IMF Lending to Developing Countries

Issues and Evidence

Graham Bird

• Publisher: Routledge
• Year: 2003
• Print ISBN: 9780415117005
• eBook ISBN: 9781134817634
• Topic: Physical Sciences
• Subtopic: Geography
• Index: Geography

As the linchpin of the global financial system, the International Monetary Fund provides the balance of payments support, chiefly to developing countries, conditional on strict remedial policy measures. Its approach to policy remains highly controversial, however. While the Fund claims it has adapted, critics allege its policies are harshly doctrinaire, imposing hardships on already poverty-stricken people. For the critics, the half century of its existence is `fifty years too long' and radical change is essential. This book examines the arguments, tracing the extent of Fund adaption, presenting major new evidence on the consequences of fund programes, and considering its future role.

1
THE IMF AND DEVELOPING COUNTRIES

The International Monetary Fund was originally established in order to encourage international co-operation to cope with recession and protectionism on a world scale and to discourage individual countries from pursuing policies that would beggar their neighbours and eventually themselves. The desire to improve on the international chaos of the 1930s led to the Bretton Woods Conference in 1944 and an attempt to devise a financial system which would provide a more permanent and acceptable framework for international transactions. It was intended that the emerging Bretton Woods system would generate benefits for international trade in the form of stable (though not necessarily fixed) exchange rates, whilst, at the same time, avoiding the deflationary rigidities of the gold standard mechanism. The system was designed to ensure a world of full employment and economic growth.

If the general purpose of the Fund at its inception was to oversee the operation of the infant Bretton Woods system, its more specific purposes were spelt out in Article 1 of its Articles of Agreement as follows:

1. To promote international monetary co-operation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems.
2. To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.
3. To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.
4. To assist in the establishment of a multilateral system of payments in respect of current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade.
5. To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with the opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.
6. In accordance with the above, to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.

Within the framework set by these terms of reference the Fund operated, first, as a balance of payments adjustment institution, encouraging payments correction by means other than the use of exchange rates (except in cases of fundamental disequilibrium) or protectionist trade measures; second, as a balance of payments financing institution, providing temporary finance designed to support adjustment measures to cushion self-reversing payments instabilities; and third, as a focus for a system of rule-based international macroeconomic policy co-ordination, based essentially on the defence of established currency par values. The Fund thereby provided a linchpin for the centralised management of the international monetary system.

Throughout the 1950s and 1960s few questions were asked about the legitimacy of what the Fund was doing. On most criteria the world economy was performing well, or at least satisfactorily. Given these circumstances, the question of the extent to which success was due to the operation of the Bretton Woods system and the IMF simply did not arise. Deeper thought would have revealed the fundamental difficulties that exist in evaluating international monetary systems, and would have suggested the possibility that it was the success of the world economy which concealed the weaknesses of the Bretton Woods system and enabled it to survive. But such issues hardly seemed relevant at the time. Superficially at least the Fund appeared to be successful in achieving the objectives it had been set. The Bretton Woods exchange rate regime did provide a code for the non-aggressive use of devaluation; the IMF did provide a consultative forum within which international financial reform was debated and implemented; the world economy did enjoy a period of sustained expansion; and world trade was liberalised and did grow. So what went wrong?¹

A lengthy answer to this question would articulate the various deficiencies of the Bretton Woods system in terms of the adjustment mechanism it incorporated, the method of reserve creation it used, and its vulnerability to speculative attacks. However, shorter answers are available.

The first is that the Bretton Woods system ultimately broke down. As a result, the IMF as the agency that had been charged with overseeing the operation of that system, was left disoriented. It was apparently left with little or no systemic role. The second is that the Bretton Woods system was replaced by a much looser set of international monetary arrangements. There was very little ‘system’ left, and, in effect, the international monetary system was privatised, with the result that there was no clear-cut role for a quasi-governmental institution such as the Fund.

Moreover, the way in which international financial arrangements evolved during the 1970s and 1980s served to marginalise the systemic role of the Fund. First, there was the adoption of generalised flexible exchange rates. Initially these were inconsistent with the Fund’s own Articles of Agreement; but even after the Articles had been modified to accommodate floating, the Fund continued to exert little influence over the direction and size of exchange rate movements. Efforts to provide a degree of surveillance over them, and to devise a set of guidelines according to which government intervention in foreign exchange markets might be carried out, had little discernible impact.

