Adoption, implementation and impact of IMF programmes: a review of the issues and evidence (1).

Joyce, Joseph P.

INTRODUCTION

In recent years, the activities of the International Monetary Fund (IMF) have drawn increased attention. The rise in the scrutiny of Fund activities is due in part to the IMF's heightened profile. The IMF played a prominent role in dealing with the Asian currency crisis of 1997, as well as the subsequent crises in Russia, Brazil and, most recently, Turkey and Argentina. A number of studies were undertaken in response to criticisms of the IMF's policies, which resulted in proposals for changes in its response to crises. (2)

The increase in public notice has been accompanied by a rise in scholarly work on the Fund. New questions about the adoption, implementation and outcome of the IMF's lending programmes have been raised, while the political dimensions of these arrangements have received increased examination. Economists and political scientists have utilised innovative tools of theoretical and empirical analysis, such as game theory and duration models, to address these issues.

This paper reviews the recent literature on the IMF's lending programmes, and outlines the advances that have been made and the issues that merit future analysis. It does not address all aspects of the Fund's activities, many of which have been examined in other surveys, such as Krueger (1998). (3) Rather, it assesses the state of our knowledge about IMF-sponsored programmes, and points to promising areas of further work.

The next section reviews the research that has been undertaken on the factors that affect the decision to initiate a program. The third section surveys issues relating to the design and implementation of IMF programmes, including the changing nature of conditionality and programme completion. The fourth section reviews the literature on the economic impact of Fund-sponsored policies. The fifth section deals with the response of private capital markets to IMF programmes. The last section summarises our understanding of Fund programmes and delineates issues that need to be further explored.

EX ANTE COUNTRY CHARACTERISTICS

A member country of the IMF that faces an external sector crisis may request financial support from the Fund. A government that is participating in a programme signs a 'letter of intent', which specifies the policies that it will implement to restore external sector balance. (4) In some cases, these have been 'precautionary' programmes, which indicates that the domestic government has stated that it does not intend to utilise the available credit. However, this is not a binding commitment, and the government can later reverse its decision and borrow from the Fund.

The Fund's primary lending facilities are the stand-by arrangement, which is designed to deal with short-term (usually 1-year) balance-of-payments problems, and the extended fund facility, which provides assistance for structural reforms and tares place over a longer time horizon, typically 3 years. The IMF also administers the poverty reduction and growth facility to provide assistance on concessional terms to low-income countries for the purposes of fostering economic growth and reducing poverty. The latter was known until 1999 as the enhanced structural adjustment facility, and it had replaced the structural adjustment facility.

A substantial portion of the research devoted to Fund programmes has dealt with the economic characteristics of countries that adopt IMF programmes. Among the papers that addressed this issue are those of Joyce (1992), Edwards and Santaella (1993), Conway (1994), Santaella (1996) and Knight and Santaella (1997). These studies often used a binary choice model to distinguish between countries and time periods where an IMF programme was in place and those where it was not, and sought to determine the economic factors that influenced the initiation of a Fund programme. Knight and Santaella (1997) pointed out that these estimation equations can be interpreted as the reduced form derived from the 'demand' for a Fund programme by a borrowing country and the IMF's 'supply'.

Bird (1996) summarised this literature, and the areas of overlap and disagreement. He noted that these studies generally showed that the adoption of a Fund programme was linked to the occurrence of balance-of-payments deficits, low levels of reserve holdings, increased debt, an overvalued exchange rate and a record of past programmes. These features are consistent with economies that have external disequilbria, and therefore fall under the IMF's mandate in its Articles of Agreement to address such imbalances. (5) However, the studies left unexplained much of the variation in the occurrence of Fund programmes.

Recent work has focused on political and institutional determinants of Fund borrowing. The relevant papers include those of Thacker (1999), Vreeland (1999, 2003), Przeworski and Vreeland (2000), Bird and Rowlands (2001b), Barro and Lee (2003) and Dreher and Vaubel (2004b). The literature has progressed enough for some areas of consensus to emerge. Thacker (1999) and Barro and Lee (2003), for example, found evidence that access to Fund programmes is skewed towards countries that are aligned with the US, as measured by United Nations voting patterns. Przeworski and Vreeland (2000) and Dreher and Vaubel (2004b) report that governments are more likely to enter into an agreement with the IMF in the year after an election, suggesting that some form of political business cycle may exist. Oatley and Yackee (2000) and Oatley (2002) found that the size of a country's IMF loan is related to the size of its commercial bank debt.

