A quarterly magazine of the IMF

December 2002, Volume 39, Number 4

How much of a problem is it?

The IMF's original mandate was to provide assistance to member countries in short-term crisis situations, but, in practice, a number of countries have depended on IMF support for long periods. The Philippines, for instance, was engaged in IMF-supported programs for almost 25 years over 1971-2000, and several other countries (for example, Haiti, Panama, Pakistan, and Senegal) for 20 years or more.

Such cases of prolonged involvement with IMF-supported programs raise many questions at the heart of recent controversies about the IMF's role in countries requiring a longer adjustment period. Some critics have argued that prolonged use constitutes a departure from the IMF's traditional mandate of providing temporary balance of payments support and suggests that IMF-supported programs are not effective. Others have argued that frequent recourse to IMF lending arrangements can take place for good reasons in countries with deep-seated adjustment problems and that it can be fully compatible with the IMF's mandate. This is why the IMF's Independent Evaluation Office, established in 2001, chose, as its first study, to investigate the issue of prolonged use. The report looks at the questions of what factors account for prolonged use, when it is a problem, and what can be done to ameliorate the situation.

The cases mentioned above are symptomatic of the substantial rise in the past two decades of the number of prolonged users of IMF loans—defined as countries engaged in IMF-supported programs for at least 7 years out of any 10. Indeed, over 30 countries now fall into this category. During 1971-2000, 51 countries out of 128 borrowers were prolonged users at some point (Table 1). Most of the increase in prolonged use has involved low-income countries eligible for the IMF's concessional (or low interest) loans or "facilities," but, in financial terms, the bulk of commitments to prolonged users concerns the IMF's nonconcessional resources, and their expansion has been even larger (see chart). Prolonged use is also persistent in the sense that relatively few countries "graduate" from such use.

Our study found that prolonged users typically faced wider imbalances and more deep-seated problems than other countries receiving IMF financing. However, these characteristics need not necessarily lead to prolonged use, especially if they are well integrated into the design of adjustment programs. One therefore needs to look for additional explanations. We were able to identify three major systemic factors, combined with flaws in program design and weaknesses in governance.

The first systemic factor is a broadening of the rationale for IMF program involvement. Over time, it was accepted that many balance of payments problems, especially in the low-income countries, arose from deep-seated structural problems that required more time for adjustment. This led to an acceptance of IMF financing being provided over a longer period in low-income countries and to the establishment of the concessional facilities in the mid-1980s, with limits on the time spent under this type of arrangement gradually relaxed and eventually eliminated. However, the evolution of these facilities did not explicitly recognize some of the potential consequences for the extent of prolonged use. As a result, the IMF was left with a mismatch between its core operational approach (which is still focused on promising and achieving a restoration of external viability within a relatively short time frame) and some of the new tasks it is being asked to perform. This mismatch of time frames is an important factor behind the tendency highlighted by the report toward overoptimism in program design.

The second factor is the increased emphasis on IMF lending arrangements as a "seal of approval" for other sources of financing (for example, debt relief and adjustment loans or grants from many multilateral and bilateral donors). However, we found that linking aid to IMF-supported programs can compromise the quality of programs—and, hence, the quality of the seal of approval. This is because this linkage raises the stakes of program negotiations to the point of putting strong pressure on both country authorities and the IMF to reach an agreement, even though both parties may have doubts about the program's feasibility.

The third factor is related to choices about where the boundaries between programs and surveillance (that is, the regular consultations with member countries during which the IMF independently assesses their economic policies) should lie. In some cases, the continuation of IMF program involvement reflected a judgment that surveillance was not a strong enough vehicle to achieve desired results, either in terms of signaling on the soundness of the macroeconomic framework or promoting desired policy changes. However, recent efforts to make surveillance assessments more transparent, to sharpen their diagnosis on vulnerability issues, and to promote the observance of internationally agreed standards and codes (for example, on statistics or fiscal transparency) already provide stronger instruments than existed for much of the evaluation period, and additional steps could be taken to further strengthen surveillance.

Weaknesses in the design and implementation of economic programs supported by IMF lending have also contributed to prolonged use. We found a number of reasons why some programs were less effective than expected in achieving their objectives, although many are not specific to cases of prolonged use.

• Prolonged users' programs often had an optimistic bias, especially the projections of real GDP growth and (for users of concessional facilities) export growth (Table 2). Too little attention was paid to analyzing how the real economy would respond to key policy measures and to assessing the expected sources of growth.
• Many programs had difficulty dealing with uncertainty, in part because program documents often did not analyze the key risks to a program and specify how policies would broadly respond to those risks.
• The risk to programs of weak ownership and lack of political commitment was often understated, and not enough attention was paid to assessing and developing implementation capacity.
• Political commitment to core policy adjustments was much more important than the extent and structure of specific policy conditions in IMF-supported programs ("conditionality").
• Conditionality on structural policies was often exceedingly broad, without a clear order of priority among conditions, and its specification did not always ensure a good integration with program design (particularly as far as prior actions are concerned). As a result, compliance with a subset of these conditions did not ensure that the most critical problems were being addressed, even though it was often sufficient for continued access to IMF resources.

