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Business
Rethinking IMF conditionality
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The basic debate should be not about conditions themselves but whether the prevailing practices of conditionality promote or hinder economic growth in the borrowing countries.
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A RECENT report in The Hindu indicated that the executive directors of the International Monetary Fund (IMF) have issued guidance note on ``conditionality'', which has been a subject of controversy for quite some time now. The objective is to streamline and focus on conditions for lending to member countries. Briefly, the guidelines are: (i) structural reforms for achieving macroeconomic objectives need to be covered by IMF conditionality; (ii) relevant reforms require a more focused and parsimonious application of conditionality; (iii) coverage and content of conditionality vary depending on countries' circumstance; (iv) coordination with World Bank and other agencies is important; (v) programme reviews should not weaken member countries' confidence in continued access to Fund's resources; (vi) letters of intent should cover only those aspects of policy covered by conditionality and (vii) the negotiation of reforms should allow the authorities to consider various policy alternatives, to ensure ownership of the programme.
The concept of conditionality must be placed in proper perspective before the IMF guidelines are analysed. When the IMF provides financial support to member countries, it must be sure that the members are pursuing policies that will improve or eliminate their external payment problems, so that IMF resources are safeguarded and finally repaid. The explicit commitment that the members make to implement corrective measures in return for IMF support is known as conditionality.
Conditions for IMF financial support may range from general commitment to cooperate with IMF in setting policies, to the formulation of specific plans for economic and financial policies. The IMF requires a letter of intent or a memorandum of economic and financial policies, in which the member government outlines its policy intentions during the period of the programme. Periodic reviews by the Executive Board (of IMF) facilitate assessment of whether members' policies are consistent with programme objective and also monitoring of progress against various benchmarks. The point to note is that all transactions arising from business contracts have conditions-preconditions to be met. Debates on conditionality generally tend to obscure this reality.
Conditions have been attached to IMF lending since the mid-1950s, emphasising monetary, fiscal and exchange rate policies. However, the number and severity of the conditions increased since the 1980s due to a paradigm shift from project lending to programme lending that is from lending to individual projects to programmes covering several projects. The idea underlying the paradigm shift is that the success of a project depended not only on its inherent soundness but also on the overall capacity and quality of macroeconomic management in the recipient country, that is, the overall development policy concerned with the goal of economic growth. This approach not only expanded the involvement of the IMF but also broadened the area of conditionality. For instance, an average programme involved two or three structural conditions a year in the 1980s and it rose to 12 or more by mid-1990s. This broadened concept of conditionality is based on the assumption that (i) balance of payments deficits are evidence of domestic economic mismanagement; (ii) markets are superior allocators of resources; (iii) economic agents respond positively to removal of restrictions; (iv) growth and development are private sector-led and (v) all this is facilitated by a liberalised policy environment.
Experience
The broadened conditionality, though valid to some extent, has had serious adverse implications for borrowing members, especially the LDCs (Less Developed Countries). In actual operation, the prevailing patterns of conditionality became highly defective and unworkable. First is the insensitive manner in which conditionality is applied by the IMF, regardless of the economic context of LDCs. The economies of LDCs are structurally different and therefore vary from country to country. As a result, conditionality imposes high social costs in LDCs without much of economic pay-off.
Second, the real impact of conditionality became clear, as the IMF focussed too much attention on its adjustment policies, instead of providing the financial support required to facilitate structural adjustment.
Third, where the policy reforms were too abrupt and harsh, the IMF programmes lost public support in the recipient country and failed.
Fourth, it became obvious over the years that the main aim of conditionality has been to bring about structural adjustments in the economies of deficit countries especially LDCs, to make them conform to market economies. This impression is strengthened by the unanimity in the policy prescription between the IMF and the World Bank; and this unanimity is known as the Washington Consensus, which has earned enough odium in recent years. Last, the conditionality approach amounts to infringement of national sovereignty in policymaking, which was not envisaged at Bretton Woods.
These inferences are borne out by the recent experience of Southeast Asian countries and other transition economies, where the "hoped-for" effects of reforms imposed by the IMF did not materialise.
What is needed?
It needs to be recognised that all business contracts carry conditions and the contracts with IMF and the World Bank cannot be exceptions to this. The basic debate should be not about conditions themselves but whether the prevailing practices of conditionality promote or hinder economic growth in the borrowing countries.
A pragmatic package of IMF conditions should broadly satisfy whether (i) these are user-friendly; (ii) they have flexibility, that is, whether they can accommodate changes when needed; (iii) they are open-mined, that is, without de facto unilateral imposition; (iv) whether all parties to the contract assume obligations under this and (v) whether the member country is involved, right from the start, in the formulation of the reforms programmes and conditions attached to them, to give it a sense of belonging, that is, avoidance of excessive details of policy conditions.
Even standard business contracts are alterable by consent. If an LDC is to accept conditions which impose costly policy changes, it has every right to expect parallel conditions on others.
For example, if trade liberalisation is imposed on an LDC, it has every right to expect liberalisation of access to the developed countries' markets. In short, conditionalities should be reasonable, broad, few, relevant and performable.
Going by these observations, the guidelines issued by the Executive Board of the IMF seem to be an important step in restoring to the IMF its image and credibility.
The Fund seems to have at last decided to abandon its hide-bound approach to conditionalities. The essentials of the guidelines are: the Fund will make "adjusting" countries co-authors of adjustment packages; it is no use prescribing policy correctives without first studying the borrowing country's historical, cultural and institutional conditions; the guidelines, if put into practice sincerely and effectively, will make a substantial departure from IMF's past practices.
Two features of the guidelines seem to be out of tune. The first is that these are described as interim guidelines. There seems to be uncertainty about the final shape.
The second is the requirement that conditionalities need to be coordinated with the World Bank and other agencies. Though it is willing to dilute conditionalities, the IMF is obviously not prepared to give up Washington Consensus, an approach which was has only enhanced the odium of prevailing conditionality practices. It would certainly take line to change the mindest of IMF bureaucracy!
T. K. Velayudham
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