While political and institutional factors undoubtedly play a role in the decision to initiate a Fund programme, the evidence to date does not indicate that they have a predominating influence. Bird and Rowlands (2001b), for example, found that while such variables are in some cases statistically significant, they do not greatly increase the ability of models to predict the occurrence of Fund programmes. Sturm et al. (2002) reported a similar result in their tests of the determinants of changes in the amount of IMF credit disbursed. While this area of research on the IMF's programmes, therefore, may have reached the point of diminishing returns, it does provide evidence on the economic and political factors that make borrowing from the Fund more likely.

Another approach to explaining patterns of IMF lending has been taken by Vaubel (1991, 1994, 1996), who utilised public choice theory. He maintains that an increase in lending allows Fund officials to maximise their power and remuneration, as manifested by their budget and staff size, as well as operational independence. Willett (2001, 2002) also adopts a public choice perspective, although he differs from Vaubel in emphasising institutional autonomy and a desire to avoid failure as determinants of the actions of Fund officials. This line of analysis seems better suited to explain lending in the aggregate than the start of individual programmes.

The significance of past lending in explaining the introduction of new programmes has recently led to a new focus of research on the use of Fund credit. A number of countries have participated in consecutive lending programmes over time. Such continued borrowing would appear to contradict the IMF's own Articles of Agreement, which include as a purpose of the Fund the 'temporary' availability of its resources to member countries.

Several studies have dealt with the characteristics of countries that are frequent borrowers. The IMF's (2002) new Independent Evaluation Office's first report dealt with the prolonged use of IMF resources, and found that the programmes of frequent users exhibited an optimistic bias in their projections of growth. Bird et al. (2004) used models of count data to examine the characteristics of 'recidivist' borrowers, and found that the factors that contributed to prolonged borrowing included low reserve holdings, frequent current account deficits, large debt service ratios and low investment rates. Conway (2000) examined how participation in IMF programmes affects the probabilities of a country entering and exiting a crisis. He reported that participation in Fund programmes lessens the length of an external crisis, but that continuing reliance on Fund programmes weakens this effect.

Duration models have been used to examine the spells of uninterrupted programme participation. Conway (2003) reported that prior participation in IMF programmes is negatively related to the length of a new spell, while the length of time between spells increases with cumulative prior participation. Joyce (2004) investigated the factors that affect these spells, and found evidence of extended programme duration for countries with lower per capita income, exports concentrated in primary goods and autocratic regimes.

These studies shift the focus from the decision by a government to adopt a programme in period t to a government's sequential decisions regarding participation in Fund programmes over periods t, t+1, t+2, etc. A government may use a multi-period perspective when deciding whether to fulfil all the conditions of a particular programme, or to let a programme lapse in the hopes of negotiating a more favourable one in the following period (see the discussion in the next section). This choice will be based on a government's assessment of its bargaining ability vis-a-vis the Fund as well as its forecast of future economic conditions. Modelling this intertemporal governmental decision-making process could be a useful area of future research.

PROGRAMME DESIGN AND IMPLEMENTATION

The Fund disburses credit only if a government adheres to the policies outlined in the letter of intent. The IMF periodically evaluates a country's fulfilment of its obligations as measured by performance criteria, structural benchmarks and overall programme reviews, and non-compliance usually results in the suspension or termination of a programme. (6) Several studies, including those of Killick (1996, 1997), examine the justification for conditionality in the context of a principal-agent relationship, where the IMF seeks to ensure that the borrowing government implements policies consistent with the Fund's goals, with conditionality serving as a monitoring device.

Much recent work has dealt with the changing nature of the policy conditions. IMF conditionality traditionally focused on measures of demand management, such as constraints on a central bank's holdings of domestic assets and a government's fiscal position. The increased emphasis by the IMF on growth as an objective has resulted in the increasing use of structural conditions. These measures are designed to foster the use of markets in the allocation of resources, and include domestic deregulation and the liberalisation of trade and capital flows.

