Public Information Notice No. 05/144

Public Information Notice: IMF Executive Board Discusses Policy Support and Signaling in Low-Income Countries

October 14, 2005

On August 3, 2005, the Executive Board of the International Monetary Fund (IMF) concluded its review of an IMF staff paper on Policy Support and Signaling in Low-Income Countries.

Background

The issue of close engagement between the Fund and its member countries outside the context of a Fund financial arrangement has arisen repeatedly over the years. The Fund has used various instruments to provide policy support to its members as well as regular monitoring and signals on the strength of a member's economic and financial policies; these instruments have included staff-monitored programs, assessment letters, and various forms of strengthened surveillance.

The Fund has paid renewed attention to modalities for policy monitoring and signaling over the past year. The issue has arisen in discussions of the Fund's surveillance activities (See PIN No. 04/95), the Fund's support of low-income member countries (See PIN No. 04/40), the proposal for a Policy Monitoring Arrangement (PIN No. 04/114), and Signaling by the Fund - A Historical Perspective. At its October 2004 meeting, the International Monetary and Financial Committee (IMFC) called for further work in this area to be undertaken in close consultation with potential users, donors and creditors.

The staff paper on Policy Support and Signaling in Low-Income Countries explores how the Fund's instruments and practices might be adapted to support better sound policies in low-income members, in particular those that do not need to use Fund resources. To inform the paper, and in response to the call from the IMFC, staff conducted a survey of Poverty Reduction and Growth Facility (PRGF)-eligible members and of donors. These results were complemented by information obtained in the context of staff's regular bilateral contacts with members. The survey identified a need for: (i) the development of a new instrument designed to provide policy support to members that do not need, or want, Fund financial assistance; and (ii) filling information gaps, especially in program cases. The staff paper makes specific proposals about how the Fund's instruments might be adapted. In particular, it proposes: i) the creation of a Policy Support Instrument, or PSI, to meet the needs of low-income members not desiring Fund financial support but still wanting the Fund to support their program and endorse the quality of their policies; and ii) the more frequent use of assessment letters to fill information gaps that can arise when there are delays in approving programs or completing reviews, in order to reduce the risk of an unwarranted interruption of donor support.

Executive Board Assessment

Executive Directors welcomed the opportunity to begin another phase of the discussions—which have been under way for some time—on actions the IMF can take to serve its low-income members better. Support for low-income members' efforts to secure and maintain macroeconomic stability and achieve strong and sustainable growth and reduce poverty is a key IMF responsibility, whose fulfillment requires the institution to adapt as members' needs evolve.

As part of these actions, Directors have had a thorough and constructive discussion on policy support and signaling in low-income countries. This discussion is complementary to the discussions on three other topics—on strengthening the IMF's ability to assist low-income members meet balance of payments needs arising from sudden and exogenous shocks; on the G-8 debt cancellation proposal; and on the financing of the PRGF. Taken together, the IMF's actions resulting from these discussions will allow the Fund to respond better to the evolving demands of our low-income members.

The specific proposals on policy support and signaling in low-income countries that were considered by Directors have evolved from staff work undertaken in accordance with the mandate given by the IMFC in April 2005, and focus on low-income members that may not need, or want, Fund financial support, but still want the IMF to support, monitor, and endorse their policies. Low-income countries in this category have usually achieved macroeconomic stabilization, and are well advanced in their structural reforms. Directors recognized that, while an Article IV consultation provides policy advice and an assessment, it does not provide an explicit Board endorsement. Directors noted that a staff survey on how the mechanisms of Fund support for low-income members could be made more helpful suggested that PRGF-eligible members and donors would welcome proposals along the lines discussed today.

Against this background, most Directors supported the creation of a Policy Support Instrument to address the needs of the group of low-income countries that are "mature stabilizers." Since members' use of the new instrument would be subject to Board approval, the PSI, by providing an explicit IMF endorsement of a low-income member's policies, would deliver clear signals to donors, creditors, markets, and the general public on the strength of that member's policies. Since it is PRGF-eligible members that have expressed an interest in PSIs, it is understood that the new instrument will be made available to those countries only. However, in the event that other members express an interest in these types of instruments in the future, it may be necessary for the Fund to revisit the issue, taking into account the principle of uniformity of treatment.

In coming to the above conclusion, Directors had a wide-ranging exchange of views on how an instrument such as the PSI would fit in the toolkit available to the IMF to help its low-income members. Some Directors felt that precautionary stand-by arrangements and low-access PRGF arrangements have served as useful instruments to support members and provide signaling. It was also pointed out that intensified forms of surveillance have played a useful role in some cases. These Directors emphasized that these instruments will and should continue to play their important role in policy support and signaling and, accordingly, were not convinced of the need for the PSI, which they were concerned could dilute or undermine the positive signals associated with these instruments. Some Directors noted that having members treat their PRGF arrangements as precautionary is also an alternative that would offer most of the benefits of a PSI, without creating a new instrument.

Most Directors were nevertheless of the view that the PSI would constitute an important addition to the toolkit of instruments from which low-income countries can choose their desired form of engagement with the Fund. The PSI would be available on a purely voluntary basis to eligible members that want an IMF endorsement of their policies. In this context, it was recognized that there is room in the toolkit for a variety of signaling mechanisms, which do not and should not follow a one-size fits all approach, but rather should be tailored to suit the diverse needs and circumstances of individual countries. Directors saw a variety of situations in which countries could benefit from policy support and signaling through the PSI in the absence of a Fund financial arrangement. They underscored that the PSI would not replace, but instead complement, the PRGF, which would remain the instrument of choice for IMF financial support for low-income members with balance of payments needs. More generally, our discussion has emphasized the importance of ensuring that the PSI as actually implemented remains a voluntary, "demand-driven," instrument—supported by strong country ownership—in order to fulfill its appropriate role in the IMF's toolkit. The key role of Fund technical assistance in strengthening PSI users' capacity to access capital markets was also underlined.

