that the CCL was intended to avert.

Despite these improvements, many other Directors still believed that the CCL should have been extended.

As several Directors have observed, the Fund-as a learning institution-will continue to assess the range of its instruments and policies with a view to exploring the room for further improvement. Against this backdrop, most Directors have expressed interest in considering further possible ways in which the Fund could develop its lending instruments to encourage members to pursue strong policies that limit the risk of financial crises, while providing them with a precautionary line of support should a crisis emerge. In this connection, they asked the staff to explore the way precautionary arrangements could be structured to support members that might be subject to potential capital account shocks. Many of these Directors stressed that such an approach should be pursued on its own merits, as it would not fully achieve the objectives of the CCL.

Directors have raised a range of important issues that will need to be carefully examined if precautionary arrangements with access beyond normal limits are to be used as a tool for crisis prevention. These issues relate to the specific circumstances and potential balance of payments needs that these arrangements would aim at addressing; the application of the exceptional access criteria; and the use of SRF resources in precautionary settings. Some Directors saw merit in exploring the coupling of precautionary arrangements within normal access limits with an explicit recognition by the Fund of its readiness to augment access if needed. Some Directors also called for a more careful analysis of the implications of allowing exceptional access in precautionary arrangements, in particular of their potential impact on debtor behavior, on creditor behavior, and on the Fund's finances. Many Directors were of the view that the use of precautionary arrangements with high access should remain limited, with some Directors suggesting that they only be used to support a member's exit from exceptional use of Fund resources. A few Directors expressed interest in a broader review of Fund facilities.

Directors also considered the option to establish an Enhanced Monitoring Policy, which would provide a framework for close Fund monitoring, without performance criteria, and with a limited financial backstop. Directors generally felt that such a policy would not be effective in meeting the CCL's objectives, and-given its great similarity to precautionary arrangements-would not be a useful addition to the toolkit of existing financing facilities. A number of Directors, nevertheless, considered that an Enhanced Monitoring Policy might be a useful signaling device for low-income member countries making the transition to a pure surveillance relationship. They encouraged the staff to explore this idea further. It was also suggested that an instrument akin to the Enhanced Monitoring Policy but without a direct link to Fund financing might be a useful addition to the Fund's surveillance framework.

This concludes the review of the Contingent Credit Lines. In the context of the upcoming review of the exceptional access framework before the Spring Meetings, the staff will return to the various issues relating to exceptional access in a precautionary setting. The staff will also prepare a follow-up paper on the use of precautionary arrangements for crisis prevention in light of the many helpful suggestions made by Directors in today's discussion. Finally, the Board will next have an opportunity to consider the use of the Enhanced Monitoring Policy in the discussion of the paper on The Fund's Support of Low-Income Member Countries, scheduled for January. This discussion will also be an opportunity to consider the issue of precautionary PRGF arrangements.

ANNEX 1

Directors noted that the Contingent Credit Line (CCL) was created to help member countries with strong policies confront the challenges of more integrated capital markets by providing assurances of Fund support in the event of financial market pressures due to external events, and to reinforce the incentives for implementing sound policies. They identified a number of reasons that the CCL has not been used to date. Most important among these relate to design issues, particularly the "entry" and "exit" problems. As to the former, members were worried that a request for a CCL could be viewed, both in international financial markets and domestically, as a sign of weakness rather than strength. Concern about adverse consequences upon a member's exit from a CCL arrangement was also considered an important factor that reduced interest in the CCL. Some Directors also felt that the existing eligibility criteria might have been too restrictive, and some referred to the lack of automaticity in the design of the CCL, which reduced confidence that substantial resources would be available from the Fund in the event of need. A number of Directors indicated that, since the crises of the late 1990s, many potentially CCL-eligible countries have reduced their vulnerabilities to contagion through reserve accumulation, the adoption of more flexible exchange rate regimes, and other reforms, while financial markets seem to have become more discriminating. They noted that these changes have reduced the need for a CCL-type facility. At the same time, some Directors, based on country experiences, felt that the CCL had provided a positive incentive for countries to adopt sounder policies.

