International Monetary Fund: Lending Policies

Published by the Government Accountability Office on 1999-06-22.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                          United States General Accounting Office

GAO                       Testimony
                          Before the Subcommittee on Domestic and International
                          Monetary Policy, Committee on Banking and Financial
                          Services, House of Representatives

For Release on Delivery
Expected at
10:00 a.m. EDT
on Tuesday
June 22, 1999             MONETARY FUND
                          Lending Policies
                          Statement of Susan S. Westin, Associate Director
                          Financial Institutions and Markets Issues
                          General Government Division


                          Harold J. Johnson, Jr., Associate Director
                          National Security and International Affairs Division


              Mr. Chairman and Members of the Subcommittee:

              We are pleased to be here this morning to present several key findings in
              two reports that we are releasing today. We prepared these reports to
              address the mandate in the Omnibus Appropriations Act for 1999 that we
              report on (1) the conditions the International Monetary Fund (IMF)
              negotiates with its borrower countries and (2) the trade policies of
              borrower countries. One report describes how the IMF establishes and
              monitors financial arrangements with borrower countries and assesses
              how this process was used for six borrower countries—Argentina, Brazil,
              Indonesia, Korea, Russia, and Uganda. While we describe the conditions
              for financial assistance to these countries, evaluating whether these were
              the appropriate policies was beyond the scope of our work. The second
              report identifies the trade policies of four IMF borrowers—Brazil,
              Indonesia, Korea, and Thailand--and the likely effects of their policies on
              certain U.S. industry sectors. We will be reporting separately on the IMF’s
              financial condition this September.

              First, looking at how the IMF establishes and monitors conditions, we
              concluded that:

            • The IMF has a process for establishing and monitoring financial
              arrangements with member countries and it generally followed the process
              for the six countries in our study. The process encompasses data
              collection and analysis as well as judgment by the IMF Executive Board
              and staff, and gives the IMF wide latitude in assessing a country’s initial
              request for assistance, negotiating terms and conditions for that
              assistance, and determining the country’s continued access to IMF
              resources. Under its charter, the IMF limits financial assistance to

                With the exception of some financing for low-income countries, the IMF does not loan funds to a
              country, per se. Rather, the country “purchases” the currency it needs from the IMF with an equivalent
              amount of its own currency and then later “repurchases” its own currency according to the terms
              applicable to the IMF financing policy. For the purposes of this statement, we will use the terms
              “disbursement” and “loan” to refer to “purchases,” and “repayments” to refer to “repurchases.” In this
              statement, we use the term “arrangement” to describe the broad concept of IMF’s financial assistance
              to countries and the associated conditions that are intended to address the underlying causes of the
              countries’ need for assistance. We use the term “program” to describe the conditions that are the policy
              changes and reforms as outlined in the documents the countries prepare in the context of their IMF
              financial assistance.
               International Monetary Fund: Approach Used to Establish and Monitor Conditions for Financial
              Assistance (GAO/GGD/NSIAD-99-168, June 22, 1999).
               International Monetary Fund: Trade Polices of IMF Borrowers (GAO/NSIAD/GGD-99-174, June 22,

              Page 1                                                                   GAO/T-GGD/NSIAD-99-194

               members with a balance-of-payments need; the IMF has broadly
               interpreted this to encompass a wide range of financial difficulties.
             • The IMF has continued to make disbursements to a country that had not
               met all conditions when it decided that the country was making
               satisfactory progress; this decision was based on the IMF’s analysis of data
               on the country’s progress and the IMF’s judgment.
             • When the IMF determined that the country’s progress in meeting key
               conditions was insufficient, disbursements have been delayed, and have
               not resumed unless or until satisfactory progress was achieved, in the
               IMF’s judgment.

               Second, our report on the trade policies of IMF borrowers concluded that:

             • IMF financial arrangements in four borrower countries that are important
               trading partners of the United States focus primarily on macroeconomic
               and structural reforms rather than trade reform because restrictive trade
               policies were not major causes of the countries’ financial problems leading
               to the request for IMF assistance, according to the U.S. Treasury
               Department and the IMF. Nevertheless Brazil, Indonesia, and Korea have
               undertaken some trade liberalization within the context of their most
               recent IMF arrangements. According to the Treasury Department,
               Thailand’s recent IMF financial arrangements have had no trade
               liberalization commitments because trade policies were not the root
               causes of its financial crisis, and also because Thailand’s trade system was
               more open than the other three countries’ systems.
             • The large macroeconomic changes in these four borrower countries
               caused by their recent financial crises have probably been a more
               important source of changes in their trade than trade policies. This greatly
               complicates the task of measuring the impact of the trade policies on the
               United States. The countries’ trade policies can distort trade in specific
               sectors, however, which could contribute to import surges.