The shift to generalised flexible exchange rates also took away the means by which macroeconomic policy had been internationally co-ordinated. The retreat from international policy co-ordination essentially carried on until the mid-1980s. The Bonn Summit of 1978, involving the world’s leading industrial nations, represented an exception to this trend, although even here co-ordination was not organised around exchange rates. The early 1980s were characterised by the sustained appreciation in the value of the US dollar and by the ‘benign neglect’ that the US Administration showed for this. It was not until the Plaza Accord of 1985 that a co-ordinated move to bring down the dollar’s value was implemented, with this arrangement being followed by further attempts to manage exchange rates, the most notorious of which was the Louvre Accord of 1987. However, such co-ordination was handled outside the IMF by the G-7 or the G-3 countries; the Fund’s Managing Director was not even involved in the Plaza discussions. The late 1980s illustrated the degree of overlap between the former systemic role of the IMF in terms of exchange rate management, balance of payments adjustment, and the avoidance of world-wide inflation or deflation, and the actual role being contemporaneously played by a small sub-group of powerful industrial countries outside the auspices of the Fund.

The second area in which the activities of the Fund were marginalised after the breakdown in the Bretton Woods system involved balance of payments financing. Although the oil price rise of 1973 and the related acceleration and diversity in rates of inflation dramatically increased the need for international financial intermediation, this largely took place through the private international banks. The late 1970s saw the privatisation of balance of payments financing. The privatisation was, of course, neither instantaneous nor complete. The Fund did respond to the oil price rise by introducing the Oil Facility and it did expand its loans in the mid-1970s by liberalising the Compensatory Financing Facility (CFF). But the extent of privatisation was on a sufficient scale to reflect a broad systemic change. During the period 1977–82 short-term bank lending to developing countries ran at an annual average of $19.5 bn, whereas net purchases from the Fund were only $2.5 bn.

Related to both the move to exchange rate flexibility and the private financing of balance of payments deficits, the Fund’s importance as a source of official reserve creation also became marginalised during the 1970s. Ironically, the decade had begun with the introduction of the Special Drawing Right; and even as late as 1976, at its Jamaica meetings, the Fund was setting the objective of establishing the SDR as the principal reserve asset in the international financial system. The reality, however, was that, with flexible exchange rates and the private financing of payments deficits, the quantity of official reserves became viewed as an unimportant issue. The ‘system’ moved over to the wider use of certain national currencies as international reserve assets, thereby becoming a multiple reserve currency system; SDR creation was not maintained, and attempts to introduce a substitution account failed; even the SDR’s use as a unit of account was superseded by the European Community’s European Currency Unit (ECU). Some critics observed gleefully that, rather than just being marginalised, the SDR had been almost obliterated. Certainly no effective role seemed to be left for the Fund in influencing global reserve adequacy—a role that had appeared central in the 1960s.²

Finally, the trend seemed to be to move away from international monetary arrangements and towards regional ones. Increasing regionalisation was most dramatically illustrated by the establishment of the European Monetary System in 1979. It was now at the regional level that the management of exchange rates and the co-ordination of macroeconomic policy occurred.

While such developments led some people to call for the establishment of a European Monetary Fund to carry out within Europe the former systemic functions of the IMF, others now argued for the dissolution of the IMF. During the 1970s this call was loudest from those developing countries which, observing the collapse of the old economic order, of which the Fund was seen as a central part, urged the establishment of a New International Economic Order (NIEO) with brand-new institutions. However, the political influence of this argument was only ever likely to be as strong as the commodity cartels that in fact failed to materialise.³ More influential remained the argument that the Fund was no longer needed in a non-Bretton Woods and market-dominated world economy. What was there left for the Fund to do?

