Change of Editor · Change of Editor Samuel I. Katz Editor of Financ e & Development since 1977, completed his tenure in February 1982. Mr. Katz had succeeded Ian Bowen in February

Change of EditorSamuel I. Katz

Editor ofFinance & Development

since 1977,completed his tenure

in February 1982.Mr. Katz had

succeeded Ian Bowenin February 1977.

ABahrain Nowzadis the new Editor.He was previouslyAssistant Director inthe Exchange and TradeRelations Departmentof the Fund in chargeof the ExternalFinance Division.

Mr. Nowzad was educated in England atthe Universities of Birmingham and Oxford.He has written widely on internationaleconomic subjects, including articlesfor Finance & Development.

EditorManaging EditorAssistant EditorEditorial Officer

Art EditorGraphic Artist

Bahram NowzadShuja NawazJoslin Landell-MillsSheila A. MeehanRichard W. StoddardDeborah Salzer

Advisors to theEditor Dinesh Bahl

Carl BellBarend A. de VriesJ. Price GittingerNorman K. HumphreysCarlos E. SansónCharles F. SchwartzU Tun WaiDavid WilliamsChristopher R. Willoughby

Advisor on books Shahid YusufAdvisor for the

Arabic edition Salah El Serafy

NEWFROM THE WORLD BANK

International Comparisons Project: Phase HiWorld Product and Income:International Comparisons of Real Gross Domestic Product¡wing B. Kraute, A/an Heston, and Robert SummersThis is the third volume in a series designed to establish a worldwidesystem of international comparisons of real product and the purchas-ing power of currencies. The report restates and extends themethodology set out in the first two volumes. Particular attention isgiven to the problem of comparing services and to the conflictingdemands of regional and global estimates.

Comparisons are given of prices, real per capita quantities, and finalexpenditure components of gross domestic product (GDP) for 34countries for 1975. By relating the results to certain widely availablenational income accounting data and related variables, the authorsdevelop extrapolating equations to estimate per capita GDP for these34 countries for 1950-78.

The first volumes in the series are A System of InternationalComparisons of Gross Product and Purchasing Power [1975, clothUS$27.50 (£16.50), paper US$8.95 (£5.50)] and /niemationa/Comparisons of Real Product and Purchasing Power (1978, clothUS$25.00 (£15.00), paper US$8.50 (£5.00)].

400 pages. Cloth US$30.00 (£18.00), paper US$12.95 (£8.50).

Economic Analysis of Agricultural ProjectsSecond edition, completely revised and expandedJ. Price GittingerIn the ten years since its publication, the first edition of the WorldBank's best-seller has been widely accepted as a standard referencetool in its field. This complete revision adds a wealth of recent projectdata; an expanded treatment of farm budgets and the "efficiencyprices" used to calculate the effects of an investment on nationalincome; a glossary of technical terms; expanded appendixes onpreparing an agricultural project report and on the use of discountingtables; and an expanded, completely annotated bibliography.

The presentation is accessible to a broad readership of agriculturalplanners, engineers, and analysts. Differences between this and othermethods of project analysis are delineated; financial economic con-cepts are explained for the nonspecialist; calculations are given insimple arithmetic; and the applications of a simple electronic calculatorare detailed.

Approximately 432 pages. Cloth US$37.50 (£22.50), paperUS$13.50 (£8.75).

These books are published for the World Bank by The Johns HopkinsUniversity Press and are available from The World Bank, PublicationsDistribution Unit (Dept. FD), 1818 H Street N.W., Washington, DC 20433,USA

Finance & Development is published quarterlyin English, Arabic, French, German, Portuguese,and Spanish by the International MonetaryFund and the International Bank for Recon-struction and Development, Washington, D.C.20431, U.S.A. (USPS 123-250).

The Arabic edition is published in collabora-tion with An-Nahar Publications Internation-ales S.A., 19 Av. Franklin Roosevelt, 75008Paris, France.

The French language edition is published incollaboration with Groupe Expansion, 67, Ave-nue de Wagram, 75017 Paris, France.

The German language edition is published incollaboration with HWWA-lnstitut für Wirt-schaftsforschung-Hamburg, and produced byVerlag Weltarchiv GmbH.

The Portuguese edition is published in col-laboration with the G et ú lio Vargas Foundation,Rio de Janeiro, Brazil.

Second class postage is paid at Washington,D.C. and at additional mailing offices.English edition ISSN 0015-1947

New readers who wish to receive Finance &Development regularly may make an applica-tion through an appropriate institution, orindividually, to be added to the mailing list.Individuals should briefly state the reasons fortheir request. Please indicate which languageedition is wanted—only one edition will besent. Applications should be mailed to Finance& Development, International Monetary FundBuilding, Washington, D.C. 20431, U.S.A.

Opinions expressed in articles and other ma-terial are those of the writer or writers; they arenot statements of Fund or Bank policy.

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Finance & Development is available onmicrofilm from University Microfilms, P.O. Box1346, Ann Arbor, Michigan 48106, U.S.A., andon microfiche (English only) from MicrophotoDivision, Bell and Howell Company, Old Mans-field Road, Wooster, Ohio 44691, U.S.A.

The contents of Finance & Development areindexed in Business Periodicals Index, PublicAffairs Information Service (PAIS), and Biblio-graphie Internationale des Sciences Sociales.

An annual index of articles and book reviewsis carried in the December issue of Finance &Development.

©International Monetary Fund. Not for Redistribution

June 1982/Volume 19/Number 2

_. Finance.Development A quarterly publication of the International Monetary Fund and the World Bank4 A conversation with Mr. de Larosière

An interview with the Managing Director of the Fund

A.w. Clausen 6 A financial appraisal of the BankAn overview of the financial policies and operations of the World Bank,from a recent speech by the Bank President

Andrew Crockett 10 Issues in the use of Fund resourcesMajor issues in negotiations between the Fund and member countrieson adjustment programs and an outline of procedures

Michael Upton and 16 The World Bank and povertyAlexander Shakow A recent Bank study of poverty-oriented lending confirms the importance

of this emphasis

Aklilu Habte 20 Education and national developmentLending for education projects serves economic as well as socioculturalobjectives in developing countries

Jack P. Barnouin 24 Trade and economic cooperation among developingcountriesAn outline of international discussions and their prospects, accompaniedby data on trade flows

Economic development and the private sectorChauncey F. Dewey and 28 Market factors in large industrial development projects

Harinder S. Kohli Whether in the public or private sector, such projects must meet thestrict financial criteria of the Bank

Larry £. Westphai 34 The private sector as "principal engine" of development:KoreaHow the private sector played a critical role in Korea's economic growth

Bijan B. Aghevli 39 Exchange rate policies of selected Asian countriesCoordinating monetary and exchange rate policies can help curb inflation

2 Bank activityGraduation policy reaffirmed

3 Fund activityNew commitments; new members

43 Book noticesWorld Inflation and the Developing Countries, by William R. Cline andassociates, reviewed by Abul K.M. SiddiqueOther books received

The Editor welcomes views and comments from readers on the contents of the magazine.


World Bank's graduation policy reaffirmedGraduation of borrowers from the WorldBank is a firmly established principle andhas been a long-standing practice. Thegraduation policy was reaffirmed at a meet-ing of the Bank's Board of Executive Direc-tors recently.

Graduation is a process of slowly phasingout World Bank lending as the borrowingcountry reaches a level of development,management capacity, and access to capitalmarkets that permits it to carry on withoutWorld Bank financing. The major features ofthis policy are the following:

1. Graduation is a logical step in the de-velopment process, and a clear set of guide-lines for graduation from Bank lending is re-quired.

2. Graduation should be a flexible and fairprocess, sensitive to each country's individ-ual circumstances; special features, such asthe problems of small countries with nar-rowly based economies, will be recognizedin the phase-out program.

3. Graduation will normally occur withinfive years after a country reaches a per cap-ita gross national product (GNP) bench-mark, but this period might be longer if thesituation deteriorates during the phase-outperiod.

4. Graduation should be seen as a stagein the evolving relationship between the bor-rowing country and the Bank; the Bank willcontinue to provide support to those coun-tries that wish it after lending has ceased,including such services as technical assis-tance (assistance in project work and institu-tion building, review of economic policies,and arrangements for private financing),continued access to the courses of theBank's Economic Development Institute(which offers training to senior officials fromdeveloping countries), and continued eligi-bility for operations of the International Fi-nance Corporation (IFC).

5. Once a program of graduation isagreed upon with the borrower, manage-ment will make a full report to ExecutiveDirectors.

6. The graduation issue, including anyproblem that may arise in the application ofthe per capita GNP level that triggers gradu-ation, will be reviewed annually.

In 1973 the per capita GNP level thatwould trigger graduation was set at

US$1,000 in 1970 prices. The 1980 equiv-alent is estimated at $2,650, after updatingfor inflation and exchange rate changes.