The programmes initiated during the Asian crisis were criticised for imposing an excessive number of structural conditions, particularly in the case of Indonesia. Goldstein (2000) examined the record of structural conditions in IMF programmes and found an increase in the average number of these structural conditions in programmes over time. Goldstein (2000) and Bird (2001b) suggested that this might have led to a decline in programme compliance. Dreher and Vaubel (2004a), who use a public choice perspective, found that the number of conditions depended negatively on international reserves and positively on world interest rates, domestic monetary conditions and the number of World Bank loans. Dreher (2004b) also showed that the number of IMF conditions increased with participation in World Bank programmes. Gould (2003) attributed the rise in the use of structural conditions to the influence of private creditors who supplement Fund resources.

The IMF itself (2001a-d) undertook several studies of conditionality in the aftermath of the Asian crisis. The authors of these reports also reported an increase in the number of structural conditions contained in Fund programmes, but claimed that there was no evidence that the number of criteria was linked to programme compliance. However, they did agree that conditionality should be streamlined.

The record of programme completion by borrowing countries has received increasing scrutiny. Killick (1995) undertook an examination of programmes that took place between 1979 and 1993, and used the proportion of credit actually disbursed by the end of a programme relative to the amount initially committed as a criterion to measure programme completion. He selected an 80% disbursal rate as a floor to indicate whether or not a programme was 'completed'. (7)

Killick (1995) reported that by this standard only 47% of all programmes were successfully completed. He found empirical evidence that the completion rate was affected by a country's external debt position, with more frequent breakdowns in programme completion occurring in highly indebted countries. He also found that the size of the IMF's initial commitment of credit relative to a country's current account deficit was higher in those countries that successfully finished their programmes.

Mussa and Savastano (2000) provided a comprehensive review of the IMF's lending arrangements over the period 1973 and 1997. They point out that a country may not receive all of the originally planned credit for a number of reasons, including external shocks. In some of these cases, the programme is cancelled early because of an unanticipated change in the external environment and a new arrangement is made.

They characterised those programmes where 75% or more of the planned credit was actually disbursed as situations where the governments generally completed the agreed-on policies. Such programmes represented 46% of the total, which is almost identical to Killick's (1995) calculation of the proportion of successful completions. The programmes where 50%-75% of the credit was disbursed represent a range of circumstances and outcomes, including some successful programmes, some that were rescheduled and some that were not finished because of failure to comply with the performance criteria. There was a serious divergence between the planned policies and those executed in the remaining cases where less than one half of the planned credit was disbursed.

Studies originating at the IMF of its programmes have pointed to the importance of political factors in successful programme implementation. Schadler et al. (1995) pointed out that there is a large variation among countries in their commitment to carrying out reform measures, while Mecagni (1999) attributed a major proportion of programme breakdowns to political changes and civil instability. The IMF's (2001b) own study of the literature on programme implementation concluded that a national commitment to reform is necessary to the successful completion of a program. (8)

Theoretical models based on a political economy perspective focus on the domestic political factors that affect programme implementation. These models stress the divergent interests of the different interest groups within a country and the impact of an IMF programme on their relative positions. Vreeland (1999), for example, contends that some governments adopt Fund programmes even when economic conditions do not warrant one in order to increase their bargaining leverage over domestic opponents of reform policies.

Drazen (2002) and Mayer and Mourmouras (2002) presented models of the political environment within a borrowing country, where there are 'veto players' within a government and special interest groups outside that could block reform. Mayer and Mourmouras (2002) demonstrate that conditional assistance can strengthen or 'tip the hand' of the reformers. Boughton and Mourmouras (2002) reviewed this theoretical modelling of policy reform and drew implications for strengthening policy ownership, a subject also analysed by Khan and Sharma (2001).

Ivanova et al. (2003) used several measurements of programme implementation in their study of the factors that affect the outcomes of Fund programmes. They reported that completion is linked to domestic political conditions, including political cohesion, ethnic fragmentation, conflict and the strength of special interests. Joyce (2003) found that programme implementation is affected by a country's trade openness, the ideological cohesion of the government, the duration of the political regime and the degree of political openness. In a related study, Dreher (2004a) showed that the completion of an IMF programme in the year before an election increases the probability of a government's re-election only when the growth rate of GDP is low.

