Public Information Notice No. 03/49

Public Information Notice: IMF Concludes Discussion on Prolonged Use of Fund Resources

April 9, 2003

On March 24, 2003, the Executive Board of the International Monetary Fund (IMF) concluded its discussions on prolonged use of Fund resources, based on the report of the IMF's Independent Evaluation Office (IEO) and the conclusions of a staff task force.

Background

The IEO issued its first evaluation report on the prolonged use of Fund resources on September 6, 2002. Shortly afterward Managing Director Horst Köhler issued a statement to the Executive Board welcoming the IEO's report, agreeing with many of its findings, and indicating that Management would establish a staff task force to make recommendations on how issues raised in the report could best be addressed. Executive Directors welcomed this proposal, and looked forward to following up on the recommendations of the task force early in the next year.

The IEO report identified a number of problems associated with prolonged use of Fund resources. These included:

• risks to the revolving character of Fund resources,


• the possibility that prolonged use may be the result of weak program design and implementation,


• unwarranted intrusion on the development of domestic policies and institutions (particularly in the case of low-income countries), and


• a possible blurring of the Fund's role and mandate, especially in relation to the work of the World Bank and other development institutions.

Financial support from the IMF is intended to assist members in overcoming temporary balance of payments difficulties. Particularly under stand-by and extended arrangements, a primary objective of Fund-supported programs is the attainment of external viability, after which the IMF's financial support should no longer be needed. At times, prolonged use of Fund resources may signal a failure to achieve this key objective—which can impose costs on the member country, damage the IMF's credibility, and make it more difficult for the member to meet its external obligations (including its obligations to the Fund). In past discussions of prolonged use, the Executive Board has stressed the importance of distinguishing between countries that are making adequate progress toward achieving their program objectives, and those that are not.

The IMF's role in the global economy has evolved over time, and some of the attendant changes have contributed to prolonged use of Fund resources. For example, the Fund's role in cushioning the effects of sharp increases in world oil prices during the 1970's, and in the subsequent "recycling" of external surpluses, had implications for the scale of its involvement in countries with limited debt-servicing capacity and ability to reduce its exposure subsequently. Since then, the Fund has also been called upon to expand its activities in low-income countries and to play a major part in guiding the transition to market in former centrally-planned economies. Because these countries faced simultaneous challenges of macroeconomic stabilization, institutional development, and structural reform that were expected to take considerable time, there was a presumption of sustained Fund engagement, including financial support. While many transition countries have by now "graduated" from Fund financial support, there is still a presumption that most low-income countries will make use of IMF financing for an extended period, mainly under the Fund's concessional lending window, the Poverty Reduction and Growth Facility (PRGF).

Another source of incentives for prolonged use of Fund resources is the "signaling" role that Fund-supported programs play for a country's external donors and creditors. Official donors and creditors often condition some forms of development assistance on the existence of a financial arrangement with the IMF, on the grounds that a sound macroeconomic policy framework is important for the effectiveness of this assistance. This signaling role has also been important at times with regard to private creditors. The IMF has experimented with alternative ways of addressing this objective, but has found that neither member countries nor their external partners considered these to be complete substitutes for a Fund-supported program. To a large extent this reflected a judgment that the Fund's willingness to approve arrangements enhanced the credibility of its advice and underscored the seriousness of the government's policy intentions. However, this also created pressures on the Fund to support programs even in cases where the prospects for implementation of credible policies were weak.

In considering a strategy for following up the IEO's report, the staff task force focused both on measures aimed specifically at cases of prolonged use, and measures aimed more broadly at enhancing the prospects for success of all Fund-support programs. The latter included a strengthening of the Fund's work on surveillance, program design, and conditionality, to devise better programs that stand a better chance of being implemented, in conjunction with procedures to ensure that the Executive Board decisions on proposed Fund financial arrangements are taken transparently and with a full understanding of the risks and constraints. To help reinforce this process and strengthen "due diligence" in dealing with cases of prolonged use of Fund resources, the task force also proposed a systematic process of assessment and strategic forward planning, whose results would be incorporated into Article IV consultation discussions and staff reports. It proposed that this process be applied for all countries identified as prolonged users of Fund resources—including those with relatively successful programs and, in line with the IEO's recommendation, countries with precautionary arrangements.

In its work, the staff task force benefited not only from the IEO report, but also from comments received by the IEO through a process of external outreach, including seminars in Berlin, Cambridge, London, Manila, and Tokyo.

Executive Board Assessment

Executive Directors welcomed the opportunity to discuss the conclusions of the task force on prolonged use of Fund resources, which the Managing Director had convened to consider the recommendations of the Independent Evaluation Office (IEO) on this topic. They appreciated the work of the task force as a key step in following up on the IEO's candid and comprehensive analysis. Directors stressed that thorough implementation and review of the measures proposed by the task force—along with timely attention to the IEO's future reports—will be critical to ensure that the work of the IEO makes its maximum contribution to enhancing the listening and learning culture within the Fund.