In its early years the Bank had made sub-stantial loans to a number of industrial coun-tries. By 1967, most of these borrowers hadgraduated. During the 1970s another groupof higher income countries was graduated,

Table 1IBRD borrowers with per capita GNP

over $1,500'

1980 per capita GNPCountry (In U.S. dollars)

OmanTrinidad and TobagoCyprusBahamasBarbadosUruguayYugoslaviaArgentinaPortugalRomaniaChileMexicoBrazilAlgeriaFijiCosta RicaPanamaMalaysiaKorea

4,3804,3703,5603,3003,0402,8202,6202,3902,3502,3402,1602,1602,0501,9201,8501,7301,7301,6701,520

Source: 1981 World Bank Atlas.'Countries to which IBRD loans have been made in fiscal

years 1979-82.

including Finland, Greece, Iceland, Ireland,Israel, New Zealand, Singapore, Spain, andVenezuela.

The principle of graduation derives mainlyfrom the Bank's Articles of Agreement; theserequire that the Bank must, before making aloan, satisfy itself that the country cannotobtain the loan on reasonable terms in theprivate capital market. The Bank has inter-preted this provision to refer to the extent of

a country's access to private markets formeeting its overall borrowing requirementsat reasonable terms. But since "extent ofaccess" and "reasonable terms" are notpossible to measure precisely, the Bank hassince 1973 used a per capita GNP bench-mark as a proxy for the level of developmentthat should normally warrant detailed con-sideration of graduation.

In practice, this guideline has been ap-plied quite flexibly. By the time they actuallygraduated from Bank lending, nearly all ofthe countries mentioned above had per cap-ita incomes substantially above that bench-mark, even after adjusting for inflation. Asoverall constraints on the Bank's resources

Table 2Past IDA

Country

ChileColombiaCosta RicaNigeriaDominican RepublicIvory CoastKoreaTurkeyBotswanaEcuadorSyriaMauritiusMoroccoSwazilandEl SalvadorParaguayTunisiaJordanPhilippinesThailandIndonesiaCameroonEgypt

borrowers

Year of last IDA credit(Fiscal year)

1961

1962196219651973197319731973197419741974197519751975197719771977197819791979198019811981

Source: World Bank.

IBRD loans are repayable over a 15-20 year period, with interest currently at 11.6 per centa year and an annual commitment charge of 0.75 per cent on undisbursed balances; the loansalso carry a one-time front-end fee of 1.5 per cent on the amount of the loan.

IDA credits are for 50 years, including 10 years grace; they carry no interest but bear a smallannual service charge—0.5 per cent on the undisbursed balances of the credit and 0.75 percent on the disbursed balances.

Finance & Development / June 1982

Bankactivity


have increased in recent years, there hasbeen a need to review the Bank's graduationpolicies. This was done at the recent Boardmeeting.Graduation from IDA to IBRD

The principal criteria for International De-velopment Association (IDA) eligibility arealso well established. These are lack of suf-ficient creditworthiness to meet capital re-quirements on commercial terms and percapita GNP below an established ceiling.The current per capita GNP ceiling foreligibility is $730 at 1980 prices, althoughin recent years the great bulk of IDA re-

sources (nearly 90 per cent) has been allo-cated to countries with per capita incomesbelow $400.

A complete list of IDA graduates is shownin Table 2. Several of these countries, suchas Jordan, Mauritius, and Paraguay, havebeen graduated because their income hadexceeded the IDA eligibility level, while oth-ers such as Egypt, Indonesia, and Thailandwere graduated because their credit-worthiness reached a point where they couldservice loans on International Bank forReconstruction and Development (IBRD)terms.

Countries will continue to graduate fromIDA to IBRD lending. If the drastic reductionof resources continues (from the level of$4.1 billion originally planned for fiscal year1982), the graduation process will have to beaccelerated at a faster than desirable pace.Substitution of IBRD funds for IDA does not,however, offer a means of meeting theneeds of most IDA countries, since few aresufficiently creditworthy to permit significantsubstitution and none could afford to borrowIBRD funds in amounts equal to current IDAlending.

Total new commitments by the Fund for bal-ance of payments support to member coun-tries under stand-by and extended arrange-ments amounted to nearly SDR 12.7 billionat the end of March 1982, of which SDR 3.8billion has been disbursed. As shown in Ta-ble 2, total purchases from the Fund duringthe first quarter of 1982 were SDR 1.8 billion,of which the largest share consisted of re-serve tranche purchases totaling SDR 592.4million.

There were 22 stand-by arrangements ineffect at the end of March, as well as 14extended arrangements, all but 3 of whichwere under highly conditional facilities. Thetotal gross amount approved under stand-byand extended arrangements as of the endof March was SDR 16.9 billion. There wasan undrawn balance of SDR 12.2 billion un-der such arrangements on March 31, thatmay be drawn subject to phasing and toperformance criteria in individual countryprograms.

New members

On February 25 Antigua and Barbuda be-came a member of the Fund with a quota ofSDR 3.6 million and Belize joined on March16 with a quota of SDR 7.2 million.

With the admission of the HungarianPeople's Republic on May 6, the Fund nowcomprises 146 member countries. The Hun-garian quota, SDR 375 million, brings totalmembers' quotas to SDR 61,059,800,000.

Table 1New commitments and use of Fund resources

(In billions of SDRs)

Calendar yearJanuary-

March

1979 1980 1981 1981 1982

1a. New commitments (net of cancellations)1 1.8 6.8 12.7 3.1(Amount disbursed)

Industrial countriesDeveloping countries

1b. Purchases3

Industrial countriesDeveloping countries

2. Trust Fund loans disbursedDeveloping countries only

Total (1 + 2)4

(1.4) (2.6) (3.7) (0.9)

1.80.7

0.7

0.5

3.0

6.8

1.0

1.0

1.39.1

12.71.5

1.5

0.414.6

3.10.1

0.1

0.43.6

0.12

0.3

0.3

0.3

Source: IMF, Treasurer's Department.... Indicates less than SDR 500,000.— Indicates zero.\ Under stand-by and extended arrangements in period, including supplementary financing where applicable.Í; Disbursements from prior commitments.3 Compensatory financing, buffer stock, and oil facilities purchases, plus credit tranche purchases made outside stand-by

and extended arrangements with members (namely, first credit tranche).4 A broad measure combining commitments made in the period (to lend over the ensuing one to three years amounts

subject to balance of payments need and performance criteria in individual country programs) with balance of paymentsassistance provided in the period outside such arrangements with members.

Table 2Summary of transactions, 1978-82

(In millions of SDRs)

Calendar year

Total purchasesReserve trancheCredit tranche

(Of which, supplemen-tary financing facility)

(Of which, enlargedaccess)

Compensatory financingExtended facility

(Of which, supplemen-tary financing facility)

(Of which, enlargedaccess)

Buffer stockTotal repurchases

Trust Fund loans

Source: IMF, Treasurer's Departme— Indicates zero.

1978

3,744.32,535.5

421.0

(-)

(-)577.7174.0

(-)

(-)36.1

4,845.2688.1

nt.

1979

1,842.8147.1853.1

(205.4)

(-)572.0233.0

(101.5)

(— )37.7

4,215.3526.6

1980

3,752.7359.2

1,798.6

(943.1)

(-)980.4614.5

(275.2)

(— )—

3,344.81,256.0

1981

7,081.7310.4

3,436.6

(1,468.9)

(305.5)1 ,242.52,092.2

(570.7)

(480.6)—

2,109.8367.7

January-March

1981

1,505.7202.9

1,117.3

(342.6)

(— )19.4

166.1

(51.0)

(-)—

592.4367.7

1982

1,826.2592.4419.8

(300.7)

(10.0)309.9504.1

(108.8)

(150.0)—

528.2—

Finance & Development /June 1982

Fundactivitŝ ^^


AconversationwithMr. de Larosière

The Managing Director of the Fundinterviewed by Finance & Development

Q. In recent speeches you have emphasized that industrialcountries must persevere with their strict financial policies tobring down inflation. In the light of unemployment andreduced economic activity—both particularly harmful tothedeveloping countries as well—isn't the cost too high? Whydoesn't the Fund promote other policies, for example,complementary incomes policies to reduce inflationaryexpectations?A. I think that what we have to stress now is that unemploymentand reduced economic activity have been bred by years ofinflation and lax financial policies. There is no way of reducingunemployment by rekindling inflation. Countries have tried thatin the past and it just doesn't work. Some immediate but artificialactivity could well be created by a relaxation of demand manage-ment but sooner or later, probably sooner rather than later,inflation would get worse, savings would abate again, andbalance of payments problems would become more acute; coun-tries following those policies would be compelled to return tomore restrictive financial policies which would, at that time, beeven more costly for them and for the world as a whole. For thisreason, we in the Fund strongly encourage all countries to engagein strong anti-inflationary struggles and to carry out these policiesto the end.

