New IMF Conditionality Guidelines

New IMF Conditionality Guidelines

Order Code RS21357
November 19, 2002
CRS Report for Congress
Received through the CRS Web
New IMF Conditionality Guidelines
Martin A. Weiss
Analyst in International Trade and Finance
Foreign Affairs, Defense, and Trade Division
Summary
The International Monetary Fund (IMF) recently revised the guidelines for the
design of conditionality in its loans. Conditionality requires a borrower country to
adhere to various macroeconomic and other policy “conditions” when it borrows funds
from the IMF. It is an inherent feature of all IMF lending. Four guiding principles are
at the core of the revised IMF guidelines: national ownership of the reform program,
parsimony and clarity in the application of program-related conditions, tailoring of
programs to the member’s circumstances, and effective coordination between the IMF
and other multilateral institutions. This report provides background on the issues,
summarizes the principles underlying the new guidelines, discuses the criticisms they
respond to, and assesses their likely effectiveness. This report will not be updated.
Background
Since the creation of the IMF, conditionality has been an integral part of IMF
lending. Conditionality is described as “the link between financing from the Fund and
implementation of policies by countries that make use of Fund financing.”1 It refers to
the macroeconomic “conditions” that the IMF requires from borrower countries. Over
the last twenty years, and especially since the financial crises of the 1990s, IMF
conditionality has come under increasing criticism.
One major criticism is that its conditionality focuses too heavily on stabilization of
the economy in crisis and not enough on creating policies for longer term economic
growth. As the IMF began lending to very poor countries, through structural adjustment
loans, it expanded the types of conditions to include removing protectionist trade policies
and implementing market-based resource allocation policies. Concerns arose that the IMF
1 “IMF Conditionality” Press Briefing by Masood Ahmed, Deputy Director, IMF Policy
Development and Review Department, March 21, 2001.

Congressional Research Service ˜ The Library of Congress

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was designing and enforcing conditionality in areas outside of its core competencies of
macroeconomic policy, fiscal policy, and monetary and exchange rate policies.2
Critics have also called IMF conditionality too intrusive and not essential to the
actual success of the IMF program. This trend can be seen in the number of IMF
programs that remain uncompleted. For example, in the 1970s and 1980s the IMF made
many loans to African countries, that were unable to comply with IMF conditionality and
eventually ceased payment on the debt. Some remain in default to this day.
Current completion rates for IMF programs are very low. From 1973 to 1997 only
35% of IMF loans were fully disbursed.3 Between 1993 and 1997, the IMF approved 141
arrangements to be disbursed in numerous tranches(installments), pending the completion
of conditionality requirements. Of these loans, only 16.3% were completely disbursed.
While in some cases, the IMF did not disburse funds regardless of country compliance
with its conditionality, the excessively poor completion rate implies either a failure of the
IMF policy guidance, or a mismatch between the IMF’s stated country reform agenda and
capabilities and/or the policy goals of the recipient country.
Criticism of IMF conditionality evolved in the wake of the 1990s East Asian
financial crisis. Prior to the East Asian crisis, most financial crises could be traced to
imbalances in a country’s current account. A current account crisis could be due to
weakening domestic economic fundamentals such as price stability, fiscal deficits, or
savings rates.4 In a current account crisis, the IMF’s usual mix of policy conditions of
fiscal austerity and structural reform seem appropriate and likely to restore economic
confidence.
Many analysts, however, agree that the Asian crisis was due not to fundamental
imbalances in the current account, but rather the capital account. Large increases in the
volatility and magnitude of global capital flows and the prominent role of sovereign debt
as a primary source of capital to emerging market economies has left many developing
countries captive to international capital markets. A decrease in global liquidity or
increased risk aversion among international investors can lead to decreased capital flows
to developed countries, and the subsequent collapse of a country’s currency and
macroeconomic fundamentals. Weakening fundamentals do not necessarily reflect
internal structural economic problems, but rather the rapid cut-off of foreign capital.5 The
2 See William Easterly, What did Structural Adjustment Adjust, Working Paper No. 11, 2002
Center for Global Development, Washington, DC, for a critical assessment of the IMF and World
Bank’s experience with structural adjustment loans.
3 Graham Bird, The Completion Rate of IMF programs: What We Know, Don’t Know and Need
to Know” The World Economy, Issue 6, Vol. 25, pg. 833-47.
4 Capital Account Crisis and Credit Contraction, Masaru Yoshitomi and Kenichi Ohno, May
1999, ADBI.
5 Guillermo A. Calvo, Capital Flows and Capital-Market Crises: The Simple Economics of
Sudden Stops, Journal of Applied Economics, Vol. 1, No. 1, November 1998, pp. 35-54.

