“Adjustment Programs Supported by the Fund: Their Logic, Objectives, and Results in Light of Recent Experience”

J. de Larosière, Managing Director, IMF

 

         In this article, originally given as a speech, Managing Director of the IMF J. de Larosière seeks to explain the rationale underlying the policies of the International Monetary Fund in the area of adjustment. He starts off by discussing the policy weaknesses that are to be associated with the balance of payments difficulties that countries had experienced (he wants to stress to the listener that any economic problems experienced by member nations can be traced back to policy sources prior to Fund assistance rather than the mechanisms of aid themselves). He then goes on to outline the ways in which adjustment programs offered by the IMF had helped countries in overcoming their economic problems. He closes with a discussion of the steps that must be taken to ensure that current Fund adjustments are successful.

 

Policy Weaknesses Associated with Balance of Payments Difficulties

         Though the global recession following the first oil shock were beyond the control of the countries hurt most by them, de Larosière argues that the refusal of many governments to adapt and adjust their economies to the new times left them with the deficit problems they experienced. In the 70s it had been easy for many countries to exist as external borrowers but with the 80s came a complete change in the conditions of the global economy. With the world in a recession financial lending became much more difficult and expensive a process. What’s more, many countries were as a result left with growing external indebtedness and a maturity structure that made it impossible to pay off.

 

  1. Weaknesses in demand management result most often in an alarming growth in fiscal deficits. The result of this is a monetary policy that comes under great pressure and brings about high rates of inflation, which the evidence tells us, tends to aggravate the balance of payments and external financing difficulties.
  2. Deficiencies in supply-side policies also characterize countries that have run into external payment problems. Part of this involves the reluctance of countries to adjust their nominal exchange rates in response differences between foreign and domestic inflation rates. As a result domestic currencies will appreciate which for developing countries weakens their trade account by encouraging imports and decreasing the profitability of exports. Instead of easing inflationary pressures, this has the effect of increasing inflation with tighter restrictions on imports and subsidies to domestic exporters. Another example of these deficiencies is seen in negative real interest rates. The failure of interest rate policy to be flexible results in negative real interest rates which diverts savings away from financial institutions which are crucial for stimulating productive investment. Overall these negative real interest rates weaken the incentives to save and invest and further undermine the balance of payments for developing countries.
  3. Inadequate debt management plays a crucial role in contributing to the debt crisis. For the developing countries that were large commercial borrowers 1982 and the debt crises brought a very pronounced deterioration in the maturity profile of external debt.

 

Policy Content and Fund-Supported Adjustment Programs and Their Impact

         When countries approach the Fund for assistance programs are designed to correct the above mentioned policy weaknesses. At this point de Larosière uses examples of various member countries where such policies have been implemented and how successful they have been.

 

  1. MEXICO – Fiscal discipline coupled with an effective depreciation of the currency brought the Mexican account balance out from a $3 billion deficit to a $4 billion surplus. Though this included an immediate drop in real output, de Larosière claims that without the Fund’s assistance the drop would have been far worse.
  2. other LATIN AMERICAN COUNTRIES – The combined remaining Latin American countries saw a decrease in their external current accounts deficit from $42 billion to $11 billion dollars from 1981 to 1983. Over this same period moved from a deficit of $7 billion to a surplus of $24 billion. Speaking in general terms de Larosière claims that the over all balance of payments positions have seen significant improvements. The IMF draws the conclusion from this data that those countries that did not pursue adjustment programs through the Fund have suffered increasing inflation and balance difficulties.
  3. INDIA – Policy adjustments in India have been directed primarily at structural adjustments such as domestic savings and investment particularly in the public sector. The policy directed in these areas has been geared towards increasing prices of goods produced by the public sector, the relaxation of controls and regulations over industry and exports, as well as efforts to reduce import restrictions. This has resulted in increased food production, increased productivity in agriculture, and a substantial increase in public investment. As a side note, India has decided to continue pursuing these structural adjustments though not under the guise of Fund financing.
  4. PAKISTAN – Structural reforms in Pakistan were aimed at price rationalization, public finance, and the trade system. Increases in agricultural output as well as energy production were noted during the period of IMF assistance. Tighter demand management policies helped to curb the inflation that resulted from the needed price adjustments, while competitiveness was increased by the unhooking of the Rupee from the appreciating dollar that resulted in the downward float of the domestic currency.
  5. AFRICA/EURPOPE – Kenya, Somalia, and Mauritius have all received aid from the Fund that has helped to correct the impacts of their balance of payments problems. In Europe the same has applied for Turkey, Hungary, Romania and Yugoslavia. On the whole these programs are very similar to those pushed by the Fund in the above examples. Huge external debts, increasing deficits, and other structural difficulties demanded the structural management of the Fund to correct their Economies. And of course, they were successful! Good work IMF.

 

Conditions for Successful Adjustment

         The history of the Fund has revealed a variety of conditions that are most conducive to the successful implementation of Fund programs. The four “ingredients” he highlights are strong political commitment, early action, flexible implementation of policies, and a sustained adjustment effort. Political commitment and communication with the people of a country are indispensable to the success of programs inasmuch as governments are determined to pursue the courses of action which are drawn out by the IMF, and to the degree to which these policies are explained to the people who will ultimately bear the brunt of the consequences that come with adjustment. Also, the earlier such adjustment can be undertaken the more easily it can avoid the inability to pay external debts that comes with postponing adjustment in favor of external borrowing. Furthermore the degree of flexibility in policy formation is essential to coping with the external effects and shocks that can accompany Fund programs. Finally, sustained adjustment efforts must be kept up. Structural changes can not be made overnight and usually are most successful when implemented over the long term by countries receiving aid.

 

         The article concludes with a discussion of the conditions necessary for an orderly adjustment in the world economy. The international financial community has responded to the challenges of maintaining the global economy in two ways. First new financing has been provided by the banks to non-oil developing countries. Second the maturity structure of the external debt of non-oil countries has been substantially improved through rescheduling provided by the banks. But beyond these adjustment efforts and immediate financial requirements, de Larosiere emphasizes that the international community – particularly the industrial countries – have wider responsibilities that must be met in order to maintain the adjustment processes. Three elements are fundamental to this:

 

  1. A broad and sustained recovery throughout the industrial world. Without this there can be no recovery in world trade, which, in turn, has an overriding impact on the conditions for growth and balance of payments performance in developing countries.
  2. Development assistance. Official long-term concessional loans or grants should play a more dynamic role in financing flows because they constitute a key element in the long-term balance of payments adjustments process.
  3. Preserving an open trading system. Recovery can only be extended throughout the world economy in liberal and open trading conditions.

 

 

 

Summary by Cristopher B. Sapstead