On the costs to developing countries, I would like to point outthat the Fund staff has been working on various scenarios for theWorld Economic Outlook. One scenario, which we call thecentral scenario, assumes that the industrial countries are suc-cessful in their anti-inflationary policies and by 1984 manage toreturn to sounder growth. In the second scenario, the samecountries are assumed to relax their demand policies now.Clearly this second scenario would have much more serious, infact dramatic, consequences on the developing countries than thefirst one in terms of growth and international trade. But the

In future issues Finance & Development will present other interviewswith senior Bank and Fund officials.

developing countries are not only interested in seeing that theindustrial countries remain resolute in their efforts to controlinflation, they are also keenly interested in the modalities of thisanti-inflationary policy. They are particularly interested in themix of fiscal and monetary policies adopted by major industrialcountries and, of course, interested in its implications for interestrates in the world. They are also keenly interested in theapproaches of industrial countries toward the question of opentrade and official development assistance. On incomes policy, Iwould like to say that in our judgment whilst income policies, or Iwould prefer to say income practices, may be useful in combatinginflation, they cannot be in any case the sole, or principal,element of such a policy. They can have a complementary rolebut they can't take the place of a sound demand managementpolicy.Q. Many observers purport to have detected a sharp change inthe degree of Fund conditionality in recent years. Specifically,they claim that there was a substantial loosening until about ayear ago, but that the pendulum has swung since then towardmuch tighter conditionality. First, is this true? If so, what are thereasons for it?A. To answer that question one has to recall what conditionalityis about. Conditionality refers to the economic and financialmeasures which are needed in a particular country in order torestore a sustainable external position at the end or toward theend of a Fund program—that is, a deficit that can be financed bylong-term capital flows without undue burden or strain on thedebt service position of the country in question. For instance, if acountry runs a balance of payments current deficit amounting tolet's say 8 per cent of its gross domestic product (GDP), and if inthat particular case its sustainable deficit is considered to be in theorder of 2 per cent of its GDP, an adequate three-year adjustmentprogram would imply an adjustment of some 2 percentage pointsa year in the deficit of that country. But, suppose now, for thesake of the argument, that this same country has moved into aworse balance of payments position. For instance, a deficit of 12per cent instead of 8 per cent of GDP because of an irreversible

Finance 6- Development / ¡une 19824


deterioration in its terms of trade or/and because of a slippage inits domestic financial policies. Its long-term sustainable financ-able position has not by the same token changed and it is still, inmy example, at 2 per cent of GDP. The necessary adjustmentwould imply a reduction of a little more than 3 percentage pointsa year in the course of the three-year program. Now, in such asituation, which in fact often happens and has occurred in 1980and 1981 with the worsening of international recession, theperception might have arisen that conditionality has tightened.But what has really happened is not a tightening of conditionalityper se, it is a worsening of the external conditions of the countryin question and the need for more adjustments.

A number of programs designed in 1979-80 have encounteredsuch problems; putting these programs back on track implies inmost cases supplementary adjustment measures. It has becomenecessary for the Fund, in view of these changing conditions, toobtain from members requesting assistance substantial assur-ances that the requisite adjustment measures would, in effect, beundertaken. More and more often the assurances are bestprovided by members willing and able to undertake policymeasures right at the beginning of their programs and this is arequirement that the Fund relies upon quite frequently now.

It is important to have a clear understanding and a consensuson the crucial importance of conditionality in the present condi-tions. In the wake of the first oil shock, such a consensus had notbeen reached. Unconditional facilities, or facilities with lightconditionality, were resorted to or designed in the expectationthat the balance of payments problems might be reversible.It became very clear by 1978 that such an unconditional or"recycling-oriented" approach was not warranted by the realitiesof the situation as we saw it evolve at that time. Balance ofpayments must be adjusted and the Fund must link its high credittranche resources to the adoption of meaningful adjustmentpolicies by member countries.

Why did some people perceive or feel a loosening of condition-ality a few years ago? Perhaps because conditionality was beingagain applied after a period of practically no conditional lendingin favor of developing countries from 1974 to 1978. In addition, inthe wake of the second oil shock and the consecutive explosion ofexternal imbalances in 1979-80 the amounts of financial supportprovided by the Fund had rightly been increased in order to givethe Fund that "critical mass" which is needed to entice membercountries to agree on meaningful and realistic programs, and alsoto catalyze the provision of other external funds needed for thefinancing of the balance of payments problems in question.

In reality the degree of adjustment measured in terms of, forinstance, annual reductions in external deficits relative to GDPhas not decreased since 1978 as measured against the Fund'slong-lasting standards or experience. It has, if anything, in-creased because of the increase in the magnitude of the problems.

To summarize my answer I would say three things: 1) the Funddecided to abandon pure recycling methods after 1978; 2) theFund decided to equip itself better financially in order to cope

with balance of payments problems as they emerged in the wakeof the second oil crisis in 1979-80; and 3) with the worsening ofworld conditions in the recent period the Fund has often insistedon supplementary measures to be taken by member countries inorder to restore the initial objectives of Fund programs which hadgone off track. Thus, as has been the case for more than 30 years,Fund conditionality has been constantly adapted—in theframework of its guidelines and under the guidance and controlof its Executive Board—to the size of the imbalances and thestronger adjustment efforts they called for.

It is, of course, quite obvious that one cannot always resolveeverything in one, two, or three years, especially in the case ofthe poorest countries whose abilities to effect adjustments arequite limited. In such cases, however, I do not believe thesolution is to be found solely with the IMF. The Fund is not adevelopment assistance agency. It has extended its terms andmay now lend for up to 10 years within the framework ofextended arrangements. But the structural difficulties that theleast developed countries face in a complicated world cannot beresolved by an uncontrolled expansion of the lending facilities ofthe Fund. This approach would be fruitless and contrary to thevery purpose of our institution, which is to provide medium-termbalance of payments assistance on a revolving basis. If we think acountry is not in a position to right its balance of payments withina few years, and that the adjustment measures that ought to betaken go beyond socially tolerable limits in the country con-cerned, the proper solution is to present the problem to theinternational community in very clear terms. We have done thison several occasions in the recent past. In cooperation with theWorld Bank, we then ask potential creditor countries directlyconcerned with the economic future of the country in question totake a close look at the financing problems. In the event, restoringa viable balance of payments position in such a country requiresmore than an improvement in economic policies; it .entails long-term or grant-type international assistance as well. The Fund canplay a useful role in implementing a "concerted action" whichincludes both a recovery program supported by the Fund andbalance of payments assistance or development assistance fromvarious other sources.Q. When it comes to affecting policies of individual countries,some observers claim the Fund's influence is severely limited,and only to deficit countries that come to the Fund for financingrather than to the market. Is this fair?A. It is a fact that some countries need Fund financial supportand, in order to obtain it, have to engage in negotiations oneconomic and financial measures incorporated in the programs,while some other countries do not have to resort to the Fund'sfinancial support either because they have ample access to capitalmarkets or because they are in a surplus position. Now we can'tchange that basic situation. But I think it would be wrong to inferfrom it that the Fund has little or no influence on its othermember countries. As you know, the Fund has a surveillancefunction whereby it conducts with each of its member countries

Finance & Development I June 1982 5


consultations on the policies of those countries, and this surveill-ance function is a very important one. We must strive in theFund, and we do strive, to act in such a way that the Fundexercises surveillance over the exchange and related policies of allits members, those with a high degree of financial autonomy andthose which have to borrow from the Fund, in a spirit ofsymmetry.

We must strivein the Fund, andwe do strive, to actin such a way thatthe Fund exercisessurveillance...in a spiritof symmetry.

I referred a moment ago to the mix of monetary and budgetarypolicies in major industrial countries which is so relevant for theworld as a whole and for interest rates on the internationalmarkets which have such a bearing on developing countries. TheInternational Monetary Fund has laid considerable stress on thismatter in its consultations with the industrial countries, in itsWorld Economic Outlook documents, and in my public state-ments. There are perhaps no immediate operational sanctionsattached to our recommendations on surveillance but the Fund isan institution which holds a very high moral authority. Acountry, or a group of countries, which were openly in violationof the Fund's major surveillance recommendations would be putunder very strong pressure to right its or their situation. Theexistence of this surveillance function perhaps explains why therehas been, in a time of floating rates, no open recourse tomanipulation of exchange rates for competitive objectives.Q. The Fund is now involved in a large number of low-incomeAfrican countries. Many believe that in these countries, theproblems of the balance of payments are inseparable from theproblems of development and that, consequently, a true adjust-ment program would be a development program. Do you agreewith this view? Is it not the case that these countries require farmore economic aid than balance of payments assistance on Fundterms?A. It is indeed true that the problems of many poor Africancountries are large and of difficult solution. Dealing with them ona systematic basis requires a careful analysis of the causes andnature of the balance of payments problems. It is important toascertain whether they are temporary or permanent in character,and whether they are of internal or external origin. Such ananalysis is an obvious first step before a balance of paymentsadjustment program can be designed for any one country. It is, ofcourse, true that external circumstances, especially changes interms of trade, do affect heavily the balance of payments positionof African countries. It is fully within the competence of the Fundto assist countries to adjust to such developments. Externallyoriginated imbalances, when they are permanent, need to beadjusted.