Directors generally reaffirmed their observations during the Board's discussion of the IEO report, last September, regarding the extent and nature of problems posed by the prolonged use of Fund resources. Most Directors agreed that, under proper circumstances, long-term Fund financial engagement can be an appropriate response to help member countries address deep-seated problems that, by their nature, require many years to resolve. These problems have been particularly prevalent in low-income countries and countries in transition. Directors also observed, however, that at times prolonged use can be associated with inadequate progress in dealing with a country's key economic problems, and that, in some cases, prolonged use and the associated policy conditionality can hinder the development of domestic institutions. The financial implications of prolonged use for the Fund's regular resources and for PRGF resources also were a possible concern. Directors broadly endorsed a number of measures aimed specifically at cases of prolonged use, while stressing that attention should also focus on improving the prospects for successful implementation of all Fund-supported programs. This will be achieved through the adoption of policies and procedures that promote better program design and strong local ownership, along with accountability for outcomes. In that context, Directors also supported the recommendation that Board decisions on the provision of Fund financial support be transparently based on candid assessments by the staff of the risks and constraints involved.

Directors were in broad agreement with the strategy outlined by the task force. This will entail the rigorous implementation of IEO recommendations to improve surveillance, conditionality, and program design (including those already internalized in the Fund's work program); additional measures to strengthen "due diligence" for prolonged users and enhance information for decision-making; and further substantive consideration of a number of IEO recommendations in the period ahead. They stressed the importance of systematically monitoring the timely implementation of the various elements of this strategy.

Directors considered that wholehearted observance of the new guidelines on Fund conditionality will improve considerably the prospects for sustained implementation of Fund-supported programs. They highlighted, in particular, the emphasis of the guidelines on the institutional, social, and political contexts; the improved prioritization of reforms and collaboration with the World Bank and other donors; the promotion of local ownership of reforms; and the focus on strengthening institutional capacity in member countries. Directors also agreed that improvements in conditionality will need to be accompanied by greater selectivity in recommending and approving Fund financial support, based on a careful assessment of the member's implementation capacity and ownership. A number of Directors suggested that an explicit and structured assessment of various dimensions of ownership should be included in all staff reports on use of Fund resources. It was recognized that such assessments would need to be based on careful judgment. Directors emphasized that appropriate program design and technical assistance should help members overcome the capacity constraints that may limit their ability to implement reforms successfully.

Directors stressed the importance of continued efforts to improve the design of Fund-supported programs. They noted that combining realism with the necessary ambitiousness, and determining the appropriate pace and sequencing of reforms in individual cases, remains a challenging but essential task. In general, there is a need for greater realism in program objectives and assumptions. Directors therefore looked forward to further work by the staff on the relationship between external financing, adjustment, and sustainability; on the analytical framework for program design; on the tradeoffs between macroeconomic and structural policies; and on the parameters for assessing program success.

Most Directors underscored the importance of consistently applying the existing policies on access that relate to Fund financing for prolonged users that fail to make sufficient progress toward program objectives. As specified by the Executive Board at its discussion on the review of conditionality on July 22, 1991, continued Fund financing for countries with slow progress toward external viability might require strong policy justification, and access should continue to be guided by the need to reduce their outstanding use of Fund resources over time. Directors also agreed that, more generally, staff reports on requests for the use of Fund resources should consistently discuss the justification for the proposed levels of access. There was virtually no support for the IEO's proposal to levy higher rates of charge or interest rates for prolonged users of Fund resources.

Directors concurred with the priority accorded by the IEO and the task force to increasing the effectiveness of Fund surveillance. Diligent implementation of the conclusions of the recent surveillance review will be key to identifying economic weaknesses and vulnerabilities and building domestic support for the adoption of sound policies. Directors stressed the need for the staff to combine clarity and candor with a recognition of the social and political realities that shape economic policy; to complement sound advice on economic objectives with discussions of alternative ways to achieve those objectives; and to reach out more broadly, including to legislative bodies.

Directors highlighted the importance of ongoing efforts to ensure that Article IV consultations in program countries "step back" from the program context. This will allow the Fund to take account of a broader perspective on the economic challenges facing a country and on the adequacy of current policies to meet those challenges. Directors welcomed the recent progress in this direction. Some Directors, however, saw a need to complement these ongoing efforts with steps toward a greater operational separation of surveillance missions from discussions on the use of Fund resources. Seeking opinions from outside the Fund on key policy issues can, in some program countries, also be a useful input to the surveillance process. Directors looked forward to discussing progress in strengthening surveillance and priorities for further work in the coming weeks.