Most Directors continued to support the objectives of the CCL, which was aimed to be a proactive instrument to strengthen crisis prevention efforts, and noted that it could help sharpen the Fund's conduct of surveillance. However, Directors agreed that the CCL as presently constructed is unlikely to be used by the membership. The question they confronted was whether the CCL can be re-designed to eliminate the identified problems. In this context, they considered several possible modifications proposed by the staff.

Two options to modify the CCL were discussed. Option 1 would establish more transparent and objective criteria for determining member country eligibility for the CCL; prepare and publish a list of countries eligible for the CCL; grant more automatic access to the CCL; make the CCL available in a wider set of circumstances than financial contagion; and increase the attractiveness of the terms and conditions of CCL borrowing. There was limited interest in this option, as many Directors strongly opposed the publication of a list of members that were pre-qualified for the CCL, on the grounds that countries omitted from the list could face adverse market reactions, and because the Fund should not take on a role similar to a credit rating agency.

A number of Directors were in favor of retaining a modified CCL along the lines of Option 2, which included many of the elements from Option 1 but without the published list of eligible members. Several of these Directors thought that more explicit assessments of members' policies and vulnerability during the Article IV consultation, based on the proposed eligibility framework, would clarify eligibility sufficiently and, by identifying areas of weakness, provide an incentive for action. However, other Directors, including some who otherwise favored Option 2, were skeptical that Article IV consultations could be used to assess eligibility without falling into the pitfalls of Option 1.

Many Directors, however, believed that it would not be desirable to reform the CCL along the lines of either of the preceding options. Noting that reform had already been tried once, they felt that it would not be possible to develop a structure for the facility that would both be likely to encourage the use of the CCL, and provide for the necessary safeguards to the Fund. These Directors also felt that there is lack of demand for such a facility as noted earlier, and that, in any event, there was potential to adapt existing Fund facilities and the Article IV process to serve the purposes of the CCL. They, therefore, preferred the third option identified in the staff paper-to let the CCL expire in November 2003. A number of Directors preferred not to allow the facility to expire before viable alternatives were put in place.

It was clear from the discussion that the 85 percent majority required to extend the CCL beyond its sunset in November 2003 would not be achieved at this point in time. It was, therefore, agreed that the staff would explore the possibility of strengthening surveillance and improving existing Fund lending instruments to make them more effective in crisis prevention and to strengthen the Fund's capacity to respond quickly to the needs of members with strong policies. Some Directors were skeptical about access above the limits under the credit tranches and EFF in the context of Fund arrangements intended to be precautionary, while a number of other Directors saw merit in the idea. Directors looked forward to a staff paper following the Spring IMFC Meetings considering further the use of precautionary arrangements to help reinforce the Fund's crisis prevention and signaling role. In addition, it was agreed that the staff will return to the question of whether and how the eligibility framework set out in the current staff paper might be adapted for use in surveillance to facilitate more systematic assessments of countries' vulnerabilities. Directors will have an early opportunity to take up this issue in the context of the forthcoming discussion on the effectiveness of surveillance. The Board will consider how to best continue promoting the objectives of the CCL in light of this further work on precautionary arrangements and surveillance.

ANNEX 2

Directors welcomed today's discussion on possible ways of adapting precautionary arrangements to help in crisis prevention and achieve some of the objectives of the Contingent Credit Lines facility (CCL). They considered that precautionary arrangements have been successfully used by members in a broad range of circumstances. Precautionary arrangements have been effective instruments to signal the Fund's endorsement of a member's policy, foster close collaboration between the Fund and the member, and help boost the confidence of the international or domestic financial community in the member's policies, thus helping to ensure that a balance of payments need does not arise. In many circumstances, particularly when balance of payments pressures are more likely to arise in the current account, Directors felt that the current structure of precautionary arrangements has worked well. However, a number of Directors also considered that, particularly for members with the strongest policies, precautionary arrangements would not be an effective substitute for the CCL. They noted that, for those countries, the negative stigma to entry into precautionary arrangements could even be higher than in the CCL.

Many Directors saw potential to better tailor some precautionary arrangements in those situations where members with strong policies are nevertheless still vulnerable to capital account pressures. However, many other Directors were of the view that the existing structure of precautionary arrangements continues to serve its purpose well, and that continued application of the flexibility available in the Fund's instruments will allow the Fund to respond adequately to the specific circumstances faced by its members.