It is also true that in many instances the persistent balance ofpayments problems of most African countries have originated or

have been compounded by inappropriate domestic adjustmentresponses to the impact of adverse external factors; we have hadmany cases where the implementation of domestic policies tokeep domestic demand beyond sustainable levels has provokedexternal imbalances and at the same time has discourageddomestic supply through inefficient resource allocation and use. Ihasten to say that these developments are not limited to Africa.Many other regions in the world, developed or developing, arethe scene of similar inappropriate policy responses.

Adjustment programs supported by the Fund are directed atcorrecting the effects of inappropriate policies and of lastingdeterioration in terms of trade and to this end they includedemand restraint as well as supply-oriented measures. It is wellknown, of course, that the Fund's balance of payments assistanceis temporary and revolving in character and limited to a specificmultiple of the member's quota. These limitations and char-acteristics of the Fund's intervention are an essential feature ofthe Fund and will not be changed. But it is important whendevising a balance of payments adjustment program for a Fundstaff mission not to make the wrong choices or the wrongrecommendations as far as actual conditions are concerned. Afiscal or a pricing policy obviously has a major impact on theallocation of resources and the fundamental economic structuralcomponents of an economy. A monetary policy can discouragesavings and encourage imports, or promote exports and encour-age savings. So what is important is not that the Fund gets intolong-term structural policies, but that the Fund, in designing amedium-term balance of payments stabilization program, shouldmake sure that its adjustment measures are not incompatiblewith the long-term structural changes which are necessary in acountry. That is why it is so important that Fund balance ofpayments missions rely in this area on the expertise of the WorldBank. We have to cooperate actively with the World Bank inreaching the appropriate choices on stabilization measures whichcan have an impact, and a lasting impact, on the structural futureof the country.Q. Do you think that it is possible—or even sensible—to try tokeep the Fund and Bank completely separate? Or would it bebetter to recognize that there is a degree of overlap and to try topromote coordinated and parallel activities?A. The difference between the Fund and a development lendinginstitution, such as the World Bank, can be seen most clearly bylooking at the nature of the Fund's lending and the policy focus ofits programs.

The Fund's resources are of a revolving nature. I spoke of thisearlier. Countries borrow from the Fund when faced withtemporary balance of payments disequilibria. The Fund providesthis financing in the context of a policy program which isdesigned to return the country to a balance of payments positionwhich can be sustained without continued recourse to excep-tional financing and which enables the country to repay the Fundwithin a few years. The time frame of a Fund program, thepolicies adopted, and the financing provided all depend upon thenature and size of the disequilibrium, but the central feature ofthe program is always the implementation of a consistent set ofmacroeconomic policies which will enable the country to reestab-lish a sustainable balance between aggregate demand and supplyin the economy.

The main objective of development lending, on the other hand,is to enable a country to invest more than it is able to save,thereby increasing its stock of capital faster than would otherwisebe possible and raising its rate of growth over the long term. Thebasic assumption is that the country will, on average, have acurrent account deficit which is financed, inter alia, by devel-opment lending and that this net resource transfer will continue

Finance & Development I June 19826


until some time in the future when the country reaches a higherstage of development. The primary policy focus of a developmentinstitution is, therefore, on the efficient use of productiveresources. Is investment being directed toward the sectors andprojects with the highest economic return? Does the incentivestructure ensure that scarce resources are allocated efficiently?

Having drawn this essential distinction between the basicnatures of the two types of institutions, I must emphasize thatthere are important areas of interdependence between theobjectives sought by each. While the Fund and the Bank retaintheir separate responsibilities and functions, we call upon eachother for advice within each institution's area of expertise andconsult and collaborate so as to ensure that the efforts of eachinstitution reinforce the effectiveness of the programs supportedby the other. The Fund, for example, looks to the Bank for viewson the size and composition of a country's investment programand for analysis of the microeconomic impact of pricing deci-sions, while the Fund provides the Bank with guidance onmacroeconomic policies. Both institutions have found this type ofcollaboration to be most fruitful, and we fully intend to continueand expand our efforts in this direction in the future. It is, forexample, becoming more common for staff members from oneorganization to participate in missions of the other.Q. We read increasingly that Fund financial programs withmembers have broken down because the country was unable tomeet performance criteria. Does this trend disturb you? Whatare the causes? Were the programs unrealistic to start with, orwas the breakdown due to circumstances beyond the control of aparticular country?A. Well, first of all, I would like to answer by facts. LastSeptember the Executive Board of the Fund reviewed theperformance of all 23 member countries for which upper credittranche stand-by arrangements were approved in 1978-79. Thisreview showed that performance toward the major targets underthese programs was as follows. First, the targets for the currentaccount of the balance of payments were fully achieved in half ofthe programs. The current account improved in relation to GDPin almost two thirds of the cases. Second, the original targets forinflation were also achieved in about one half of the programs.Although the rate of price increase actually declined in only abouta third of the programs, many of the programs provided for wide-ranging increases in officially set prices for price decontrol. Third,in almost two thirds of the programs credit expansion sloweddown. On average for all programs the rate of credit expansiondeclined by more than 20 per cent. Fourth, on the fiscal front,substantial budgetary adjustments were made by many mem-bers. In more than a third of the programs the budget adjustmentexceeded 2 per cent of GNP. In about a fifth of the programs theimprovement in the budget was as high as 5 per cent of GNP oreven more.

Now this performance is very obviously a mixed one and actualperformance fell short of the targets in a number of cases. I wouldsay roughly half. But here I would like to make a few remarks.First of all this is hardly surprising when one allows for the factthat conditions in the world economy during this period turnedout to be much worse than expected when many of the programswere drawn up. In particular, the second wave of oil priceincreases took place during the period, adding to the strains onthe balance of payments of many of these countries. Second, therecord shows that the Fund's programs have been healthy, albeitwith the shortcomings that our review pinpointed, and they havebeen helping the borrowing countries to adjust and the world atlarge to achieve better international payments conditions. Butthere is much scope for achieving further improvement in theimplementation of programs and this was recognized amply by

the Executive Board during the last review. It was felt that muchcould be gained by putting more emphasis on early and priorpolicy action by member countries seeking Fund support. Im-provements in our monitoring methods and devices were alsocalled for. More extensive use of technical assistance by the Fund,particularly in the fiscal field, in helping countries to devise andcarry out programs was also suggested.

To summarize, my answer to your question is yes, I amdisturbed by the mixed performance of a number of our pro-grams. Incomplete programs always should concern the Fund.Whenever such instances arise, we analyse these cases in detail toget at their causes, to find out whether they are the result offaulty programming, faulty implementation, or unanticipatedevents. Let me stress here that there are hardly ever any instanceswhere causes of departures from the agreed programs can beclassified in a very neat fashion. But to the extent feasible we try,and we must try, to ascertain their relative importance, and weare continually trying to find practical ways of eliminating or atleast minimizing them.

The importance ofperformance criteriaas signposts cannotbe overstressed ina world economicenvironment thathas not contributedto easing the problemsof adjustmentof members.

You mentioned in your question circumstances beyond thecontrol of the member as one of the possible reasons fordeparture. There are, of course, numerous examples of thisparticular kind, most notably in recent times, energy pricedevelopments and, as I said a moment ago, recession and interestrate hikes. In many respects, they are the relatively simplestfactors to identify, if not to deal with. If the circumstances aretransitory, the departure is also bound to be transitory, and theprogram can be expected, without major changes, to return ontrack in due course. But, if these circumstances are not reversible,then further measures must be taken and there are well-established methods to reach understandings on the requiredpolicy adaptations.

In this context, I would recall that consultation clauses betweenthe members and the Fund are standard features of Fundarrangements. More important, we should not lose sight of oneof the most, if not the most, important roles of performancecriteria. They are devised to provide signals about the perfor-mance of the economy. Thus, lack of observance, while itinterrupts the member's right to continue borrowing from theFund, also serves to indicate the need for a review of the situationso that suitable understandings can be reached. The importanceof performance criteria as signposts cannot be overstressed in aworld economic environment that has not contributed to easingthe problems of adjustment of members. Such an environmentnot only increases the hazards associated with the design ofperformance criteria but makes it difficult for many countries tosteer a steady policy course for a sustained period.

continued on page 45

Finance & Development I June 1982 7


A financial appraisal of the

Speaking before representatives ofthe financial community in NewYork on February 25, 1982, thePresident of the World Bank,A. W. Clausen, discussed thefinancial policies and operationsof the World Bank. The followingtext is excerpted from his talk.

