Public Information Notice No. 04/19

Public Information Notice: Follow Up on the Recommendations of the Independent Evaluation Office Report on Fiscal Adjustment in IMF-Supported Programs

March 11, 2004

On March 1, 2004, the Executive Board of the International Monetary Fund (IMF) discussed Follow Up on the Recommendations of the Independent Evaluation Office (IEO) Report on Fiscal Adjustment in IMF-Supported Programs.¹

Background

At an August 29, 2003 Executive Board discussion of the IEO evaluation on fiscal adjustment in IMF-supported programs, Directors endorsed most of the IEO recommendations and looked forward to an action plan that would operationalize them.² In response to Directors' call, staff prepared a paper that presents new initiatives, as well as several strands of ongoing work, to address the IEO recommendations that the Board supported.

The IEO evaluation found no evidence to support some of the most common criticisms of fiscal adjustment in IMF-supported programs—notably that IMF-supported programs adopt a "one-size-fits-all" approach, are inflexible, cause a decline in social spending, and are associated with lower growth. Nevertheless, the IEO identified room for improvement in some important areas. They called for a clearer articulation of the rationale for the magnitude and pace of fiscal adjustment in IMF-supported programs. The IEO also pointed to over optimism of growth forecasts, which may at times have led to a contractionary bias in fiscal design, and called for more realistic growth projections. They also called for IMF-supported programs and IMF surveillance to place greater emphasis on structural and institutional fiscal reforms. Finally, the IEO drew attention to the importance of protecting critical social spending in program design.

The main new initiatives of the action plan submitted to the Board were: i) preparation of a guidance note for staff on the presentation of the rationale for the magnitude and pace of fiscal adjustment; ii) an analysis, in the forthcoming conditionality review, of the Fund's track record in growth projections and of the scope for countercyclical fiscal policy; iii) heightened attention to structural/institutional fiscal reforms in programs and surveillance, including via better use of Fiscal Strategy Briefs, and in 10-15 countries via a special focus in this area in the next Article IV Consultation; iv) consideration, in the 2004 Biennial Surveillance Review, of when and how social issues should be dealt with in Article IV consultations.

Further, as building successfully on the IEO work and related guidance from the Board will require effective absorption of the relevant lessons across the Fund, the staff is using a range of internal dissemination modalities to ensure that these initiatives are adequately reflected in the Fund's work to the benefit of member countries.

Executive Board Assessment

Executive Directors welcomed the opportunity to discuss the actions that the staff is implementing and proposes to undertake to operationalize the IEO recommendations on fiscal adjustment, as discussed by the Executive Board on August 29, 2003. They noted that fiscal adjustment is often a critical and keenly-debated aspect of Fund-supported programs, and emphasized the need for expeditious and comprehensive action to follow up on the areas identified by the IEO for improvement. Directors supported the thrust of the staff's proposals, although some Directors felt that the proposals could have gone further. They called for effective implementation of the proposals and close monitoring by both the staff and the Executive Board, in the context of both Fund-supported programs and Fund surveillance.

Directors were pleased that the staff's proposals resulted from a wide consultation process within the Fund. They welcomed the staff's efforts to disseminate the lessons of the IEO report within the Fund, using a multi-pronged approach. They stressed that the impact of the IEO's work in enhancing the Fund's effectiveness in serving its members depends critically on the absorption capacity of the institution as a whole.

Most Directors agreed that the shortcomings identified by the IEO report in the fiscal area could be addressed by fostering the generalization of best practices, and that new formal requirements or a fundamental redirection of the staff's efforts were not necessary. They emphasized the need for selectivity and careful judgment in identifying the crucial issues on which the Fund should focus in each country case.

Directors supported the staff's efforts to address the IEO's recommendations within the existing resource envelope, and felt that the resulting action plan was in line with what they had envisaged in their discussion last August.

Regarding Recommendation 1 of the IEO report, on the need to justify fiscal adjustment more fully and link it more explicitly to growth, Directors welcomed the preparation of a guidance note for the staff on the presentation of the rationale for the magnitude and pace of fiscal adjustment, which should, over time, be reflected in an improvement in the extent to which staff reports justify the fiscal targets, or changes in the fiscal targets, agreed with country authorities. However, Directors emphasized that individual country circumstances may require significantly different treatment from case to case.

Regarding Recommendation 2, on the desirability of earlier consultation in the review process, Directors were encouraged by the increasing prevalence of interdepartmental pre-brief meetings and noted their role in promoting internal debate about critical policy issues at an early stage. A few Directors encouraged the staff to provide information to the Executive Board, in an appropriate manner, on the possible alternative approaches that emerged during interdepartmental discussions, as this would enrich the Board's understanding of the issues and trade-offs presented in each country case.

Regarding Recommendations 3 and 4, on the need for increased focus on the formulation and implementation of key structural and institutional fiscal reforms, Directors saw the staff's proposal to encourage wider use of Fiscal Strategy Briefs and produce 10-15 Article IV reports over the next year with a special focus on the fiscal reform agenda as a constructive way, at least initially, of resolving the tension between heightened concentration on these issues and resource constraints. It was also noted that for countries requiring intensive fiscal treatment, priority attention and resources should be directed to them whether or not the country had benefited from a Fiscal Strategy Brief. In addition, while agreeing that a case-by-case approach is necessary when dealing with structural and institutional issues, Directors considered that more extensive cross-country analysis of structural fiscal issues would be helpful in drawing common elements from the vast experience accumulated by the Fund. They also encouraged the staff to include in staff reports short assessments of progress in implementing previous Fund policy advice and the recommendations of technical assistance and Reports on the Observance of Standards and Codes (ROSC) missions, as well as to identify constraints on reform by distinguishing among those requiring legislation, executive action, and capacity building.

Directors agreed that the inclusion of structural and institutional fiscal reforms in programs and related conditionality should continue to be guided by the 2002 conditionality guidelines. They noted that overall progress in structural and institutional fiscal reform is often macro-critical in Fund-supported programs, particularly with respect to medium-term fiscal sustainability. Directors recognized, however, the practical problems involved in applying conditionality in this area—namely, the difficulties involved in identifying specific small steps in the process of reform as critical, and the need to specify required steps with sufficient clarity that their observance may be objectively monitored. They looked forward to further discussion of the appropriate modalities of conditionality in this area as part of the review of the 2002 conditionality guidelines.

On Recommendation 5, to delineate better the Fund's involvement in social issues, Directors reiterated that the Fund does have a role to play in the social sector—while emphasizing that the World Bank is the lead agency in this area. They welcomed the staff's efforts to focus, in close collaboration with the World Bank, on protecting critical social spending and incorporating the costs of social safety nets into program design.

Directors looked forward to an analysis of the Fund's track record in growth projections and its implications for program design, to further analysis of the scope for countercyclical fiscal policy in the context of financing constraints and debt sustainability concerns, and to consideration of the tendency for fiscal adjustment to take place during the first year of a program, in the 2004 conditionality review. They also looked forward to examining, in the 2004 biennial surveillance review, the proper coverage of social issues in Article IV consultations, as well as the specific IEO suggestion that the staff should inquire during Article IV consultations whether the authorities have identified critical social programs that they would like to protect in the event of a crisis. Some Directors suggested that even this limited involvement should be left to the World Bank.

Directors recommended that the Executive Board review the progress in implementing the staff's proposals at a future date as part of the regular conditionality and surveillance reviews, and that these reviews address specifically how the proposed approach to the IEO's recommendations is being implemented. Several Directors considered it important that the Board be provided with a separate update of progress in assimilating the lessons learned from the IEO's recommendations.