               The IMF’s first purpose is promoting international monetary cooperation.
Background     Its Articles of Agreement, as amended, provide that it may make its
               resources available to members experiencing balance-of-payments
               problems; this is to be done under “adequate safeguards.” The IMF’s
               approach to alleviating a country’s balance-of-payments problems has two
               main components—financing and conditionality—that are intended to
               address both the immediate crisis as well as the underlying factors that
               contributed to the difficulties. Although financing is designed to help
               alleviate the short-term balance-of-payments crisis by providing a country
               with needed reserves, it may also support the longer term reform efforts by
               providing needed funding.

               Page 2                                                GAO/T-GGD/NSIAD-99-194

                               The access to and disbursement of IMF financial assistance are
                               conditioned upon the adoption and pursuit of economic and structural
                               policy measures the IMF and recipient countries negotiate. This IMF
                               “conditionality” aims to alleviate the underlying economic difficulty that
                               led to the country’s balance-of-payments problem and ensure repayment to
                               the IMF. As the reasons for and magnitude of countries’ balance-of-
                               payments problems have expanded (due, in part, to the growing
                               importance of external financing and changes in the international
                               monetary system since the 1970s), conditionality has also expanded.
                               According to the IMF, conditionality has moved beyond the traditional
                               focus of reducing aggregate demand, which was appropriate for relieving
                               temporary balance-of-payments difficulties, typically in industrial
                               economies. Structural policies—such as reducing the role of government
                               in the economy and opening the economy to outside competition—that
                               take longer to implement and are aimed at increasing the capacity for
                               economic growth—became an important part of conditionality. More
                               recently, the financial crises in Mexico (1994-95) and in Asia and Russia
                               (1997-99) have resulted in an increased focus on strengthening countries’
                               financial sectors and the gradual opening of their economies to
                               international capital flows.

                               Over time, the IMF has developed a broad framework for establishing and
Approach Used To               monitoring financial assistance arrangements that is applied on a case-by-
Establish And Monitor          case basis considering each country’s circumstances. This process, based
Financial                      on the IMF’s analysis of country data and projections of future economic
                               performance, gives the IMF wide latitude in establishing an actual or
Arrangements                   potential balance-of-payments need, the amount and timing of resource
                               disbursements, and the conditions for disbursements; and in monitoring
                               and, in some cases, modifying the arrangements.

Its Process for Establishing   Under its Articles of Agreement, as amended, the IMF provides financial
                               assistance only to those countries with a balance-of-payments need. Under
and Monitoring Programs        these Articles, the IMF primarily considers actual or potential difficulties
Gives IMF Latitude             in either the country’s balance of payments or its reserve position to be a
                               basis for providing financial assistance. This framework has provided the
                               IMF with wide latitude to consider countries’ individual circumstances and
                               changes in the international monetary system in its financial assistance

                               The specific conditions that the IMF and the country authorities negotiate
                               are intended to address the immediate and underlying problems that
                               contributed to the country’s balance-of-payments difficulty, while ensuring
                               repayment to the IMF. These conditions are intended to be clear indicators

                               Page 3                                                GAO/T-GGD/NSIAD-99-194

of a country’s progress toward the overall program goals, such as
strengthening the country’s balance of payments or reducing inflation.
These conditions can include a variety of changes in a country’s fiscal,
monetary, or structural policies. Fiscal policy conditions may call for
countries to reduce budget deficits; Brazil’s program, for instance, called
for limits on public sector debt. Monetary policy conditions seek to, among
other things, rebuild international reserves to promote financial stability;
Uganda’s program set a minimum level for its net international reserves.
Changes in structural policies may include revisions to financial market
regulation or tax policies; Korea’s program called for restructuring its
financial supervisory system. Political constraints and economic
uncertainty can make these negotiations sensitive and difficult. After a
country fulfills any early IMF requirements, known as “prior actions,” and
the IMF Executive Board approves the financial arrangement, the program
is to take effect and the country is eligible to receive its first disbursement
of funds.