... The function of the World Bank, quitesimply, is to provide financial and technicalassistance to stimulate growth and produc-tivity in our developing member countries.

In fulfilling that function, the Bank per-forms a unique and critically importantinternational role—a role of financial in-termediary that serves the interests of theindustrial as well as the developing coun-tries. We are carrying out that role at a timeof growing difficulty and complexity in theglobal economy. After 31 years as a com-mercial banker, I accepted the presidencyof the World Bank because I believe that thedevelopment of the emerging world andthe attendant improvement in the standardof living of those people is one of the mostchallenging tasks confronting us in the fi-nal decades of the twentieth century. I be-lieve the World Bank's role in helping tomeet this challenge is more important thanever....

To begin with, the Bank is, as the nameimplies, a bank. It's a very sound andprudent bank. But it is more than, and dif-ferent from, the kind of bank we are usu-ally accustomed to. It is an internationaldevelopment institution, with most of theworld's governments as its shareholders—the United States being the largest.

Even though the Bank is wholly ownedby governments, its philosophy isgrounded in the interdependence of thepublic and private sectors. This concept isreflected fully in our founding charter andremains the touchstone of our operations.Indeed, the private sector—in terms of theinvestor community throughout theworld—is the primary source of the WorldBank's lending to developing countries. Weborrow from the private capital markets allover the world and lend to the develop-

ing countries on the basis of sound eco-nomic criteria for productive purposes thatenhance the prospects for further privateinvestment and effort—both local andinternational.

It will not surprise you that having beena commercial banker for so many years,one of the first things I did was to lookcarefully at the way the World Bank oper-ates on traditional financial terms. At theoutset, let me say, I have been impressedwith the record established: a loan portfoliothat has not suffered one penny of loss inthe Bank's entire 35 years of operations; afirm policy against any participation in debtreschedulings; callable capital of US$35 bil-lion from the world's governments—to beincreased to $72 billion—that serves exclu-sively as a guarantee for the protection ofthe Bank's bondholders; high-quality liq-uid assets amounting to more than $8 bil-lion; and annual net profits—currently run-ning at the level of about $600 million ayear—realized every year since 1948, ofwhich more than $3 billion have beenplowed back into the institution tostrengthen its equity base. The fact is, it isan overwhelmingly strong institution asmeasured in purely traditional financialterms.

Financial assets

The Bank essentially has two financial as-sets: its outstanding loans and its liquidity.On the liability side, it has outstandingdebt and a unique capital structure. I wantto touch on each of these items briefly in aneffort to explain how the Bank functionsas a unique profitable and sound financialinstitution.

Since it began operations in 1946, theBank has loaned about $71 billion. Of thisamount, approximately $13 billion has al-ready been repaid or sold to other parties,leaving about $58 billion of committedloans. However, $29 billion of that balancestill remains undisbursed—to be drawndown by borrowers over the next six toseven years. Therefore, the World Bank'saccounts receivable, currently disbursedand outstanding, is about $29 billion. It isexpected to rise to about $32 billion byJune 30, 1982. That represents the Bank'srisk assets. It is our loan portfolio. What

has been the financial experience with thatportfolio?

In the first place, the Bank has never hada default on any of its loans It has neverhad a nonaccruing loan.... It has neversuffered a loss on a loan We have seennumerous changes of governments incountries but without exception the suc-cessor governments have honored theirpredecessors' obligations to the Bank.

The Bank has a firm policy against debtrescheduling and does not participate insuch exercises. It does not change the inter-est, the principal, or the terms of a loanafter it has been approved. Nor does theBank refinance loans to permit its bor-rowers to service their debt. It is a projectlender for the most part and does not pro-vide a cash flow to its borrowers. In excep-tional circumstances, nonproject lendingmay be considered but the conditionality isstringent and, furthermore, this type oflending in any one year has never exceeded10 per cent of total annual commitments.

It takes, on average, more than two yearsto help a country develop and then to ap-praise a project before it is presented to theBank's Board of Directors for loan ap-proval. The Bank's investigation covers allaspects of the project: economic, technical,financial, organizational, managerial, andoperational. The project must be of highpriority to the economic growth of thecountry. If it is not, the Bank will not fi-nance i t . . . .

Of $4 billion in interest and principal andother charges due to the Bank from itsloans for the fiscal year which ended onJune 30, 1981, only approximately $160,000of interest was more than 60 days past dueon that date and only $1.6 million in prin-cipal was similarly late. By October 22, thedate of our first prospectus in the UnitedStates after June 30, 1981, all of even thesetrivial amounts had been paid.

The second major asset of the WorldBank is its liquidity. The Bank's liquid cashbalances are currently about $8 billion andat the end of this fiscal year, June 30, 1982,will stand at about $10 billion. That liquid-ity is equal to about one third of all ouroutstanding debt.

Why do we keep such a high level ofliquidity? First, it has been a consistent

8 Finance & Development / June 1982

BANK


profit center of the Bank invested at higherreturns than the cost of borrowing. Second,it gives us flexibility on when, where, andhow much to borrow. We simply draw itdown when rates are high or capital mar-kets are unstable and build it up (by bor-rowing more than we have to) when wehave access to stable capital markets at lowcosts. Quite simply, we do not wish to becaptive to unstable markets. Therefore, wehold liquidity.

One final point on our liquidity. Wenever take a currency risk on our liquidity.We do not speculate among the differentcurrencies. Our job, however, is to predictinterest rates in the 20 different currencieswhich make up our liquidity—to decidewhether to be long or short—and to man-age the liquidity so it produces the highestfinancial rate of return. That, in turn, per-mits us to keep our lending rate at a min-imum without jeopardizing the Bank'sprofitability.

Liabilities

Let me turn now to some specifics aboutthe liability side of the balance sheet. Weexpect our outstanding debt to be about $34billion at June 30,1982. The main character-istics of that indebtedness are quite differ-ent from those of a commercial bank.

First, it is in 16 different currencies andthe Bank does not take a currency risk onits borrowings.

Second, the average life of the Bank's debtis seven years; all at fixed interest rates. Forthe World Bank to obtain funds for its lend-ing, it must meet the rather vigorous testsof the medium- and long-term capital mar-kets—the demands of the insurance com-panies, pension funds, and other institu-tional investors. Because of the success ofour borrowing program, we have notfound it necessary to have a "discountnote" or CD [certificate of deposit] base offunds or to issue other forms of variablerate paper.

About 30 per cent of our debt is held bycentral banks or governments who havebought our paper, mostly through directprivate placements, and who hold our obli-gations as part of their foreign exchangereserves.

The balance of our debt comes from pri-vate financial marketplaces all over theworld. We are the largest nonresident bor-rower in the world in every capital-exporting country.

• We are a triple-A borrower every-where.

• The maturities of our debt range from2 years to 25 years.

• We estimate that only $6-7 billion ofour debt is held by U.S. investors. As much

paper has been placed by the Swiss, theGermans, and the Japanese, each, as by theU.S. investment banking community. Thisis not to say that the United States marketdoes not figure prominently in our plans. Itdoes indeed. We have just recently re-turned to the American market after an ab-sence of several years, but it is our intentionto be a regular participant in this marketfrom here on out.

• OPEC [Organization of Petroleum Ex-porting Countries] has supplied 15-20 percent of our outstanding debt—mostly bymeans of 5-12 year fixed rate direct privateplacements in half a dozen currencies....

We have adopted a policy of diversifyingour indebtedness by currency, by country,by source, by maturity, by technique ofborrowing. We do 50-60 different public is-sues, private placements, and fixed ratesyndicated loans a year. We never rely onone method, source, or market. We will notbe hostage to one environment....

In 1975, the cost of our then $12 billion ofoutstanding debt was 7.2 per cent. We pro-ject that as of June 30, 1982, after years ofinflation and the erosion of the fixed ratemarkets, we will have outstanding debt of$33 billion—almost a 300 per cent increase.We project the cost will be about 8.2 percent!

In one sense, we are very much like acommercial bank, but instead of matchingshort-term and volatile funding with simi-larly variable rate loans, we seek to makemedium- and long-term fixed rate loansand fund them with medium- and long-term fixed rate borrowings. When the timecomes that fixed rate resources are insuf-ficient to meet the size of our lending pro-gram, we will simply consider variable rateborrowing and, of course, variable ratelending in some form or another.

Capital structure

Permit me now to say a word or twoabout the unique features of the Bank'scapital structure.

The Bank's equity as of June 30, 1982, isprojected to be about $9 billion. That equityis divided into two roughly equal parts: re-tained earnings and paid-in capital. Wehave never paid dividends on equity, notbecause we could not but because we chosenot to do so.

As you can see, we have a debt/equityratio of about 4 to 1, as compared to a com-mercial bank's 25 to 1. Not bad—partic-ularly for an institution which has neversuffered a loss on a loan and does not par-ticipate in rescheduling or refinancings andhas almost $10 billion in cash.