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applicability of IMF policies for capital account crises can be questioned. Many stress the
negative effects of austerity packages on countries experiencing a capital account crisis.6
In addressing these criticisms, the IMF on September 25, 2002, approved new
guidelines for the design and implementation of conditionality in Fund-supported
programs.7 The document includes sections describing the principles, modalities, and
methods for internal review of the new guidelines. The document also includes a staff
statement that discusses the principles of the guidelines in greater detail. This is the first
revision to IMF conditionality since 1979 and is the result of a two-year review. The
review was initiated by IMF Managing Director Horst Kohler and responded to
substantial internal and external criticism of the IMF’s use of conditionality in its lending.
Congress also played an important role in pressing for changes in the IMF’s use of
conditionality. During the 1998 appropriations process, Congress established the
International Financial Institutions Advisory Commission (IFIAC) to recommend policy
on the IMF and other international financial institutions. Presenting its report to Congress
in March 2000, IFIAC proposed abandoning IMF conditionality and replacing it with
mandatory preconditions of good economic polices and robust financial institutions. In
a crisis situation, the “pre-qualified country” would receive automatic support.8 The
Commission also concluded that conditionality supported inadequate policy options in
developing countries, and proved burdensome and ineffective in promoting long-term
economic reform.9 10
The IMF acknowledged that the reasons for balance of payments difficulties vary
across countries and the IMF along with the member country must design a unique
program of “conditions” for each national applicant. The principles of the new guidelines
and the criticisms that led to their inclusion will now be discussed.
Country Ownership of Fund-Supported Programs
Ownership refers to country officials assuming responsibility for a program of
economic reforms, based on the mutual understanding between the country officials and
the IMF that the economic reforms are in the best interest of the country. Demand for
increased country ownership represents probably the most significant change in the new
guidelines. It is a reform created to legitimize conditionality in the eyes of the member
country and the international community, many of whom have criticized the IMF for
6 Stiglitz, Joseph. Globalization and its Discontents, New York: W. W. Norton & Co. 2002.
7 International Monetary Fund Guidelines on Conditionality available at
[http://www.imf.org/External/np/pdr/cond/2002/eng/guid/092302.htm].
8 See CRS Report RL30635, IMF Reforms and the International Financial Advisory Committee,
by J.F. Hornbeck.
9 Report of the International Financial Institution Advisory Commission. Submitted to the U.S.
Congress and U.S. Department of Treasury, March 8, 2000, pg 7-8.
10 A criticism of the Meltzer Report is that under this arrangement, many developing countries
would be ineligible for IMF assistance. While not all critics agree with the Meltzer Report in
abolishing conditionality in its entirety, many agree that fundamental flaws existed in the IMF’s
conditionality policies and a new approach was warranted.

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insisting on increasingly pervasive conditions requiring more and more structural reform
of the domestic economy. By harmonizing interests between the member country and the
IMF in advance, country ownership is expected to circumvent this problem.
But it is a complex issue. A prominent hindrance to program completion is weak
political capacity in many borrower countries. The governments of numerous countries
have crafted and promised significant economic reforms, only to fail in passing reform
legislation through the domestic bureaucracy or in bowing to pressure from labor unions,
opposition parties or special interest groups to abandon the conditionality program. It is
this internal opposition, according to many analysts, that makes conditionality necessary,
even if country officials and the IMF agree on the reform program. While government
officials may be in full support of the reform program, there have been many occasions
where the reforms have been undermined by opposition parties or special interests within
the country. Constraints at the international level can increase the leverage of the
incumbent government and strengthen the bargaining power of the government vis-a-vis
special interest groups and opposition parties.11
In the new guidelines, the IMF acknowledges that a country’s capacity and ability to
implement reforms is a determining role in program success. The new guidelines stress
that the IMF will provide a range of policy options and plans and will provide technical
assistance to help countries that do not have an administrative capacity strong enough to
implement reforms by themselves. In this way, greater flexibility is allowed in
harmonizing the often country-specific components of IMF packages.
Parsimony in Conditionality Formulation and Clarity in its
Implementation
By parsimony, the IMF means that conditions in its assistance programs “should be
limited to the minimum necessary to achieve the goals of the Fund-supported program or
to monitor its implementation and that the choice of conditions should be clearly focused
on those goals.” The two goals of Fund-supported programs are the solving of balance of
payments problems and support of sustainable economic growth. Conditions that are not
of “critical importance” for achieving these two goals are to be avoided.
The guidelines also state that program-related conditions should be clearly
distinguished from other reforms taken by the member country in both IMF documents and
the member country’s documents. This is to avoid confusion between broad economic and
political reform agendas and the actual conditions and criteria required for continued
access to IMF resources.
While these parsimonious reforms appear sensible, in practice it can be quite difficult
to ascertain what conditions are actually “necessary” to move toward the agreed upon
outcome. Nonetheless, these major reforms are deemed an essential response to a growing
body of criticism that the IMF’s conditions are too broad, too intrusive, and require policy
11 See Robert D. Putnam, “Diplomacy and Domestic Politics: the logic of Two-level Games.”
International Organization 42, 1987: 427-460 and James Raymond Vreeland The IMF and
Economic Development Cambridge University Press, Forthcoming 2003.