Korea and Argentina exemplify the differences that can exist between
countries’ financial arrangements with the IMF. Korea’s program provided
substantial funding at the earliest stage of the program to counter an
ongoing balance-of-payments crisis in late 1997 resulting from substantial
losses in Korea’s foreign currency reserves and the depreciation of the
won, Korea’s currency. The country faced balance-of-payments problems
primarily due to significant capital outflows. Korean banks had a large
amount of short-term external debt that needed frequent refinancing. As
market confidence fell, the willingness of external creditors to “roll over”
or refinance these loans declined rapidly. The government’s attempt to
support the exchange rate rapidly depleted official reserves of foreign
currencies. The main goals for the program’s monetary policy were to limit
the depreciation of the won and contain inflation.

In contrast, Argentina’s 1998 program was designed as a precaution against
a potential balance-of-payments problem that could result from external
economic shocks. Although Argentina enjoyed good access to capital
markets and had employed a strategy to lengthen the maturity of its debt
and borrow when interest rates were low, it faced an uncertain future due
to deteriorating conditions in the international financial environment and
the effect this likely would have on its future access to capital markets.
Argentina agreed to access IMF resources only if external conditions made
access necessary. The program was principally concerned with
maintaining fiscal discipline and enacting labor market and tax reforms
that were intended to maintain investor confidence and strengthen the
economy’s competitiveness.

Page 4                                                  GAO/T-GGD/NSIAD-99-194

                              The process of monitoring a country’s progress toward overall program
                              goals and compliance with program conditions involves both the borrower
                              country and the IMF. The approach is designed to incorporate data on a
                              country’s economic performance as well as the judgment of the IMF
                              Executive Board and staff. IMF staff reviews a member’s economic
                              performance and implementation of policy changes that were negotiated
                              as conditions of the financial assistance. The staff then reports to the
                              Executive Board at regularly scheduled intervals for each assistance
                              program. In situations where conditions have not been met, the staff
                              formally or informally advises the Executive Board. The staff may
                              recommend that the Board grant a waiver for the nonobservance of the
                              unmet conditions. Typically waivers can be recommended if the
                              nonobservance is minor and program implementation is otherwise “on
                              track.” If there is no waiver, additional financial assistance is not to be
                              made available to the country and the program is effectively suspended
                              until there is an agreement between the IMF and the country that is
                              approved by the IMF Executive Board. This agreement may mandate
                              policy changes before any further assistance is granted and change the
                              conditions for future assistance.

The IMF Has Disbursed         In monitoring compliance, IMF missions to each country documented a
                              country’s progress in satisfying conditions. In some cases, the IMF
Funds on the Basis of         determined the countries had made sufficient overall progress in meeting
Sufficient Overall Progress   program conditions so that additional funds could be made available, even
                              when the countries had not satisfied some key conditions.

                              For example, in response to the Argentine government’s request, the IMF
                              staff recommended, and the Executive Board approved, a waiver on the
                              basis of the IMF’s judgment that there was sufficient overall progress in
                              implementing the program and that the deviation from meeting the
                              required condition was minor. In March 1999, the IMF Board approved a
                              waiver when Argentina’s fiscal deficit (1.1 percent of gross domestic
                              product) slightly exceeded its target of 1 percent. Access to funding was
                              not delayed.

                              Similarly, in April 1998, the IMF Board approved a waiver when the
                              Ugandan government experienced a temporary shortfall in its checking
                              account balances, causing it to miss a required condition. According to the
                              IMF staff, this shortfall happened because the government made payments
                              sooner than expected. The staff viewed this as a minor, technical issue and
                              recommended the waiver.