As I mentioned earlier, the outstandingprojected debt of $33 billion is expected tocost about 8.2 per cent as of June 30, 1982.

Thus, the cost of total funds (debt plus eq-uity) will be about 6.5 per cent as of June 30,1982. Our current lending rate is 11.6 percent.

Another unique feature about the Bank isits subscribed capital. The $4 billion ofpaid-in capital represents only 10 per centof the Bank's total subscribed capital. It isthe portion that is actually paid to theWorld Bank by its member governmentsand is available for use in our general lend-ing operations. But it is just the tip of theiceberg. There is, in addition, another $36billion of callable capital. There are severalpoints to consider with respect to theBank's callable capital.

First, it can never be used to run theBank. It can never be used for disburse-ments to developing countries. It is solelyfor the protection of the Bank's bond-holders or other creditors. The only time itcan be used is to meet obligations to bond-holders or creditors if we need to call on it.We never have had to call on it, and wenever expect to. Not with the quality of ourloan portfolio, our cash position, profits,sources of funds, and our loan experience.Nonetheless, the larger the amount of call-able capital, the greater the protection forthe bondholder. It is the icing on a verypalatable "financial cake."

The Bank operates, however, as if that"guarantee" fund does not exist. It oper-ates with prudent and meticulous financialpolicies. The Bank's shareholders insist onit. They guide the Bank's financial policieswith a full understanding that their callablecapital is at risk in that it is a guarantee tobondholders.

We are now in the process of receivingover the next four to five years another $40billion in capital which member countrieshave agreed to subscribe. Three billion dol-lars will be paid in and $37 billion will beadded to our callable capital. Pro forma, thatwill give us about $72 billion of callablecapital—guarantee capital if you will—inthe mid- to late 1980s, plus over $7 billionof paid-in capital, plus about the sameamount—$7 or $8 billion—of retained earn-ings. That tallies up to an aggregate equitybase of more than $85 billion....

Bank profits have risen dramatically.From $170 million in the early 1970s to $400million in the late 1970s and then to $600million in 1981, in part because of our eq-uity base compared to debt, in part becauseof the composition of that debt, and in partbecause of returns on liquidity. We arerather satisfied with that picture consid-ering we lend long term at fixed interestrates. Our forecasts indicate that profitswill remain at or about current levels for thenext few years. We intend to remain aprofit-making institution.... HD

Finance & Development / June 1982 9


IssuesWhat are the major questions that emerge in negotiations for theuse of Fund resources between member governments and Fundstaff? What is the process by which such negotiations areconducted? An overview of issues and procedures.

Andrew Crockett

Over the last three years, in the face of un-precedentedly large global payments dis-equilibria, the Fund has been more activethan ever before in making its resourcesavailable to members in support of pro-grams of balance of payments (BOP) ad-justment. From January 1979 until Decem-ber 1981, 88 arrangements were approvedfor a total of SDR 24.4 billion, comparedwith 54 arrangements totaling SDR 8.1 bil-lion in the previous three years. Of the1979-81 total, 73 arrangements in the sumof SDR 23.7 billion were either upper credittranche stand-bys or extended arrange-ments; this compared with 29 arrange-ments for SDR 7.5 billion in the earlier threeyears.

The use of Fund resources under thesefacilities is usually preceded by intensivediscussions between the authorities ofmember countries and the Fund's manage-ment and staff concerning the economicpolicies to be adopted to correct the pay-ments disequilibrium that gave rise to thefinancing need. This article describes anumber of representative issues that arisein such discussions.

In analysing these issues, it must beborne in mind that the Fund's essentialpurpose is the promotion of effective BOPadjustment. Both under the terms of itscharter and because of the limited and re-volving nature of the resources at its dis-posal, it must be assured that Fund lendingsupports policies that offer a firm prospectof achieving a sustainable payments posi-tion. In itself, this approach is not a sourceof controversy, since all member countries

accept that the eventual restoration of ex-ternal equilibrium is a constraint on policythat would apply regardless of the natureof the international economic system. It istherefore over the means by which such anequilibrium is achieved and maintainedthat differences of opinion chiefly arise.

Such differences reflect not only dis-agreements about the impact of particulareconomic measures on the BOP but alsodivergent perceptions of the way in whichthese measures impinge on the domesticpolicy objectives of the country concerned.As far as the latter are concerned, the Fundendeavors to ensure that programs sup-ported by its resources achieve the desireddegree of adjustment without causing un-due harm to domestic goals, such as thegrowth of output and investment, and theequitable distribution of income.

Adjustment need

A first step in the formulation of a pro-gram to be supported by the Fund's re-sources is to assess the extent of the BOPimprovement required and the member'sneed for additional foreign exchange re-sources while that improvement is takingplace. As just mentioned, the Fund canlend only for programs that give promisethat the economy will be restored to a vi-able payments position. Such a positioncan be defined as one in which any remain-ing deficit on current account can be cov-ered by sustainable capital flows—sus-tainable in the sense that they represent awilling long-term transfer of resourcesfrom overseas creditors and are consistentwith the debt-servicing capacity of theeconomy.

For countries with limited access to inter-national capital markets, an estimate ofsustainable capital inflows is usually ar-rived at by assessing the economic assis-tance that is likely to be available from bi-lateral and multilateral sources during andafter the period of adjustment. Where

10 Finance & Development / June 1982


in the use of Fund resourcescountries are in a position to tap additional,private, sources of foreign financing, an es-timate is needed of the country's capacityto attract and service additional debt. Thisassessment depends on a number of factorsthat cannot be forecast with any precision,such as the level of real activity in the worldeconomy, international interest rates, theavailability of finance for internationallending, and the success of individual bor-rowing countries in achieving their objec-tives for growth in output, investment, andexports.

Not surprisingly, differences of viewarise between the Fund staff and memberauthorities concerning what constitutes aviable payments position on current ac-count and how rapidly it is feasible to attainit. Sometimes, the authorities in devel-oping countries will argue that it is unfair toexpect them to compress their current BOPdeficit (which represents the net flow ofreal resources from the rest of the world),

when their payment difficulties have arisenfrom factors largely beyond their control.They would prefer to plan an adjustmentstrategy on the assumption that the worldeconomic climate will improve, perhapswith an implicit hope that additional re-sources would be available through theFund to finance them in the event that itdid not.

As noted above, however, the resourcesthe Fund can make available to members indeficit are strictly limited. Under existingcredit tranche policies the maximum that amember can borrow is one and a half timesits quota subscription in any year, or fourand a half times its quota over three years.(On average, Fund quotas are currentlyabout 3 per cent of annual imports, thoughvariations around this average are quitesubstantial.) If such lending is to be repaid,and if borrowing members are not to runinto insurmountable difficulties when ac-cess to the Fund's resources has been ex-

hausted, lending must be accompanied bya planned program of economic rehabil-itation. This need applies regardless ofwhether the factors that have given rise toan underlying payments disequilibrium areof internal or external origin.

Adjustment policies

At some risk of oversimplification, thekinds of measures and policies that usuallyform part of programs supported by useof the Fund's resources can be groupedinto three broad (and not always distinct)categories:

• the management of the level and struc-ture of aggregate demand;• the enhancement of the economy'ssupply capacity, particularly of tradablegoods; and• measures to shift the structure of out-put toward net exports.Ensuring that aggregate demand is con-

sistent with the economy's supply capacity

Procedures in establishing adjustment programsInitiation. There is no fixed procedure for initiating discussionson a program to be supported by the Fund's resources. The Fundhas regular contact with member authorities through annual Arti-cle IV consultations (on exchange rate arrangements), through theExecutive Directors, and through other visits either by Fund staffto member countries or by member government officials to Wash-ington, D.C. Whenever BOP trends suggest that a financing gapis or may be emerging, the nature and scope of possible adjust-ment measures is a central feature of discussions during thesecontacts. At such times, the member country may request Fundassistance in designing a suitable program, or the Fund staff mayitself suggest the advantages of comprehensive adjustment mea-sures supported by use of the Fund's resources. If, as occurs inquite a significant number of cases, a country is already usingresources in the first credit tranche, a dialogue would alreadyhave begun, albeit on a less comprehensive basis than would be

needed for a program supported by resource use in the uppercredit tranches.

Request for assistance. The actual request to initiate discussionson the use of Fund resources, whether in the upper credittranches or under the Fund's other facilities, need not be formal.Typically, the authorities of a member country will indicate to theFund staff or to their Executive Director their wish to discuss apossible arrangement, and this will be immediately communi-cated to the Managing Director. The request and the subsequentdiscussions are confidential and, as far as possible, unpublicized.This is because the policies that will be under discussion aresensitive and the success of the discussions cannot be assured;in the event that agreement cannot be reached, it is often desir-able to avoid unnecessary speculation on the reasons for thedisagreement.