Most Directors agreed that the new instrument would be available to all PRGF-eligible members with: (i) a poverty reduction strategy to help ensure ownership of policies to be implemented under the PSI; and (ii) a policy framework that focuses on consolidating macroeconomic stability and debt sustainability, while deepening structural reforms in key areas that constrain growth and poverty reduction. An on-track PSI could provide the basis for rapid access to PRGF resources through a new shocks window in the event of a shock. While a few Directors would prefer such access to be automatic, many other Directors cautioned against automaticity in this respect.

Directors considered that PSIs should be based on a comprehensive policy framework that is designed by the authorities, assessed and monitored by the Fund, and contains policies that meet the standard of upper credit tranche conditionality. This standard should be interpreted as signifying policies strong enough to constitute the basis for access to Fund financial resources in the upper credit tranches. It was understood that the design of a member's PSI program, as is the case for Fund-supported programs, would be determined by the member concerned on a case-by-case basis, with the needs of the country in mind. Directors also considered that the risk of a dilution of the standard is reduced by the possibility of quick access to Fund financial resources through a new shocks window.

Directors had a wide-ranging discussion on the modalities of the PSI, including documentation, Board involvement in reviews, and safeguards assessments. A number of additional suggestions were also made, such as a sunset clause for the PSI, on which we will need to reflect further as we enter the stage of decision-making on the PSI.

Most Directors welcomed the objective of streamlining documentation and the review process. At the same time, a number of Directors cautioned that more streamlined treatment, in comparison with PRGF arrangements, should not be allowed to cast doubt on the strength of the policies supported under the PSI.

Directors considered the staff's proposal for the presumed completion of mid-year reviews on a lapse of time basis. They viewed close Board involvement as critical for the credibility of the policy support and signaling to be provided by the PSI. Many Directors felt that, as a general rule, mid-year reviews should be completed in Board discussions, rather than on a lapse of time basis, in order to help establish the credibility of the PSI signal early on, as well as to provide a specific opportunity for the Board to consider the views of country authorities on program issues. On the timing of the reviews, most Directors felt that two regular reviews per annum by the Board, with only limited flexibility around a fixed six-monthly schedule, would ensure the strength and consistency of the Fund's signal and provide donors timely information to help them make independent judgments about their financing decisions. Some Directors, however, would prefer to apply the same degree of flexibility as is currently applied to the timing of PRGF reviews. Directors stressed that PSI reviews should provide the multidimensional assessment of macroeconomic performance that is standard in Fund arrangements—with clear information on conditions met and not met—in addition to off/on signals. Staff will work to elaborate the modalities of PSI reviews, including the modality of signaling when a program returns to being on-track.

With regard to safeguards assessments, Directors encouraged PSI users to undertake safeguards assessments as a way of enhancing the accountability, transparency, and institutional strength of their central banks. This would also facilitate quick access to Fund resources in the event of need. Directors generally agreed that safeguards assessments should remain optional under the PSI, but noted that quick access to Fund resources, including under a shocks window, may not be possible for PSI users that choose not to undertake a safeguards assessment. A few Directors cautioned that introducing safeguards assessments as an option rather than as a requirement risks diluting the strength of PSI programs.

On other modalities, Directors generally considered that publication of PSI reports should be voluntary but presumed, as is the case for financial arrangements and surveillance activities. Many Directors were of the view that recourse to PSIs should not be considered as part of a member's longer-term program engagement, because this instrument does not involve a commitment of Fund resources. The Board will have an opportunity to revisit this issue later this year in the context of the review of the Fund's policy on longer-term program engagement.

Directors also discussed the role of staff assessment letters for members with a PRGF arrangement. They noted that the survey of low-income members and donors showed that for members with a PRGF arrangement, delays in completing reviews often result in information on the Fund's assessment of performance not being readily available for a period of time—creating a "gray period." Directors considered that more frequent use of staff assessment letters could fill any remaining information gaps in PRGF-supported programs, thereby reducing the risk of unwarranted interruptions of donor support. They agreed that the content of these assessment letters should generally be more detailed than is the current practice, to enable recipients to form a clear view of the strengths and weaknesses of a country's macroeconomic and related policies, and should also describe the views of the authorities. Under the PSI, the possibility of such gray periods would be reduced with the adoption of regular six-month reviews.

Directors noted that the proposals that they have considered will likely imply some additional staff resource costs, stemming primarily in the near future from the increased use of assessment letters, while the PSI may require additional staff resources in the medium term. Some Directors felt that the increase in staff resource costs would likely be modest, inasmuch as PSI users would be otherwise engaged in low-access PRGF arrangements or intensified forms of Fund surveillance. Directors expressed a variety of views on whether charging for PSIs and assessment letters should be envisaged, with many Directors seeing this as undesirable and some Directors suggesting that the possibility of charging donors be further explored. Staff was asked to consider further the various options in the context of reviewing the Fund's finances.

Based on the useful guidance received from Executive Directors, staff will now work to prepare a draft decision on the establishment of the Policy Support Instrument for Board consideration.