IMF InFocus magazine

Information about Asia and the Pacific Asia y el Pacífico
Journal Issue

Lending And Conditionality: Getting Back on Track

International Monetary Fund. External Relations Dept.
Published Date:
August 2006
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Information about Asia and the Pacific Asia y el Pacífico
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The IMF provides financial assistance to members with balance of payments problems to support policies of adjustment and reform, including concessional assistance to low-income countries. The financing is for general balance of payments support, rather than for specific purposes or projects like the financing provided by development banks. All financial assistance by the IMF is approved by its Executive Board.

The volume of IMF lending has fluctuated significantly, reaching an all-time high in the early 2000s, in response to exceptional access to IMF resources by large emerging market economies facing capital account crises. Total IMF credit outstanding has declined sharply since then, owing to the benign global environment that has allowed large users of IMF resources to repay their obligations to the IMF.

Over the years, the IMF has developed a number of loan instruments, or “facilities,” that are tailored to address the specific circumstances of its diverse membership.

Pedestrians in Sofia, Bulgaria. Structural reforms in Bulgaria aim at improving the business climate.

Nonconcessional loans are provided through four main facilities: Stand-By Arrangements (SBAs), the Extended Fund Facility, the Supplemental Reserve Facility, and the Compensatory Financing Facility (see page 25). Low-income countries may borrow at a concessional interest rate through the Poverty Reduction and Growth Facility (PRGF) and, if hit by a shock beyond their control, through the Exogenous Shocks Facility (ESF). The ESF is designed for countries without a PRGF-supported program or with a Policy Support Instrument (PSI) program (see page 19). An on-track PSI could provide the basis for rapid access to ESF financing if a shock occurs, although access would not be automatic. Members recovering from natural disasters and armed conflicts can also request emergency assistance from the IMF—possibly at concessional rates for low-income countries.

When a member does not face a pressing balance of payments need, it may treat an IMF arrangement as precautionary, which provides the right—conditional on implementation of specific policies—to make drawings should the need arise.

In recent years, the largest number of loans has been made through the PRGF. The largest amount of funds is provided through SBAs, however. In the context of the IMF’s medium-term strategy (see page 7) endorsed by the policy-setting International Monetary and Financial Committee of the Board of Governors at the 2006 spring meetings, further consideration is being given to a possible new instrument to provide high- access contingent financing for emerging market economies that have strong macroeconomic policies, sustainable debt, and transparent reporting but remain vulnerable to shocks.

Nonconcessional facilities are subject to the IMF’s market-related interest rate, known as the “basic rate of charge.” This rate of charge is based on the Special Drawing Right (SDR) interest rate, which is revised weekly to take into account changes in short-term interest rates in the major international money markets. Large loans carry an interest rate premium, or “surcharge.”

The amount that a country can borrow varies with the type of loan and is expressed as a multiple of the country’s IMF quota. To finance an exceptional balance of payments need, the IMF may also lend beyond the access limits. The IMF encourages early repayment of loans. Although it has a standard repayment obligations schedule, members are expected to repay according to a faster schedule when possible.

Diverging trends in credit outstanding

Note: Data as of the end of the financial year (April 30). The decrease in FY2006 is due to delivery of multilateral debt relief on January 6 and April 28.

1 Poverty Reduction and Growth Facility.

Data: IMF Finance Department.

Conditionality in IMF lending

When a country borrows from the IMF, its government commits to strengthening its economic and financial policies—a requirement known as conditionality. Conditionality provides assurance to the IMF that the borrower will use the loan to resolve its economic difficulties and be able to repay promptly, so that the funds become available to other members in need.

In recent years, the IMF has streamlined the conditions attached to its financing. The IMF’s Board adopted revised guidelines in September 2002 emphasizing the need to focus conditionality on the key macroeconomic objectives and policy instruments and to promote stronger national ownership of policy programs. A recent review suggested that conditionally has indeed become more focused and that fewer programs now stop prematurely.

The policies to be adopted by users of IMF resources should not only resolve the immediate balance of payments problem but also lay the basis for sustainable economic growth over the longer term by achieving broader economic stability—for example, measures to contain inflation, reduce public debt, or strengthen financial systems. Policies may also address structural impediments to healthy growth—such as price and trade liberalization or improvements in governance.

Together, these policies constitute a member country’s “policy program,” which is described in a letter of intent or a memorandum of economic and financial policies that accompanies the country’s request for IMF financing. The specific objectives of a program and the policies adopted depend on the country’s circumstances. However, the overarching goal in all cases is to restore or maintain balance of payments viability and macroeconomic stability while setting the stage for sustained, high-quality growth.

How is compliance assessed?

Most IMF loans feature phased disbursements. This allows the IMF to verify that a country is continuing to adhere to its commitments before successive installments are disbursed. Program monitoring relies on several different tools:

  • Prior actions are measures that a country agrees to take before the IMF’s Executive Board approves a loan or completes a program review (see below). Such measures ensure that the program has the necessary foundation to succeed or is put back on track following deviations from the agreed policies. Prior actions could include, for example, adjustment of the exchange rate to a sustainable level, elimination of price controls, or formal approval of a government budget consistent with the program’s fiscal framework.
  • Performance criteria are specific conditions that have to be met for the agreed amount of credit to be disbursed. There are two types of performance criteria: quantitative and structural. Quantitative criteria typically refer to macroeconomic policy variables such as international reserves, monetary and credit aggregates, fiscal balances, or external borrowing. For example, a program might include a minimum level of net international reserves, a maximum level of central bank net domestic assets, or a maximum; level of government borrowing. Structural criteria are used for structural measures that are critical to the success of the economic program. These vary widely across programs but could, for example, include specific measures to improve financial sector operations, reform social security systems, or restructure key sectors such as energy.
  • Quantitative criteria may be supplemented with indicative targets. These are often set for the later months of a program and are then turned into performance criteria, with appropriate modifications, as economic trends firm up.
  • Structural benchmarks are used for measures that cannot be monitored specifically enough to be performance criteria, or for small steps in a critical reform process; breach of these would not individually warrant an interruption of IMF financing.
  • Another important monitoring tool is the program review, which serves as an opportunity for a broad-based assessment by the Executive Board of progress toward the program’s objectives. Reviews are used to discuss policies and introduce changes that may be necessary in light of new developments. In some cases, a country might request a waiver for a breached performance criterion—for example, when its authorities have already taken measures to correct the deviation.

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