Finance & Development /June 1982 11


and the authorities' objectives for price sta-bility and the BOP is always a central aspectof macroeconomic policy. Beyond this,supply-side measures have received in-creasing emphasis in recent years, with theassistance of the World Bank, because of agrowing realization that exploiting thescope that often exists for improvements inresource allocation can reduce the burdenof external adjustment and increase eco-nomic welfare. Last, shifting the patternof output toward exports and import sub-stitution, often involving action on theexchange rate, is frequently necessary toprovide a more immediate and direct in-centive to shift resources toward an im-provement in the BOP.

Demand management. In formulating a pro-gram with the Fund, member countriesusually establish objectives for the rate ofgrowth of output and investment and themoderation of inflation, as well as for theBOP. These objectives affect the flows ofreal and financial resources among sectorsof the economy and between domestic andforeign sectors. They also usually requirepolicy measures to ensure that the leveland distribution of demand are consistentwith the authorities' broad macroeconomicobjectives.

Much empirical evidence confirms thatthe rates of growth of monetary and creditaggregates affect the rate of nominal in-come growth and the BOP. Inevitably,therefore, understandings on monetarypolicy are an important part of the demandmanagement strategy incorporated in pro-grams supported by Fund resources. Theobjective is to set a target (or ceiling) forthe rate of growth of bank credit that is

consistent with the program's objectivesfor real economic growth, inflation, and thecountry's external payments position. Ofcourse, there are numerous uncertaintiesin arriving at monetary targets. The deter-minants of the demand for money are oftennot well defined; BOP forecasts can turnout to be wrong for a number of reasons—real growth can be influenced by non-monetary developments (such as weatherconditions) and so on. Nevertheless, it isclear that some judgment must be reached.

Adjustment programs also normally in-clude a target for containing the gov-ernment's budget deficit. This target isemployed because the fiscal deficit is animportant determinant, in its own right, ofthe level and structure of demand and alsobecause official borrowing to finance thedeficit can put pressure on the availabilityof funds for the private sector. Broadlyspeaking, fiscal targets are arrived at bytaking the overall rate of credit expansioncompatible with the objectives of the pro-gram and determining the needs of thenongovernment sector for the desired levelof output and investment. What remains isthe volume of bank credit that can be usedby the government without preemptingproductive nongovernment borrowing.

Setting fiscal and monetary targets isonly the first stage in establishing a set ofdemand management policies. To givesuch targets credibility, it is usually neces-sary for specific measures to be imple-mented (or at least decided on) before aprogram is presented for approval by theFund's Executive Board. In the fiscal area,such measures might include the intro-duction of new taxes, the raising of taxrates, or constraints on spending authority

under the government budget. When suchmeasures are adopted, the Fund staff re-views the fiscal prospects with the author-ities so that it can be in a position to reportto the Board that the budgetary estimatesare realistic and achievable. In the mon-etary area, it is more difficult to specify inadvance the particular measures that willbe used to limit credit growth, but the au-thorities usually indicate a willingness touse policy instruments such as interestrates, open market operations, and creditguidelines to restrain financial aggregateswithin the targets that have been set.

Adherence to fiscal and credit targets(usually on a quarter-to-quarter basis) is theprincipal monitoring instrument used bythe Fund and member countries to assesswhether adjustment programs are remain-ing on track. Programs always contain"ceilings" on overall credit expansion andbank lending to government; if these ceil-ings are not observed, drawing rights areinterrupted unless new policy under-standings are reached. Naturally, there-fore, member authorities would preferthese ceilings to be relatively high, in orderto give them freedom to respond to un-foreseen developments. The Fund, on theother hand, has an interest in ensuring thatthe programs' policies can be reviewed incircumstances where its financial projec-tions do not materialize.

There can also be divergent views on thedegree of precision with which policy mea-sures (particularly in the fiscal area) shouldbe articulated in advance. The Fund's ex-perience is that a program will carry greatercredibility and have greater chances of suc-cess if the concrete demand managementmeasures to be taken are clearly identified

Preparations by Fund staff. The Fund is prepared to try to respondto a request for discussions on the use of its resources as rapidlyas the situation requires. Prior to its departure the staff team, or"mission" as it is called in the Fund's terminology, prepares acomprehensive briefing paper that sets out the member's currenteconomic situation, reviews recent discussions between the staffand the authorities on adjustment policies, and considers in asmuch detail as possible the nature and scope of the options thestaff believes are open to the authorities to bring about the neededadjustment. This briefing paper is reviewed within the Fund staffto ensure both a consensus on the adjustment measures proposedand consistency with the Fund's uniform (which does not, ofcourse, mean identical) treatment of all members. The briefing isthen forwarded for review to the Managing Director, who willfrequently call a meeting to discuss its contents with the missionhead and other senior staff. When he is satisfied that the briefingis consistent with the guidelines established by the ExecutiveBoard, he gives it his approval, at which time it becomes theinstructions under which the staff will operate.

Negotiating procedures. While the staff always negotiates ad refer-endum to the Fund's management and Board, the degree of lati-tude given to a mission in its brief can vary. If, as often happens,the economic information on a member country available at head-quarters is incomplete or not fully up-to-date, some flexibility isneeded to enable the staff to respond to the actual situation whendiscussions take place. Further, the policy instruments that theauthorities are prepared to consider may not be precisely thosethat the staff is able to foresee when it prepares its briefing. Sincestaff missions do not normally refer to headquarters for additionalinstructions during the course of their work, it is important forthem to have adequate discretion to respond authoritatively toproposals by member authorities, even when these have not beenforeseen.

Mission composition. A typical mission consists of four to sixeconomists. The mission chief is usually a senior staff member ofthe area department concerned, and he is accompanied by oneor two staff members from that department who specialize in the

12 Finance & Development i June 1982


and, as far as possible, implemented at anearly stage. While recognizing this, mem-ber countries may also see an advantage inpostponing politically sensitive decisions.For this reason, they sometimes would pre-fer their commitment to be in terms of ageneral undertaking to raise revenue or re-duce expenditures by a certain amount.

While the Fund seeks programs that arespecific in describing the policy measuresto be implemented, the actual choice ofmeasures remains that of the member. Solong as the aggregate impact of the fiscalstance is consistent with the required mod-eration in demand, the staff is not autho-rized to insist on the manner in which it isachieved. In some cases, of course, mem-ber countries may seek Fund advice on par-ticular measures, and the staff may offersuggestions on ways in which a fiscal gapcould be bridged in a manner most condu-cive to efficient resource allocation. But itis always clear that, when questions of spe-cific taxes and expenditures are under con-sideration, the staff's role is advisory andthat the ultimate discretion belongs to themember.

Supply measures. In recent years programssupported by the Fund have given in-creased emphasis to measures aimed at de-veloping the productive potential of bor-rowing members. There are several reasonsfor this. The large size of payments imbal-ances and their structural character havemeant that many member countries have alarge and growing external debt that canonly be satisfactorily serviced if output andexport growth are adequately maintained.Further, with large shifts in the terms oftrade, particularly the rapid increase in the

real price of energy, structural changes inproduction patterns in deficit countrieshave become even more necessary thanformerly. Lastly, the fact that many Fundprograms now extend over two or threeyears offers greater scope for supply-sidemeasures that have an impact on economicefficiency and external performance in themedium term.

Broadly speaking, supply-side measuresare aimed at improving the allocation ofresources in the economy and enhancingboth the quality and quantity of produc-tive investment. By so doing, it is hopedthat the underlying rate of real economicgrowth can be accelerated and the avail-ability of tradable goods for export or im-port substitution increased. Higher growthof output and exports benefits the adjust-ment process in two ways. First, it will en-able a given target for the current accountdeficit to be achieved with less sacrifice inthe resources available for domestic use;and, second, it will improve the economy'sdebt service capacity, making possible ahigher inflow of external resources.

The nature of the program measuresthat directly affect a country's output varieswidely from case to case. Where an invest-ment program exists, it is of critical im-portance, and the Fund staff collaboratesclosely with the staff of the World Bankin assessing whether development spend-ing plans are consistent with aggregateresource availability and the need to buildup competitive and adequately diversifiedexport and import substituting sectors.Where changes in development policy aresuggested, they are often aimed at re-ducing reliance on large-scale, long-gestation industrial projects (which are

usually heavily dependent on importedcapital equipment and intermediate inputs)and increasing the emphasis given to agri-culture, infrastructure, energy, and rela-tively quick-yielding investments in themanufacturing sector.

Pricing policy is another area that is oftencarefully examined. In many countries, keyprices are regulated both for social reasonsand to prevent an undesired pattern of re-source use resulting from an unrestrictedplay of market forces. While the reasons forsuch price regulation are important and inmany cases valid, political pressures some-times make regulated prices inflexible inthe face of inflation and changing condi-tions. The Fund typically stresses the ad-vantages, if resources are to be allocatedaccording to their scarcity, of making ade-quate adjustments in controlled prices; forinstance, the Fund invariably urges thatuser prices for energy products should beraised to at least world levels. Membercountries, while usually agreeing with thisanalysis in principle, are naturally con-strained by what they perceive to be thesocial and political repercussions of pricerises.