                              Page 5                                               GAO/T-GGD/NSIAD-99-194

                               The IMF and borrower countries may also negotiate changes in conditions
                               to respond to unanticipated developments. For example:

                             • The IMF and Korea revised Korea’s program several times during its first 2
                               months. The IMF acknowledged that the initial program was “overly
                               optimistic” as economic conditions worsened; Korea continued to have
                               access to financial assistance during these renegotiations.
                             • Brazil’s program was modified due to adverse events. The maintenance of
                               the exchange rate regime was an objective of Brazil’s IMF program. Brazil
                               turned to the IMF for assistance in September 1998, when its currency
                               came under pressure as a result of the Russian crisis, and it experienced a
                               significant loss of reserves. This reserve loss decelerated after the
                               negotiations began; but, according to Brazilian officials, Brazil’s currency
                               came under additional pressure after its IMF program had started. The
                               reasons for this included the defeat in Brazil’s congress of two tax
                               measures deemed crucial to the fiscal adjustment program and the
                               reluctance of a number of Brazilian state governors to fulfill their financial
                               obligations to the government. To try to stem the additional loss of
                               reserves, the Brazilian government found it necessary to devalue and then
                               float the currency. The IMF program was then revised to reflect the new
                               economic situation and currency regime.

Disbursements Have Been        In some cases, the IMF determined that the countries had not made
                               sufficient overall progress in meeting program conditions. In these cases,
Delayed Until Satisfactory     no additional funds were made available until, in the IMF’s judgment,
Progress Occurred              satisfactory progress had been achieved.

                               The IMF delayed disbursements to Indonesia at various points during its
                               current program until the IMF determined that the country had made
                               sufficient overall progress in meeting the program requirements. For
                               example, the IMF delayed Indonesia’s disbursements from mid-March 1998
                               to early in May 1998 due to the IMF staff’s determination that Indonesia
                               had made insufficient progress in carrying out its program. The first review
                               was completed in May 1998. Indonesia met none of the required conditions
                               addressing macroeconomic components of the program and one of the key
                               conditions for structural economic changes. IMF staff recommended that
                               the Board grant Indonesia’s request for waivers of these conditions on the
                               basis of actions taken by the government. (For example, the government
                               had established a new comprehensive bank-restructuring program in
                               January 1998 to be implemented by a new agency, the Indonesian Bank
                               Restructuring Agency.) Following the Board’s approval, Indonesia received
                               its next disbursement. At this time, the IMF moved from quarterly to

                               Page 6                                                 GAO/T-GGD/NSIAD-99-194

                        monthly reviews of Indonesia’s program. Disbursements were also delayed
                        in the process of completing several subsequent reviews.

                        The IMF faced continued problems in Russia’s implementation of its IMF
                        program. Over time, the IMF delayed disbursements and program
                        approval, reduced the amount of the disbursement, and ultimately
                        suspended the program. According to the IMF, it delayed disbursements
                        because of Russia’s poor tax collections, reflecting a lack of government
                        resolve to collect taxes. However, throughout Russia’s program the IMF
                        staff expressed the view that Russia’s key senior authorities were
                        committed to the program and should be supported; therefore, the IMF
                        Board continued to approve disbursements. Events in 1998 particularly
                        illustrate this. The delayed approval of the 1998 program, due to cabinet
                        changes and difficulty in meeting the revenue package, meant that Russia
                        received no funds between January and June 1998. The program was
                        finally approved in June 1998, on the basis of implementation of prior
                        actions. In July 1998, the IMF approved additional funds to Russia but
                        reduced the amount of the disbursement from $5.6 billion to $4.8 billion
                        due to delays in getting two measures passed in the Duma. The IMF was
                        scheduled to release the next disbursement in September 1998, but Russia
                        had deviated so far from the program that the IMF made no further
                        disbursements. In March 1999, Russia requested that the program be
                        terminated. In April 1999, the IMF and Russia announced they had reached
                        agreement on a new arrangement. To date, the IMF Board has not
                        approved the new arrangement.

                        Although all borrowers restrict trade to some extent, only a few of the 98
Trade Policies of IMF   current IMF borrowers are traders large enough to affect the U.S.
Borrowers               economy. Trade policies were not the major focus of IMF conditions for
                        structural reform in the four borrowers we studied that are important U.S.
                        trade partners. The IMF did seek to promote trade liberalization in these
                        countries, however, and Brazil, Indonesia, and Korea undertook some
                        actions to liberalize their trade regimes. Also, although U.S. imports from
                        some of these countries have grown in some sectors, the effect of trade
                        policy changes on U.S. imports has probably been of lesser magnitude than
                        the effect of the substantial macroeconomic changes that these countries

                        Page 7                                               GAO/T-GGD/NSIAD-99-194

IMF Conditions Did Not       In its programs with four important U.S. trade partners, the IMF focused
                             primarily on macroeconomic and structural reforms other than trade
Focus on Trade Policies of   reforms. As we noted earlier, the IMF seeks to address the immediate and
Brazil, Indonesia, Korea,    underlying problems that contributed to a country’s balance-of-payments
And Thailand                 problem; restrictive trade policies were not major factors contributing to
                             the countries’ needs for IMF assistance.