Directors supported a strengthening of the IMF's "due diligence" in cases of prolonged use, through systematic ex post assessment and strategic forward planning in the context of Article IV surveillance. An interdepartmental staff team will prepare such an assessment and planning exercise prior to the Article IV consultation mission to a country identified as a prolonged user. The assessment will reflect input from the World Bank and, in some cases, might also draw on outside experts. The exercise will cover an analysis of the economic problems facing the country, a critical and frank review of progress during the period of Fund-supported programs, and a forward-looking assessment that takes into account lessons learned and presents a strategy for future Fund engagement. Where appropriate, the assessment will present an explicit "exit strategy;" some Directors expected this to be the normal procedure. This strategy may include, in some cases, an approach to help countries identify the steps to be taken to widen their options for external financing, for example by fostering access to foreign direct investment or to international capital markets. Following the consultation discussions with the authorities, the results of this exercise will be presented to the Executive Board in the Article IV staff report. Directors considered that such an approach could also prove useful in the case of some countries that were not identified as prolonged users. In addition, the staff report for the final review under any Fund-supported program will include a concise description of the degree to which the program has achieved its initial objectives. A few Directors also called for further consideration of how best to ensure effective Board discussions of country cases where programs appear to be off-track and an Article IV Consultation is not scheduled.

Most Directors saw the definition of prolonged use proposed by the task force and building on the IEO's recommendations as an appropriate way to identify countries for the process of ex post assessments and strategic planning. A country will be considered a prolonged user when it has spent 7 or more of the last 10 years under upper credit tranche stand-by or extended arrangements, including precautionary arrangements, or a mix of GRA and PRGF or ESAF resources. Most Directors also supported the proposal that, for countries using the Fund's concessional resources, the new assessment process be triggered when a country has gone through two or more multi-year arrangements under the PRGF or ESAF (through either completion of the arrangements, or expiration without making all of the scheduled purchases, or cancellation). Some Directors would have preferred to come back to this issue on the occasion of the forthcoming discussion of the Fund's role in low-income countries. Directors emphasized that the inclusion of a country in this new process should not be viewed as an indication of program failure, and that, in each case, the staff will need to be clear about its assessment of program implementation and achievements. A number of Directors considered that precautionary arrangements should be excluded from the definition of prolonged use. Directors agreed to a gradual phasing in of the new assessment process in line with the existing staff resource envelope, particularly in the case of low-income countries.

Several Directors highlighted the conclusion of the task force that excessive staff mobility has at times posed challenges for policy advice and program design and, in some cases, adversely affected the Fund's dialogue with members. Management will pay greater attention to continuity and stability in mission chief and other economist assignments, reinforced by appropriate incentives. At the same time, however, Directors noted that human resource management needs to be framed more broadly than in the context of prolonged use.

Most Directors, while underscoring the complexity of political economy issues, agreed that awareness and knowledge of these issues can be an important channel for better understanding and taking into account the forces shaping the success and sustainability of reforms. They encouraged the staff to enhance its analysis and reporting of political economy issues in staff reports. Some Directors cautioned, however, that the Fund should be extremely careful in venturing into this area, given the staff's comparative advantage in providing technical analysis and the need to avoid intruding on internal political matters. Enhanced reporting on political issues in staff reports will need to evolve gradually, as experience is gained. Mission teams and resident representatives will be the backbone of this effort, and the staff's capacities in this area will be strengthened through appropriate training. From time to time the Fund will draw on outside experts in analyzing national or regional issues.

Directors noted that the linkage of some forms of donor assistance to the existence of a Fund-supported program, and the Fund's catalytic role with respect to private financing sources, can result in pressures for Fund lending decisions that contribute to prolonged use of Fund resources. In that context, Directors confirmed the conclusions of their recent discussion on mechanisms for signaling the Fund's assessment of members' policies. This discussion reiterated that the Fund should not enter into financial arrangements in support of programs that fail to meet reasonable standards of policy content in order to fulfill the expectations of donors. It will therefore be important to consider carefully, on a case-by-case basis, how best to use Article IV consultation reports, Public Information Notices (PINs), PRSP assessments, and other devices for signaling the Fund's views on policies to a broader audience, including donors and creditors. In the case of low-income countries, where the Fund's signaling role and the linkage of external assistance to Fund programs is a particularly important issue, Directors encouraged the staff to continue to explore the scope for alternative signaling mechanisms, in consultation with member countries, donors, and other creditors, including the Paris Club and World Bank. They looked forward to further discussing these issues in the context of the forthcoming review of the Fund's role in low-income countries.

Directors underscored that systematic follow-up will be key to ensuring that the measures endorsed by the Board in response to the work of the IEO and the task force are effectively implemented and achieve their intended results. They agreed to the following actions (i) the circulation of additional guidelines for the staff, accompanied by a systematic internal review effort to promote the implementation of agreed measures and ensure that lessons are drawn from experience; (ii) the circulation of factual, semiannual reports on the incidence of prolonged use of Fund resources; and (iii) regular assessment of progress in the context of the Fund's periodic reviews of conditionality. In addition, a number of key issues relating to prolonged use of Fund resources will be further considered in the context of upcoming discussions on surveillance and on the role of the Fund in low-income countries, and of future work on program design issues.