CHANGING PARTNERS: THE FUND’S INVOLVEMENT WITH DEVELOPING COUNTRIES

While events during the 1970s undermined the global systemic role of the Fund, they also served to create circumstances in which it was almost forced into accepting a new and more specific role.⁴performance in the long run. This role reflected the evolving balance of payments problems which developing countries encountered during the 1970s and 1980s. During the latter part of the 1970s the Fund’s role was largely limited to the world’s poorest countries, located in Africa and Asia, which lacked creditworthiness in the eyes of the commercial banks. Beyond 1982, however, and with the arrival of the debt crisis, its dealings spread to include the better-off developing countries of Latin America. The Fund’s involvement included both a financing and an adjustment element, and it was in the context of the period immediately following the debt crisis that it transiently recaptured systemic significance by seeking to avert the collapse of the international banking system which some commentators argued the debt crisis would cause.

Table 1.1 Developing countries: net credit from IMF, 1982–92 (US$ bn)^a

The Fund’s involvement with developing countries is quite starkly revealed by considering the size and pattern of its lending since the mid-1970s.

Table 1.1 gives information on the use of Fund credit in the period 1982–92. This is confined to developing countries because no industrial country has used Fund credit in recent years. The picture it provides contrasts sharply with that for earlier periods. In 1968–72, for example, 11 industrial countries, including all the G-7 countries (with the sole exception of Japan), drew on the Fund. Drawings by developing countries, although relatively numerous, were also relatively small. Thus, over the same fiveyear period, 33 developing countries used Fund credit, but even at their peak in 1968 these drawings reached only 23 per cent of the total quotas of developing countries. In 1970, SDR 2.4 bn of the Fund’s total outstanding credit of SDR 3.2 bn was with industrial countries. Throughout the rest of the 1970s, industrial countries remained substantial users of Fund credit in one form or another, in spite of the move to flexible exchange rates. Industrial countries were not insulated from the balance of payments consequences of the oil price rise of 1973 and there were some doubts concerning the permanency of flexible rates. Indeed, drawings by the United Kingdom and Italy on their own accounted for almost 40 per cent of total drawings from the Fund during 1974–7. Beyond this period, however, no major (G-10) industrial country has used Fund credit. The United States drew under the reserve tranche in November 1978, but this did not involve the use of Fund credit. Indeed, significantly there is some evidence that this drawing, as well as an earlier drawing by the UK in 1976, had been motivated by political considerations, basically the desire to obtain an outside endorsement for unpopular domestic policy.

With the legitimisation of floating exchange rates through the amendment of the Fund’s Articles of Agreement in 1978; the establishment of the European Monetary System in 1979 and the credit facilities which this provided for members of the system; and continuing innovation in international financial intermediation using private capital markets, industrial countries could now easily bypass the IMF.

This was clearly not the case for developing countries, particularly after the debt crisis had come to the fore in 1982. Prior to that date a limited number of the better-off developing countries had enjoyed access to private capital in the form of loans from the commercial banks. By late 1981 most Fund lending was to the least developed countries. This is reflected in Table 1.1 by the relatively large amount of net Fund credit to the developing countries of Africa and Asia observed in 1982 and by the relatively small amount of net credit to the less developed countries of the Western Hemisphere. At this time a division of labour appeared to be emerging between the Fund and the banks in terms of lending to developing countries. However, the pattern was rudely disturbed in 1983 and beyond, as countries formerly deemed creditworthy by the banks found their access to commercial credit being cut off. Given the size of their adjustment problems, these countries were now forced to turn to the Fund for finance. While in 1982 Fund credit in African developing countries had been a third larger than in those of the Western Hemisphere, by 1983 it was only a fifth of the Western Hemisphere figure. The change in the pattern of Fund lending to developing countries was indeed dramatic. While there had been a steady increase in outstanding Fund credit in African developing countries during the period 1970–85, and a rather less steady increase in Asia, Fund credit outstanding in the developing countries of the Western Hemisphere actually fell between 1976 and 1981 but then increased tenfold in the next five years.

Yet while the first half of the 1980s saw the Fund becoming quite heavily involved in providing credit to developing countries, by the second half of the decade the net transfer had become negative. If the negative net transfer that developing countries faced in terms of the banks was a problem, the Fund seemed to be adding to it rather than helping to resolve it. On the other hand, the positive net flow of Fund resources in the earlier 1980s seen against a negative net flow of commercial loans had led to accusations that the Fund was bailing out the banks.