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conditions that fall outside of the IMF areas of speciality and aim to correct this in future
loans.
Tailoring Programs to Country Realities
The IMF, through its experience with multiple types of international financial crises,
has recognized that while balance of payments problems may appear similar across
countries, the underlying rationales for the imbalances vary and the type of lending the
IMF approves must reflect the specific needs of the country to resolve those problems.
For example, countries with sound and robust economic institutions might require
only short term lending to restore investor confidence. A minimum of conditions would
apply in such cases. In other countries, such as those receiving loans under the Poverty
Relief and Growth Facility (PRGF), the IMF’s concessional loan facility, the goal of IMF
lending is stimulating growth through market-oriented Structural Adjustment Loans
(SALs), which entail a more extensive use of conditionality. Finally, there are transition
economies that are trying to introduce a competitive market through privatization and
deregulation, yet maintaining sound and stable macroeconomic fundamentals. To respond
to these different types of crises, different policy measures must be used. The new
guidelines acknowledge that each financial crisis has its own unique causes. The
guidelines also stress that a member’s past performance in implementing economic
reforms is considered when the IMF designs its conditionality.
Coordination Between the IMF and Other Multilateral
Development Agencies
In general, there has been increasing collaboration between the IMF and World Bank.
These include the Poverty Reduction Strategy Papers (PRSP), the Financial Sector
Assessment Program (FSAP), and work to combat international money-laundering. These
reforms and others, generally targeted at increasing the effectiveness and governability of
developing country’s national institutions, have become known as second generation
reforms.12 In light of the recent financial crises, second generation reforms have risen on
the agendas of both institutions and have come to dominate their respective agendas. To
prevent competing or duplicitous conditionality between the two agencies, the guidelines
call for the application of a “lead agency” framework between the two agencies. The new
guidelines also allow the IMF to draw on the advice of other international organizations
in the design of conditionality. This is very important since in many developing countries
there are both IMF and World Bank assistance programs. Cross-conditionality, where
IMF’s resources would be subject to decisions taken by other international organizations
will not be permitted.
In countries where both agencies have operations, IMF and World Bank staff are
expected to design a harmonized country strategy, identify key reform areas and
implement a strict division of responsibilities in promoting the reforms, with one of the
12 First generation reforms are fiscal and macro-economic reforms. For more on first and second
generation reforms see Moises Naim “Latin America: The Second Stage of Reform” Journal of
Democracy 5(4) October, 1994.

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agencies assuming a “lead” position for each of the reforms.13 The staff statement
reiterates the IFI’s interest in second generation reforms by identifying the following
reforms as policy issues where increased cooperation would be beneficial: elements of
financial sector work, public sector reforms, and issues of transparency, governance,
corruption and legislative reform, trade policy, and debt management.
Cooperation between the IMF and the World Bank has itself been the subject of
significant criticisms. Many commentators have accused both the IMF and World Bank
of “mission-creep,”in allowing their activities to expand beyond their mandate. The
IFIAC noted this and proposed the IMF be pared down solely to the agenda laid out in its
Articles. This argument has also been made for the World Bank.14
The Likely Effectiveness of the New Guidelines
The effectiveness of the new IMF-authored guidelines will not be known at least for
a few years, until a significant number of loans are designed under the new framework.
Regardless, the formal statement of revising IMF conditionality is generally viewed as a
positive step in the reform process. The principles underlying the new guidelines appear
very sensible, open only to minimal and technical criticisms.
Experience has shown that IMF programs are bound to fail if they do not have the full
support of the borrower country; are overburdened with cumbersome and extraneous
conditions; and try to offer a “cookie-cutter” approach to economic reform in crisis-prone
economies. By requiring the IMF to prove that future conditions overcome these
problems, the new guidelines could lead to more effective and clearly designed loans. If
future IMF loans continue to exhibit the same features, the ability of the IMF to intervene
effectively and reduce the susceptibility of developing economies to financial crisis will
continue to be questioned and support of the IMF might diminish. The new guidelines are
an effort by the IMF to “lock-in” reform and are therefore an important part of turning
criticism of the IMF into a constructive new policy agenda.
13 See Strengthening IMF-World Bank Collaboration on Country Programs and Conditionality
at [http://www.imf.org/external/np/pdr/cond/2001/eng/collab/082301.pdf] and Strengthening
IMF-World Bank Collaboration on Country Programs and Conditionality - Progress Report
August 19, 2002 at [http://www.imf.org/external/np/pdr/cond/2002/eng/collab/081902.pdf].
14 Jessica Einhorn, “The World Bank’s Mission Creep” Foreign Affairs, September/October
2001.