Other studies have examined the Fund's behaviour in cases of programme suspension. Stone (2002), for example, reported evidence to support the hypothesis that the IMF is more likely to suspend programmes in more 'important countries', as measured by the size of their IMF quotas, US foreign aid and aid from other OECD members, but for shorter periods. Dreher (2003) found that non-compliance with conditionality and programme suspension is more likely to take place prior to elections, but this happens less frequently in democratic countries. Edwards (2003a) showed that democracies with fractionalised legislatures perform poorly in IMF programmes and are more likely to be sanctioned.

In response to its critics, the IMF now emphasises the ownership of programmes in order to achieve their successful completion. The Fund is paying more attention to the domestic political environment when dealing with a country. For example, the IMF and the World Bank have sought to broaden the basis of support within a country for their programmes by developing poverty reduction strategy papers that describe the policies needed to promote growth in consultation with a broad range of parties. A future focus of research will be evaluating whether this new emphasis affects programme completion.

EX POST POLICY IMPACT

The economic policies stipulated in a Fund-sponsored programme are designed to restore a sustainable balance-of-payments position in the short-run while encouraging long-term output growth. An extensive amount of research has addressed the issue of whether Fund-supported policies actually improve economic performance, as manifested through the balance of payments, lower inflation and higher growth. These studies seek to determine the efficacy of the measures that the IMF recommends.

A crucial component of the empirical analysis has been the construction of the 'counterfactual', a country's economic performance if it had not elected to adopt a programme to serve as a basis of comparison with the actual record. A variety of approaches have been adopted for this purpose. The 'before-after' approach compares a country's post-programme performance with its performance before the programme. The 'with-without' approach contrasts changes in target variables in programme countries with changes in a control group of non-programme countries. Both methods, however, ignore the systematic differences between the countries and periods where lending occurs and those where it does not. Studies that ignore these differences may exaggerate the impact of Fund programmes.

Goldstein and Montiel (1986) developed a generalised evaluation estimator (GEE) to deal with this problem. The GEE controls for the differences between countries and takes into account the policies that would have prevailed in the absence of a Fund programme. This approach has been taken in many subsequent studies, such as those of Khan (1990) and Conway (1994). Recent contributions in this area include the works of Bagci and Perraudin (1997), Prezeworski and Vreeland (2000), Dicks-Mireaux et al. (2000), Evrensel (2002), Barro and Lee (2003), Hutchison (2003) and Hutchison and Noy (2003).

Haque and Khan (1998) provided a comprehensive survey of this literature. They report that the empirical evidence generally indicates:

 '... that Fund-supported programmes lead to an improvement in the
 current account balance and the overall balance of payments. The
 results for inflation are less clear cut ... In the case of growth,
 the consensus seems to be that output will be depressed in the
 short-run as the demand-reducing elements of the policy package
 dominate. Over time the structural reform elements of the programme
 start to take effect and growth begins to rise ...' (9)

Bird (2001a) in a later survey agrees with this assessment, except with respect to the impact of IMF programmes on growth. He finds that the evidence from recent studies indicates no impact or a negative one.

Other recent works have attempted to measure the impact of IMF programmes on income distribution and poverty. Garuda (2000) found that participation in Fund programmes has important distributional effects that depend on a country's pre-income situation, with negative consequences for countries in the worst circumstances. Similarly, Vreeland (2002) reported that labour's share of income is lower in countries with IMF programmes. Easterly (2003) investigated the impact of structural adjustment programmes of the IMF and World Bank and reported that such programmes lower the impact of economic fluctuations on poverty, that is, economic expansions benefit the poor less but contractions hurt them less.

This literature has generally not taken into account the compliance of the countries in IMF programmes with their programmes' conditionality. This is a surprising omission, since presumably a country's economic performance will vary in response to its implementation of the programme's policies. Assessing the performance of programme countries without discriminating among them by their degree of compliance could give a misleading view of the effects of IMF programmes. On the other hand, if no systematic linkages exist, then new questions arise about the effectiveness of Fund-supported policies and the need for conditionality.