Many Directors observed that the structure of precautionary arrangements can avoid some of the factors that have limited the practical utility of the CCL. In particular, they noted that precautionary arrangements can provide incentives for the early adoption of strong policies without the broader complications of a pre-qualification regime based on eligibility criteria.

In reaching conclusions on possible changes to precautionary arrangements, Directors considered the following four areas: (i) access levels; (ii) the phasing of financing under the precautionary arrangement; (iii) reducing the interruptions in drawing rights; and (iv) program design.

Access under precautionary arrangements has typically been fairly low. While the Fund's policy on access already provides for the flexibility in precautionary settings to exceed the normal access limits, many Directors were of the view that additional steps to clarify this flexibility would enhance the effectiveness of precautionary arrangements as a vehicle of support for preventive measures for members with capital account vulnerabilities. They pointed out that, to provide a meaningful impact on market confidence where capital flows are significant, precautionary arrangements for crisis prevention are likely to need this flexibility. However, many other Directors held the view that a change in the current policy might unduly encourage the use of exceptional access, and could create moral hazard problems. These Directors underscored that the Fund's signaling of its support of a member's good policies is likely to have a greater impact on market confidence than the size of precautionary arrangements. While the recently adopted new criteria and procedures for exceptional access would apply to all arrangements, a number of Directors also expressed concern that some of these criteria would need to be adapted to fit the specific circumstances faced by members with precautionary arrangements.

The phasing of access under precautionary arrangements normally provides for a gradual accumulation of the amount available for purchase over the duration of the arrangement. Many Directors considered that a phasing more similar to that of the CCL would better suit precautionary arrangements for crisis prevention. This would provide for a precautionary first purchase of fixed size, whether drawn early or later in the arrangement, with the phasing of remaining amounts of access to be set only if and when the first purchase is drawn. These Directors underscored that the size of the first purchase would need to be significant to be an effective crisis deterrent. Many other Directors, however, pointed out that pre-committing a large first purchase entails risks, and that the Fund has sufficient flexibility to front-load or augment access as needed under appropriate circumstances. These Directors therefore did not see the need for a change in the normal policies on phasing.

Directors recognized that the current structure of Stand-By Arrangements causes interruptions in a member's rights to make purchases. While the Board can grant waivers of applicability to address problems created by this "sawtooth" pattern, members with precautionary arrangements may nevertheless be uncertain regarding the availability of Fund resources in the event of need. This could lessen the crisis prevention benefits of precautionary arrangements, or create an incentive to purchase preemptively. A suggestion was made that precautionary arrangements that are not drawn should not be counted for the definition of prolonged use of Fund resources.

Directors expressed a variety of views on options that could be envisaged to help address these concerns. Many Directors were in favor of extending drawing rights to pre-specified dates following test dates when new data would become available. However, many other Directors cautioned that this would reduce the level of safeguards for Fund resources too much and could increase the risks of Fund disbursements in situations where a program is off track. Some Directors expressed interest in an approach that would provide for greater use of activation reviews, although other Directors felt that this would not provide for adequate assurances that financing would be available should a need arise. There was little interest among Directors for an approach based on high-frequency performance indicators.

A number of Directors observed that, for those members whose existing policy frameworks are sufficiently strong, approval of a precautionary arrangement might not require additional adjustment beyond their existing policy baseline-a possibility that is already present in existing policies. Other Directors, however, expected that, based on experience, a strengthening of the member's policy framework would in nearly all cases be part of the appropriate response.

On balance, there is not sufficient support for the proposed modifications to precautionary arrangements at this time. There was some interest among many Directors to consider technical changes on phasing and the sawtooth problem. If, in a specific country case, these issues appear particularly important, staff may return to the Board with concrete suggestions in these areas.

I have noted that a number of Directors reiterated their strong support for extending the CCL, but that there was not enough support at this time to extend the facility after its expiration date. Directors will have a further opportunity to discuss how some of the objectives of the CCL might be met by surveillance in the forthcoming discussion on strengthening surveillance. Directors will have the opportunity to take up the issues and the question of finalizing the CCL review following the Annual Meetings.

² See "Review of Contingent Credit Lines" (SM/03/64, February 12,2003) and Annex 1.

³ See "Adapting Precautionary Arrangements to Crisis Prevention" (SM/03/207, June 11, 2003) and Annex 2.