Global Policy Forum

By Hetty Kovach

When it comes to the International Monetary Fund (IMF), most people agree that change is needed. Disagreement arises when discussing the type of change. Some say the IMF has done so much damage and is so discredited that it should be scrapped altogether. Others argue for varying degrees of reform that will move the IMF towards being an organisation that is accountable and democratic. Here, Hetty Kovach from the European Network on Debt and Development discusses what needs to be reformed.

Over the last couple years, many emerging economies have turned their back on the International Monetary Fund (IMF), due to a serious lack of faith in the Fund's policy advice and frustration at their severe under-representation and lack of voice within its structures . In December 2005 for example, both Brazil and Argentina made surprise announcements that they would settle the entirety of their debts to the International Monetary Fund (IMF) ahead of schedule. According to the Argentine Government, this decision was taken explicitly to free Argentina from IMF conditionalities and interference. In South Africa, the Government refused to even start borrowing from the IMF, probably after having looked at the rest of the continent's experiences with the Fund.

One might think that with the announcement last year by the IMF to cancel its portion of debt owed by some HIPCs, many developing countries would also at last have the choice to be IMF-free; unburdened by the load of IMF debt payment. Unfortunately, nothing could be further from the truth. Firstly, last year's debt cancellation deal only covers a handful of developing countries. For example, in Africa only14 countries will benefit this year, with a further 18 still pending. Secondly, as long as nearly all official donors/creditors continue to tie their much-needed aid and bilateral debt relief to the presence of an IMF program (or signal in the case of the new Policy Support Instrument in Nigeria), developing countries will remain in the IMF's grip, pushed to take out new programs and implement new Fund conditions, no matter how politically intrusive or development unfriendly these policies may be.

Civil society organizations both in the South and the North have campaigned for many years for bilateral donors to de-link their funding from the IMF, but progress has been slow. Donors argue that they are dependent on IMF macroeconomic analysis in the absence of another institution with the Fund's economic capacity and reach. A couple of years ago the European Commission made it an official policy to not automatically withhold money from a developing country that goes off-track with the IMF, reserving the right to continue lending if it feels this is appropriate. The UK Government last year also announced a new conditionality policy, which again in theory de-linked funding from the IMF signal. However, in reality, neither of these policies have been put into practice and tested and remain firmly on paper only.

If exit from the IMF is not an option for most developing countries in the foreseeable future, then how can the IMF better meet developing countries needs or at the very minimum do least harm?

There are three key areas which are in urgent need of reform if the Fund is to play a more constructive role in developing countries. Firstly, the IMF must radically reform the conditions it attaches to its lending programs. The Fund needs to provide developing countries with more space to determine their own economic policies. The 2005 G8 Declaration argues that ‘developing countries have the right to decide their own economic policies'). However, current Fund conditions severely restrict the economic policy choices available to developing countries. Specifically, the Fund needs to provide far greater fiscal flexibility, allowing countries to scale-up their spending in order to meet the internationally agreed Millennium Development Goals. The Fund also needs to stop imposing trade liberalization and privatization as a condition of their lending. These are clearly beyond the Fund's mandate, are highly political and have unproven poverty impacts.

Secondly, the Fund needs to realize process matters and radically transform the way it goes about devising and negotiating its lending programs. The Fund should move from imposing a one-size-fits-all approach to macro-economic stability and growth and instead provide developing countries with a set of different policy scenarios, giving countries the final choice. Negotiations should also be far more transparent, participative and subject to democratic oversight.

Thirdly, and finally, the Fund needs to rapidly change its own institutional set up. Not only is it unrepresentative of developing countries, despite these countries comprising of 40% of its members, but it is also inadequately structured and ill-equipped to deal with developing countries needs. The Fund needs to decentralize further and employ more staff with social science backgrounds.

The case for radical reform of IMF conditionality

What is wrong with the type of policy conditions the Fund is imposing on developing countries? International policy makers, civil society organizations (CSOs) and academics from both the North and the South are extremely concerned that the Fund's insistence on setting very low inflation rates and stringent fiscal deficit targets as a means to achieving macroeconomic stability are undermining the ability of countries to grow, hindering their ability to reach the internationally agreed Millennium Development Goals (MDGs) and, in some cases, causing countries to refuse increases of much-needed aid.