Killick et al. (1992) compared the impact on the balance of payments of completed versus uncompleted programmes, but did not find evidence of a significant difference in the two groups. Conway (1994) included measurements of the time spent in programmes and the amount of credit actually disbursed in his analysis of the economic impact of Fund programmes. Ergin (1999) also addressed this issue, and used different measurements of participation in Fund programmes, including a time-weighted utilisation of IMF credit that served as a proxy for programme compliance. He found that sustained access to Fund credit led to improvements in the current account and real output, and a significant decline in the inflation rate. Mercer-Blackman and Unigovskaya (2000) used the Fund's database for monitoring fund arrangements (MONA), and reported evidence of a link in the transition economies between growth and compliance, as measured by MONA's index of fund programme implementation. Boockmann and Dreher (2003) found that neither the number of IMF programmes nor the net flow of credit disbursed had an impact on an index of economic freedom.

The impact of Fund programmes on economic performance has consequences for the occurrence of future programmes. Policies that are effective reduce the need for new programmes. Unsuccessful policies could lead to more programmes to address recurring problems, although programmes with negative side effects may drive countries away. Assessing the effect of IMF programmes on economic performance will undoubtedly continue to be an important area of research.

IMF PROGRAMMES AND CAPITAL MARKETS

The research reviewed to this stage has dealt with the relationship of the IMF and the member countries that participate in a programme. However, Fund lending does not take place in isolation. There are other sources of financial resources potentially available to a country, both public and private, and these may be affected by the operations of Fund programmes.

The IMF itself states that the existence of an agreement with a country '... reassures investors and the official community and helps generate additional financing from these sources. Thus, IMF financing can act as an important lever, or catalyst, for attracting other funds'. (10) A large number of studies have tested the validity of this claim. (11) Rodrik (1996), Bird and Rowlands (1997, 2001a) and Ergin (1999), using different measurements of private capital flows, found no evidence that IMF lending to a country was followed by an increase in private credit flows. However, Ergin (1999) and Rowlands (2001) did find evidence of an increase in lending from other public sources, which is consistent with the Fund's lead role in coordinating multi-lateral assistance.

These findings indicate that the existence of a Fund programme does not serve as a sufficient condition to warrant an increase in private capital flows. This result is not surprising in view of the record on programme completion and impact reviewed above. It would be more fruitful to examine whether the private markets differentiate between successful and unsuccessful programmes.

Edwards (2003b) addresses this issue, as well as the problem of selection bias. He also found little evidence of a catalytic effect, although he does report a decrease in capital flows for programme countries that had compliance problems in the past. Similarly, Mody and Saravia (2003) demonstrated that a country's fundamentals, such as the volatility of exports, its reserves and its debt, determine the effect of a programme on the spreads that borrowing countries paid at the time of bond issuance. They also showed that prolonged usage of Fund resources raises the spreads. Benelli (2003) reported that the amount of financial assistance provided in a programme is inversely related to whether the projections for net private capital flows are met. Macro-policy adjustment seemed to have a positive impact on such flows.

The initiation of a Fund programme may affect private capital markets through an impact on existing debt. Marchesi and Thomas (1999) presented a model in which the presence of an IMF programme serves as a signalling device of a country's willingness and ability to undertake substantive reform. In these circumstances, private creditors are more willing to reschedule the country's external debt. Marchesi (2003) empirically tested this prediction and reported evidence in support of it. Easton and Rockerbie (1999) found that participation in an IMF programme lowers the expected probability of a loan default and the average spread over LIBOR.

The reaction of the private financial markets to the start of IMF programmes could be an important factor in the eventual economic impact of these programmes. Fund programmes are designed to encourage private lending, but this outcome does not always take place. An increase in capital flows may depend in part on the status of financial markets within a country, as well as the assessment of private creditors of the extent of reform measures. The literature on the determinants of capital flows to emerging economies may be useful in understanding how IMF programmes could lead to increased capital flows.

Although Fund lending does not seem to be systematically followed by inflows of private capital, the Fund has been criticised in recent years for indirectly encouraging risky behaviour by either borrowers or private creditors. Moral hazard poses a problem if the potential availability of Fund support encourages risky loans to be made that precipitate or worsen a crisis. While the dangers of moral hazard have been frequently raised by the critics of the IMF, there is a paucity of evidence on its actual magnitude and relevance. (12) This is partly due to the problem of contrasting a countervailing situation.