In quantitative terms, the Fund’s response to the changing financing role of the banks during the 1980s was only partial. Even when the Fund’s net lending was positive in the first half of the decade, it did not offset the negative net flows associated with the commercial banks. In any case, the response was largely forced on the Fund by outside events; it was not a response that the Fund had itself orchestrated, except to the extent that concerted lending had been seen as a means of averting a major international financial catastrophe as a consequence of the debt crisis. Basically, if countries are eligible to draw, then the Fund has to make resources available. The changing pattern of Fund lending largely reflected changes in the demands coming from developing countries rather than a desire on the part of the Fund to become more heavily involved in lending to them.

Table 1.2 Summary of external financing of balance of payments deficits in developing countries, 1985–93 (US$ bn)

By the beginning of the 1990s data in Table 1.2 show that commercial bank lending was again relatively heavy to developing countries as a whole. Net credit from the IMF seemed small relative to all other forms of external financing.

Whatever its cause, the changing pattern of Fund lending raised a series of questions concerning the role of the Fund. Should it be lending exclusively to developing countries? Had it become, to all intents and purposes, a development agency? Was the nature of its conditionality appropriate for the countries that were now turning to it? Did lending to developing countries not mean that there was considerable overlap between the Fund and the World Bank, and if so, how should this overlap be handled? Was the exclusivity of its clientele causing the Fund to lose sight completely of its former systemic role? Was there a need to make a distinction at the very least between the problems and requirements of the middle-income as compared with the low-income countries? Underpinning much of this was a more general question which the Fund had wrestled with during much of its history—the question of whether developing countries warranted special treatment within the international monetary system.

DEVELOPING COUNTRIES AS A SPECIAL CASE

In its early years the Fund rejected the claim that developing countries warranted any form of special treatment. However, over the years a number of reforms were implemented which were primarily or exclusively directed towards developing countries. Given the Fund’s position as a balance of payments institution, the rationale for such reforms has not been that of international equity, but rather the implicit acceptance that developing countries encounter payments problems that are different in either size or nature from those encountered by other country groups. What criteria might reflect this?

Balance of payments difficulties emanate from a number of sources. First, there may be secular changes in exports, imports and long-term capital flows. For example, a country producing and exporting goods that have a low income elasticity of demand and importing goods that have a higher one will tend to encounter balance of payments problems. Such factors reflect payments deficits and surpluses as essentially structural phenomena. On top of this, where demand and supply are themselves unstable, low price elasticities of demand and supply will tend to result in instability in the terms of trade. In part such balance of payments instability reflects vulnerability to exogenous shocks.

Both the above factors influence the incidence of payments deficits and surpluses. Other important aspects of the balance of payments relate to the speed and efficiency with which deficits may be financed or corrected. The capacity of a country to finance a payments deficit depends on the level of its reserve holdings and the availability of finance from the private international banks and the Bretton Woods institutions. In turn, the scope for payments correction varies with the capacity for adjustment within the economy. This depends on a number of factors, including the extent to which domestic consumption may be switched into exports, and more generally, the scope for short-run export expansion and efficient import substitution, the degree of money illusion, the flexibility of domestic economic policy, the level of infrastructural investment and, related to the above, the values of export supply and import and export demand price elasticities.

For example, with low elasticities and a high degree of real wage resistance the scope for balance of payments adjustment will be strictly constrained. Clearly to the extent that the adaptability of an economy is positively related to its level of economic development it is likely that developing countries will encounter more difficulty in coping with balance of payments problems than do developed economies. However, the presumption may not always be valid. It is not difficult to think of developing countries that have been characterised by their ability to respond to a changing world economic environment. Similarly, one can think of developed countries that find change difficult to accommodate because of their stymied socio-economic and political systems. An important feature of the 1970s and 1980s was the growing irrelevance of a categorisation of countries that lumped all developing countries together. Such an approach may be positively misleading. Disaggregation is therefore vitally important....

Table of contents

• Cover Page
• Title Page
• Copyright Page
• List of Figures
• List of Tables
• Preface
• 1: The IMP and Developing Countries
• 2: IMP Lending: The analytical issues
• 3: IMP Lending: The empirical evidence
• 4: IMP Lending: The way forward
• Notes
• References