I. The Role of the IMF and Environmental Policies

• surveillance of member countries’ economic policies;
• stabilization and adjustment programs, which provide financial support to members who address macroeconomic imbalances and implement structural reforms; and
• a comprehensive technical assistance program.

On a number of occasions in recent years, environmental issues with important macroeconomic consequences have been addressed as an integral part of these policy dialogues.

The Fund’s advice as regards environmental issues has been developed in close cooperation with the World Bank. While the World Bank offers a broad range of environmental technical advice, the mandate of the Fund in this area is limited to situations where environmental problems have a bearing on macroeconomic stability and sustainable growth. While this relation in some cases is evident, it is generally accepted that, most often, the linkages between environmental problems and macroeconomic stability are multifaceted and extremely complex—a fact that precludes simple generalizations on the environmental impact of stabilization policies. Adding to the complexity, the linkages go both ways: not only have sound macroeconomic policies the capacity to significantly improve environmental conditions, but unsustainable environmental policies may also have the potential to seriously undermine a country’s economic and social well-being, for example, through the overly rapid depletion of its natural resource base.

II. Measures to Address Environmental Problems

The Fund’s policy dialogue with member countries regarding environmental issues is mostly concerned with short-term measures with a bearing on economic stabilization, most importantly taxation and pricing issues.

Much environmental damage is caused by price signals that do not accurately gauge the environmental consequences of economic activity and, hence, provide for adverse economic incentives. In the context of its program operations, the IMF has usually called for up-front corrections of pricing policies, most notably by introducing market-based pricing through the elimination of environmentally harmful subsidies such as those for coal and gasoline. This is widely considered an important contributing factor behind the rapid improvement in air pollution in many transition economies. Such measures not only correct distorting incentives and improve allocative efficiency, but they may also provide the necessary means for an improved fiscal balance or free fiscal resources for more productive public expenditures. While market-based pricing has been a guiding principle, in a few instances, the Fund has advised to maintain subsidies with a positive environmental impact, most notably in the case of kerosene. Kerosene has been used in many developing countries as a household fuel replacing the burning of wood. Making this fuel available to a large portion of the population at low prices may alleviate deforestation pressures.

Of course, market prices do not always take adequate account of the environmental impact of an economic activity, hence adjustments are needed. However, correcting market prices for negative externalities is challenging as, for example, emission taxes typically require sophisticated monitoring equipment and high administrative capacities. Most countries, therefore, apply less sophisticated tax policy measures such as product taxes with a more indirect relationship between pollution levels and tax rates. Many stabilization programs have included increases in energy excises as a key policy feature—while these increases may not have been motivated primarily by environmental considerations, their consistency with environmental objectives has often been seen as an additional important justification.

Nevertheless, even well-designed stabilization policies can have an adverse impact on the environment in the face of institutional weaknesses, governance problems, and market failures. For example, adjustments in the exchange rate and trade regimes and the promotion of export-led recovery strategies may create incentives and competitive advantages for domestic producers (e.g., in sectors such as forestry, mining, large scale farming, and fishery) which in the case of institutional deficiencies can boost resource exploitation beyond sustainable levels. In situations where the negative environmental consequences of macroeconomic adjustment policies cannot be effectively addressed solely through pricing and taxation measures, some countries have found it necessary—or the Fund has proposed—to adopt short-term quantitative restrictions. In the case of increased demand for log-exports following a depreciation of the exchange rate, for instance, quantitative restrictions on logging in general or log-exports in particular have been viewed as necessary measures, at least until an effective regulatory framework has been put in place to prevent logging from exceeding a sustainable rate.

On the expenditure side of the budget, the main task in most stabilization situations is to improve the quality of expenditure programs by eliminating waste and by safeguarding appropriations, which are important for long-term economic growth and sustainable development. Awareness of these issues has highlighted the need to protect important programs both in the social and environmental areas.

Reflecting the countries’ level of development, environmental institutions and bureaucracies in many developing countries are fairly weak. This, in turn, may prevent effective enforcement of environmental laws and regulations, accentuated by governance problems, inadequate technical capacities, understaffing, and budget problems. In this connection, the increased emphasis in Fund advice has been to strengthen governance and enhance transparency. Transparency enhances accountability and enables "civil society" to participate in policy dialogues and to exert democratic control while reducing corruption incentives. However, regarding medium- and long-term environmental institution building, the IMF has little expertise, reflecting its primary mandate. In cases where capacity building is required to ensure environmental protection and sustainable high-quality growth, the IMF has continuously relied on the expertise of the World Bank and other international organizations to transfer the required institutional skills and technologies to member countries.