A number of papers have utilised the spreads on the bonds of emerging markets to determine whether the bond markets reacted to events such as IMF lending during a crisis. Zhang (1999) reported that he found no evidence of moral hazard in the wake of the Mexican crisis, and Kamin (2002) also did not find evidence of a change in the access of emerging markets to credit after the Mexican crisis. On the other hand, Sarno and Taylor (1999) found that moral hazard affected the flows of capital to East Asia. Dell'Aricca et al. (2002) presented evidence in the case of the Russian crisis consistent with the existence of moral hazard, but cautioned that their findings could also be due to a change in the market's perception of risk in emerging markets.

Lane and Phillips (2000) reported a mixed record of market responses to news of Fund initiatives. Evrensel and Kutan (2003) conducted an empirical analysis of creditor behaviour in several countries, and found results consistent with moral hazard in the case of the Korean asset markets. The limited evidence on moral hazard indicates that more research is needed in this area, particularly as developing countries move to liberalise capital flows.

SUMMARY

A balance sheet of our knowledge regarding the IMF's lending programmes would show entries on both sides of the ledger. Areas of consensus include:

* Countries that participate in IMF programmes usually show signs of an external imbalance: large current account deficits, low reserve levels, high debt burdens and an overvalued exchange rate. In addition, they have often utilised Fund assistance before. Their governments are supportive of the US in forums such as the United Nations. IMF lending often occurs in the year after an election.

* Some countries have participated in a continuous series of Fund programmes over time. Moreover, a large proportion of Fund programmes are not successfully completed. Incomplete implementation is due in part to adverse domestic political conditions that hinder the chances of economic reform.

* The execution of IMF-sponsored policies improves a country's external balance, as measured through the balance of payments. There may also be an accompanying decline in output. There is little evidence of a systematic effect on inflation.

* There is no evidence of a systematic increase in private capital flows in the wake of Fund programmes. However, foreign creditors may be more willing to reschedule debt. Credit from other official sources does increase.

There are many aspects of IMF programmes, however, that we do not yet fully understand. Among the unanswered questions are:

* Some countries do not enter a Fund programme despite adverse economic circumstances. Is there a high initial political cost in approaching the IMF, which then falls with each successive programme?

* Is recurring lending the result of unsuccessful implementation of previous programmes, badly designed policies, systematic external shocks or other factor(s)?

* Is the partial completion of programmes related to the design of the programmes, as well as unfavorable domestic economic and political conditions? How does it differ by type of programme?

* Are private capital flows a substitute or complement to IMF credit? Do private lenders distinguish between countries with 'successful' programmes as opposed to those with uncompleted programmes?

* Is there evidence that demonstrates that moral hazard has led to crises because of risky behaviour by private lenders or borrowing countries?

These questions represent a far-ranging agenda of research. In many cases, similar questions have been raised in other contexts, including the study of currency crises, the political economy of reform, the effectiveness of foreign aid and the determinants of capital flows to emerging economies. Research on IMF lending can absorb findings from these related areas to provide new insights on these programmes, which in turn may be incorporated into the Fund's future lending policies.

(1) This paper has benefited from comments by two referees.

(2) See, for example, Council on Foreign Relations (1999), De Gregorio et al. (1999) and International Financial Institution Advisory Commission (2000).

(3) Comprehensive listings of research on the IMF and World Bank, including those that are cited in this paper, are available at the International Financial Institutions Research Site: www.wellesley.edu/Economics/IFI/index.html.

(4) A country may obtain foreign exchange worth up to 25% of its quota with minimal conditionality. See Mussa and Savastano (2000) for a description of the process whereby a program is initiated.

(5) Article of Agreement I(vi).

(6) The Fund does grant waivers in situations where it feels they are warranted.

(7) The disbursal rate would not be appropriate for precautionary programmes, since the domestic government does not intend to utilise the resources. Even if it does borrow, it may not need the entire committed amount.

(8) See IMF (2001b, p. 52).

(9) Haque and Khan (1998, p. 19).

(10) 'What is the IMF?' on the Fund web site www.imf.org, August 2001.

(11) See Cottarelli and Curzio (2002) for a thorough review of these studies.

(12) Evrensel and Kutan (2003) provide a critical review of this literature.

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JOSEPH P JOYCE

Department of Economics, Wellesley College, Wellesley, MA 02482, USA. E-mail: jjoyce@wellesley.edu