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| Sunday, 1 September 2002 |
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Features |  |
| News Business Features Editorial
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Conditions vs. country ownership, sovereignty : Complications of IMF conditionality by Mohsin S. Khan and Sunil Sharma Why is reconciliation difficult? First, IMF conditionality is much more complicated than the conditionality typically contained in private contracts. It involves assessing the macroeconomic imbalances or structural deficiencies that led to macroeconomic problems and then negotiating an agreement with country authorities that will address them. Second, it is difficult if not impossible to establish a value for IMF conditionality, because this value depends on the country authorities' commitment to the program. Third, unlike private lenders, for whom it may be sufficient to deal only with a firm's management, the IMF has to take into account the positions of multiple stakeholders in a country. Fourth, the IMF, by design, is a cooperative that makes loans to its sovereign members. In the event of default, there is no court to which it can appeal, and there is no tangible collateral on offer that can be used to make up for its resources. And fifth, compared with private lenders, the IMF, given its mandate and cooperative structure, faces what is called the "Samaritan's dilemma." Countries know that, faced with underperformance and a weak economy, the IMF is unlikely to impose strict conditionality, because it is concerned with the borrowing country's welfare. Simply put, penalties established in advance have limited credibility because they are unlikely to be enforced. In recent years, the international community has proposed a number of ways to do a better job of reconciliation, all aimed at increasing country ownership -notably, encouraging countries to design "homegrown" programs, developing a menu of policy options for country authorities to choose from, and investing time and effort in selling the program to various domestic constituencies in the country. The poverty reduction strategy papers (PRSPs) - used as a basis since 1999 for IMF lending to poor countries - reflects this new direction, and initial results are promising. Four other proposals have been made to change the IMF's approach to conditionality and help increase ownership. These include (1) preselecting countries eligible for IMF lending; (2) streamlining structural conditionality; (3) introducing flexibility in the timing of structural policy measures, or "floating tranche" conditionality; and (4) applying conditionality to outcomes rather than policies, or "outcomes-based" conditionality. This article explores the pros and cons of each proposal and some early experimentation with them. Preselecting countries The preselection approach is based on the idea that, if conditionality is reduced, there must be stricter pre-qualification of countries eligible to borrow to ensure repayment. Under this approach, which was the main recommendation of the Meltzer Commission Report on International Financial Institutions, the IMF would provide resources up to specific limits to countries that are vulnerable to contagion but have a track record of good policies. This would be consistent with safeguarding IMF resources while encouraging the country to secure market financing before coming to the IMF, thereby reinforcing the role of the IMF as a lender of last resort. Obviously, preselecting countries with good track records reduces the need for explicit conditionality. What are the drawbacks of the approach? The most serious one is that preselection provides no guarantees against undesirable changes in the domestic policy stance (perhaps through changes in government) and thus may weaken the safeguards on IMF resources. Furthermore, the prequalfication requirement would exclude from IMF lending a large number of member countries that do not have access to international capital markets. There is also the serious problem of what the IMF should do when a country's policies deteriorate. The disqualification of a country may itself trigger a crisis. This last is the main reason countries have been reluctant to sign on to the Contingent Credit Lines (CCL) Facility created in 1999 by the IMF, which is based on the prequalification requirement. Streamlining structural conditions The second approach centers on streamlining the number of conditions in IMF program. While the number of conditions in programs relating to macroeconomic performance has been relatively stable over time, the number of structural conditions has increased substantially, going from an average of 3 in the late 1980s to 15 in the late 1990s. There have also been cases where the number of structural conditions ballooned drastically. This occurred in the programs with countries during the Asian financial crisis and in the Russian program of 1996. It is now widely acknowledged that the expansion of structural conditions left limited scope for domestic policy choices, thereby potentially reducing country ownership. Why did structural conditionality increase so dramatically? A few reasons stand out. |
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