Programs of medium-term adjustmentalso frequently cover the performance ofpublic sector enterprises and the nature ofthe foreign trade regime. Concerning thelatter, economic performance can often beimproved by increasing the availability ofneeded imports, exposing domestic indus-try to increased competition (by reducingimport controls), and concentrating do-mestic resources in the production of thosegoods in which the country enjoys a com-parative advantage. These considerationspoint toward a more "open" foreign trade

country involved. In addition, there will be a staff member fromthe Exchange and Trade Relations Department, whose specificassignment includes work on the external trade and paymentsaspects of the program, and often also a staff member fromanother department (such as the Fiscal Affairs Department), if aparticular area of economic management warrants special atten-tion. An increasing number of recent missions have been accom-panied by a staff member from the World Bank. This has beenfound particularly useful, and even necessary, in adjustment pro-grams stretching over more than one year to ensure that the BOPadjustment process is consistent with such longer-term goals asimproving the efficiency of domestic resource use, promotingeconomic diversification, and rationalizing the developmentprogram.

A mission usually remains in the field for about two to threeweeks, though this timetable can vary depending on the difficultyof obtaining necessary information, the complexity of the pro-gram, and the constraints faced by member authorities in mar-shaling a consensus for needed adjustment measures. This latter

factor not infrequently prevents full agreement being reachedduring a single mission. In such circumstances, discussions areadjourned, which offers the authorities of the member countrythe chance to reflect on the scope of an adjustment program andpermits the Fund staff the opportunity to present the ManagingDirector with a more comprehensive picture of the latest eco-nomic developments and the authorities' thinking.

Forms of agreement. Once understandings have been reached be-tween the staff and the authorities on needed adjustment mea-sures, the staff assists the member country in drawing up a formalrequest for its use of Fund resources. The manner in which thisrequest is presented varies slightly from case to case but, in atypical one, the Minister of Finance, on behalf of his government,will address a "letter of intent" to the Managing Director. Thisdocument, besides requesting use of resources, describes in somedetail the measures that are being undertaken to improve eco-nomic and financial performance, the policies that will be fol-lowed during the life of the program, and the circumstances

Finance & Development / June 1982 13


regime, with less reliance on administrativemeans to ration foreign exchange and regu-late imports. In urging such a course, how-ever, it is not uncommon for the Fund toencounter resistance from members whoare concerned that such actions will under-mine the economic viability of establisheddomestic industries that are not compet-itive at world prices—which will, in turn,adversely affect the BOP.

Demand-switching policies. Often demandrestraint alone is not sufficient to correct aserious BOP problem, and supply-sidemeasures are, by their nature, likely towork only slowly in improving output andexports. Thus programs of payments ad-justment supported by arrangements withthe Fund usually involve measures with amore direct effect on the balance betweenexternal receipts and payments. Theoreti-cal considerations, as well as a considerableamount of empirical evidence, suggest thatthe policy instrument that has the mostgeneral and direct impact on external com-petitiveness is the exchange rate. An ap-propriate exchange rate is central to the ad-justment process and to the Fund's otherresponsibilities, and discussions on this is-sue are frequently a major aspect of nego-tiations on a program to be supported byuse of the Fund's resources.

Exchange rate policy is almost alwaysa sensitive issue, and an exchange ratechange implies consequential changes inrelative prices in the domestic economy,not all of which will be welcome on socialand other grounds. As a result, exchangerate policy is often one of the most difficult

areas in which to reach agreement. Toavoid some of the less welcome con-sequences of exchange rate changes, mem-ber countries sometimes prefer to use ad-ministrative means (licenses and quotas) tolimit import payments or to resort to spe-cial tariffs and subsidies to help balancethe external accounts. The Fund's experi-ence, however, is that such mechanismsare less efficient, in an economic sense,than a straightforward exchange rate ad-justment. They tend to interfere with effi-cient resource allocation, hamper economicgrowth, and can usually only postpone adirect change in the exchange rate.

Where a rate adjustment appears war-ranted, a judgment must be reached on thesize of the required realignment and themanner in which it is to be brought about.The staff attempts to calculate how thedemand for and supply of exports andimports will shift as the exchange rate

Andrew Crockett

who is British, is anAdvisor in the MiddleEastern Department of theFund. He joined the Fundin 1972, and worked inthe Office of the Managing

Director and the Research Department before takingup his present position.

changes, and it supports this analysiswith a calculation of the extent to whichdomestic and international costs of pro-duction have diverged since some equi-librium base period (although informationand techniques available seldom permita very precise calculation of the size ofthe adjustment required). Where feasible,the profitability of export and import-competing sectors is assessed.

Sometimes, a comprehensive study isundertaken by the Fund staff in conjunc-tion with member authorities in an effortto establish a common analytical frame-work and begin a dialogue aimed at reach-ing agreement on a suitable rate. In somecases, an exchange rate change is post-poned pending completion of this process,with the provision that suitable under-standings be reached during the life of theprogram. In cases where a member has acomplex exchange system, with differentrates for different transactions, a gradualadjustment can be brought about by aphased shifting of transactions from onerate to another. The ultimate objective,however, is usually a unified exchange rateat a realistic level. In still other cases,phased adjustment may be achievedthrough a series of rate adjustments, acrawling peg, or temporary or permanentfloating of the exchange rate.

Preconditions, performance criteria,and review clauses

An essential aim of programs in the up-per credit tranches is to provide the Fundwith the assurance that its resources arebeing used to support needed adjustment.

under which the member will request (or refrain from requesting)drawings under the arrangement.

When the staff returns to headquarters, the mission chief pre-pares a brief note summarizing the discussions for the ManagingDirector and attaches the draft letter of intent. This is also circu-lated to interested departments within the Fund. At this stage, itis not uncommon for minor changes in the letter of intent to beproposed to the authorities for legal or technical reasons. Oncethe Managing Director is satisfied that the policies described inthe member's request are appropriate to the situation, the staffprepares a report for the Executive Board that describes the back-ground to the request, the economic developments and pros-pects, and the manner in which the proposed program will re-store a viable economic position. Preparation of this documentusually takes several weeks, though this timetable is shortenedwhen the need for financial support is urgent.

Board discussion. The staff report, together with the membercountry's request, is circulated to the Executive Directors and puton the Board's agenda for discussion and decision four weekslater. Since the program will have been framed against the back-

ground of the Executive Board's guidance (both from specificdecisions and from comments made in the course of Board dis-cussions on other subjects), a management recommendation tomake resources available to a member country is likely to be ap-proved. Nevertheless, Board discussion, which frequently ex-tends over several hours, has an important influence on the wayin which programs are put into effect. First, since usually a de-tailed record of the Board's discussion, together with the Manag-ing Director's summing up, is transmitted to the authorities, it canaffect the manner and pace at which measures contemplated forthe program period are actually implemented. Second, it canguide the staff in conducting periodic reviews of performanceunder the program. This is particularly important when certainmeasures have been left for subsequent decision under "reviewclauses." Lastly, the tenor of the Board's views on a given pro-gram gives guidance to the staff in the negotiation of other pro-grams. For example, if the weight of opinion is that, say, fiscalperformance could have been more ambitious or that inadequateattention was being paid to the energy sector, additional empha-sis would be given to these points, where appropriate, in sub-sequent programs. HD

14 Finance & Development /June 1982


To some extent, this assurance is giventhrough the adoption of measures by amember prior to the approval of an ar-rangement by the Executive Board: this isregarded as particularly necessary when amember country's performance under ear-lier programs has been disappointing andinternational confidence in the member's

Where no such agreement can be reached,the program .remains inoperative and themember's drawing rights are in abeyance.Usually, if agreement is not reached onmodifications that enable the basic goals ofa program to be preserved, and if it remainsinactive for a protracted period, the staffwould suggest to a member that the origi-

'... with or without the Fund's involvement, the process ofrestoring a viable external position is likely to involvepainful adjustments to existing economic structures. "

commitment to the adjustment process isweak. Such measures may include, de-pending on the circumstances, exchangerate action, interest rate adjustment, or fis-cal measures designed to help bring aboutthe needed budgetary improvement.

In addition, Fund programs in the uppercredit tranches always include "perfor-mance criteria" that if not met, result in aninterruption in the member's right to makesubsequent drawings under the arrange-ment. To avoid unduly detailed constraintson a member's internal policymaking pro-cess, and to obviate the need for fine judg-ment by Fund staff, performance criteriaare rather general in character and few innumber. They typically include quarterlyceilings on the rate of overall bank creditexpansion in the economy and subceilingson the amount of such credit a

Documents

Change of Editor · Change of Editor Samuel I. Katz Editor of Financ e & Development since 1977, completed his tenure in February 1982. Mr. Katz had succeeded Ian Bowen in February