IMF governance and other internal institutional factors have contributed importantly to the program design issues outslined above and to prolonged use. For example, the IMF's Executive Board did on various occasions approve the elements of a strategy to reduce prolonged use (including strengthened analytical and assessment efforts, more explicit "exit strategies" spelling out the circumstances under which IMF support would no longer be provided, gradually reduced access to IMF financing, and a more proactive use of conditionality). However, the strategy was not implemented systematically. One contributory factor was the absence of an explicit definition of prolonged use.

Furthermore, the IMF's approach to program design has until now often given insufficient priority to a proper assessment of the implementation capacity constraints that a program might face, be they related to political feasibility and ownership or to administrative capacity. In best practice cases, efforts were made to take account of these constraints, but there are insufficient systemic incentives to ensure that such an approach would be followed more generally.

The case studies also suggest that, by and large, surveillance was "crowded out" by program-related issues and therefore failed to provide an opportunity to take a critical look at the adequacy of program design and to draw lessons from the experience of past programs.

Finally, there is some evidence that political considerations have been an important factor in program-related decisions on some occasions. Although political considerations are bound to enter into the decisions made by an institution where ultimate approval rests with shareholder governments, the blurring of technical judgments and political considerations in such cases contributed to the dilution of accountability and the reduction of those programs' credibility.

The evaluation suggests that prolonged use does present problems that were not sufficiently appreciated when decisions were made that were likely to encourage extended program involvement.

• There is some qualitative evidence that prolonged use hinders the development of robust domestic policy formulation processes over time, although it is not possible to test the counterfactual of how institutions would have developed in the absence of lengthy program involvement.
• There is an inherent tension between the quasi-permanent conditionality implicit in prolonged use and country "ownership," in the sense of countries taking responsibility for the conduct of their economic policy, both by being in the driver's seat and by facing the consequences of their decisions.
• Case studies also suggest that the perception that IMF resources would be available over the long term, despite policy slippages, may have weakened incentives to take decisive action to deal with the underlying adjustment problems.
• If, as appears to be the case, prolonged use in some cases has resulted from pressures on the IMF to agree to a series of weak programs, then the effectiveness of these programs will be reduced and the credibility of all IMF-supported programs may suffer. In extreme cases, such a series of weak programs can lead to self-sustained prolonged use, in the form of arrears or credit motivated primarily by defensive lending considerations (in other words, to avoid the buildup of arrears).

Some of the adjustment problems faced by IMF member countries, especially the poorest of them, do indeed take a long time to resolve, and this justifies somewhat greater acceptance of prolonged use in these cases. Nevertheless, many of the potential costs mentioned above would also be relevant in such cases. Moreover, acceptance of a lengthy program involvement in a significant share of the IMF's membership would have consequences for the IMF's role and its place in the international financial architecture. Consequently, there needs to be a clear understanding of what the IMF's long-term role is expected to be in such cases, particularly in relation to development agencies such as the World Bank, so that its operational approach can match that role and fit within a well-conceived, forward-looking exit strategy.

What can be done to diminish the incentives for prolonged use and to reduce its adverse consequences? Our recommendations cover a broad range of issues related to the rationale for IMF involvement, program design and implementation, and IMF governance. We highlight below five recommendations that we feel have the greatest potential impact.

• First, the IMF should adopt an explicit definition of prolonged use as a trigger for automatic due diligence procedures. The definition could use different criteria for the general and concessional resources. Among due diligence procedures, an explicit exit strategy should be developed, although without setting rigid limits on the time spent in IMF arrangements.
• Second, greater efforts should be made at tailoring programs to the countries' implementation constraints. To achieve this, the IMF should strengthen the ability of its staff to analyze political economy issues to achieve a better understanding of the forces that are likely to block or enhance reforms and to take these into account in program design. Similar efforts should be devoted to judging when countries are ready to implement programs, especially in situations of prolonged use. On this basis, the IMF should be willing to be more selective in extending financial support, although this will always involve difficult judgments.
• Third, the IMF should provide the international community with credible alternatives to IMF-supported programs as a precondition for the provision of many other sources of financing. This could be done by developing a menu of tools to deliver seals of approval. These tools could build on existing instruments (for instance, strengthened surveillance, Poverty Reduction Strategy Paper assessments, precautionary arrangements, or staff-monitored programs) and adapt them to meet better the varied needs of donors and creditors.
• Fourth, specific operational procedures should be adopted so that program design builds to a greater extent on the domestic policy formulation process and places more emphasis on ownership. In particular, there should be greater selectivity in the number of conditions attached to programs, based on a clearer prioritization of conditionality, with special attention to fostering key institutional changes and strengthening implementation capacity.
• Fifth, procedures should be developed so that political considerations, which are inevitably present in decisions to grant a country access to IMF resources, are taken into account in a transparent manner, with decisions and accountability clearly at the level of the IMF's Executive Board.

Most of the report's recommendations received the general endorsement of the Executive Board. They will now be reviewed by an internal task force set up by IMF management to study their policy and operational implications. The task force is expected to report to the Board early next year with specific proposals for implementation.

This article is based on "Evaluation of the Prolonged Use of IMF Resources," the IEO's report (Washington: International Monetary Fund, 2002). The full report, including the country case studies, responses by IMF management and staff, and the summing up of the Executive Board discussion of the report, is available on the IEO's website at www.imf.org/ieo.

The IEO would welcome any comments on the report, particularly on the recommendations it contains, so as to inform the work of the follow-up task force. Comments may be sent by e-mail to ieo@imf.org.