                             Nevertheless, the IMF sought to promote trade liberalization in the
                             countries, as it deemed appropriate. Part of the IMF’s mission, as
                             embodied in its Articles of Agreement, is to facilitate the expansion and
                             balanced growth of world trade. As such, countries that have borrowed
                             from the IMF sometimes have liberalized their trade systems within the
                             context of their financial arrangements. Borrowers have eliminated or
                             reduced tariffs or nontariff barriers to imports and have ended or altered
                             export policies, such as subsidies and export restrictions.

                             Brazil, Indonesia, and Korea have undertaken some trade liberalization
                             within the context of their recent IMF financial arrangements.
                             Nevertheless, their overall conditionality has focused primarily on
                             macroeconomic and structural reforms other than trade reform because
                             restrictive trade policies per se were not major causes of their balance-of-
                             payments difficulties, according to the Treasury Department and the IMF.
                             Reflecting this, only one of the trade liberalization measures taken was a
                             required condition—the requirement that Indonesia reduce export taxes
                             on logs and sawn timber. Further, although some of the import and export
                             policies to be eliminated or modified under their IMF arrangements have
                             been of concern to the United States and other countries, the stated
                             purpose of these measures is not to benefit the three countries’ trading
                             partners. Rather, the purpose is to help resolve the countries’ balance-of-
                             payments problems and address the underlying causes of these problems
                             by promoting greater efficiency in their economic systems.

                             Korea has eliminated four export subsidies, reduced some import barriers,
                             and made improvements to the transparency of its subsidy programs.
                             Indonesia has made many changes to its trade policies in the context of its
                             IMF financial arrangements, including reducing or eliminating some import
                             tariffs and export restrictions. Indonesia has committed to phase out most
                             remaining nontariff import barriers and export restrictions by the time its
                             IMF program ends in the year 2000. Brazil has committed to limit the scope

                              Nontariff import barriers include quantitative restrictions, state trade monopolies, restrictive foreign
                             exchange practices that affect a country’s trade system, and quality controls and customs procedures
                             that act as trade restrictions.

                             Page 8                                                                     GAO/T-GGD/NSIAD-99-194

                            of its interest equalization export subsidy program to capital goods and has
                            suspended for 1999 a tax rebate given to exporters. Further, according to
                            the IMF, Brazil has kept its pledge not to impose any new trade restrictions
                            that hinder regional integration, are inconsistent with the World Trade
                            Organization, or that are for balance-of-payments purposes.

Some U.S. Imports From      The large macroeconomic changes in these four countries caused by their
                            recent financial crises greatly complicate predicting and measuring the
the Four Countries Have     trade policies’ impact on the United States. Our analysis of 1997-98 trade
Increased Markedly in the   data reveals that overall U.S. imports from Brazil, Indonesia, Korea, and
Past Year, but Impact Is    Thailand rose moderately in 1998. However, there have been substantial
Difficult to Measure        increases in U.S. imports from these countries in certain sectors. For
                            example, imports of one category of flat-rolled steel from Korea rose by 36
                            percent to $355.8 million, and paper and paperboard imports from
                            Indonesia were up by 284 percent to $40.8 million. Under U.S. law, there
                            are procedures to investigate and remedy situations, such as steel import
                            surges, where U.S. industry believes rising imports are attributable to
                            foreign government policy and harm its economic interests.

                            In some sectors, rising imports may be due to other factors besides
                            government policies. For example, market factors, such as increasing U.S.
                            coffee consumption and the need for more natural rubber for the larger
                            tires being used in U.S. motor vehicles, may be the reason for some of the
                            import surges. Also, chemical imports are causing price pressures on U.S.
                            producers in the United States, but the import increases are partly due to
                            depressed demand within Asia that has led to increased shipments to the
                            United States.

                            Mr. Chairman, this concludes our statement this morning. My colleagues
                            and I would be pleased to answer any questions you or members of the
                            subcommittee may have.

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