No one, least of all civil society, is arguing that macroeconomic stability does not matter, but there is a significant degree of latitude in academic and policy circles as to what levels of inflation, budget deficit and reserves are needed to achieve ‘stability', particularly in relation to achieving growth. Take inflation, for example, the Fund almost consistently imposes inflation targets of 5% or below in developing countries, arguing that any higher than this is harmful to growth. However, a recent United Nations Development Program (UNDP) study argues that inflation rates anywhere between 5 – 10%, if not higher, correlate well with growth, with lower than 5% inflation rates often having a harmful impact (UNDP 2005, Mckinley, T. MDG-Based PRSPs Need More Ambitious Economic Policies. Policy Discussion Paper, United Nations). This is extremely worryingly, as according to a recent study by Oxfam International 16 out of 20 countries they looked at with an IMF program had inflation targets of less than 5% (Oxfam International, "The IMF and the Millennium Goals: Failing to deliver for low income countries" September 2003. Briefing Paper No.54).

On budget deficits, the picture is even worse. The Fund imposes a high degree of fiscal austerity, with their policy conditions targeting deficits of 3% and below. This is something even developed countries find hard to achieve, the United States being a case in point. What is the danger here? Imposing limits on the budget of developing countries is often at odds with the spending these countries desperately need to meet the MDGs.

The most recent example of the negative impact of IMF fiscal austerity can be seen in Mozambique, where an IMF cap on budget spending has resulted in Mozambique effectively turning away donor money in order to stay within the confines of IMF spending limits. In November last year, Mozambique issued its draft PARPA (Plano de Accao para a Reducao da Pobreza Absoluta 2006-9; Mozambique's PRSP) which said aid would increase from $889 million in 2006 to $1,044 million in 2008, but remain constant after that. Donors, however, were upset and said they had stressed to the government that more money was available. But the Ministry of Planning and Development appears to have based its figures on the IMF cap, rather than money actually available. The IMF has put a limit on the government's current spending, committing it to cutting its deficit from 4.5 bn new meticais ($225 million) in 2005 to 3.8 bn new meticais ($190 mn) in 2006. This is, in effect, the amount of budget support the government is allowed to spend, yet budget support is predicted to increase from $274 million to $308 million.

Another clear example of the impact of harmful IMF budget deficit caps is on healthcare in Africa. A World Health Organization study in 2004 showed that overall healthcare to Africa is falling (World Health Organisation (2004) Public Health Spending Per Capita Per Region table cited in ActionAid 2005, Rowden.R ‘Changing Course: Alternative Approaches to Achieve the Millennium Development Goals and Fight HIV/AIDs' p28).

However, according to a recent study by the Joint Learning Initiative on Human Resources for Health and Development, in order to fight HIV/AIDs effectively, countries in Sub-Saharan Africa need to radically expand their healthcare spending, tripling the size of their current workforces ((2005) The Joint-Learning Initiative Strategy Report: Human Resources for Health Overcoming the Crisis, Harvard University Press cited in ActionAid 2005, Rowden.R ‘Changing Course: Alternative Approaches to Achieve the Millennium Development Goals and Fight HIV/AIDs' p28). This type of increase to the wage bill is totally out of the question in many African countries due to expenditure ceilings imposed by the IMF. Zambia is a case in point. In June 2003 Zambia was disqualified from receiving the IMF's Poverty Reduction and Growth Facility (PRGF) due to the Government breaking the Fund's strict budget deficit ceiling, which did not allow the government to go beyond a 3% budget deficit. The budget overrun was largely a result of the Government raising the pay of public sector workers, after union negotiations and a parliamentary decision to give low paid public sector workers a pay increase. The IMF withheld US$175 million in funds, with other donors following suit; the European Commission, for example, froze US$38 million in aid.

The Zambian Government was forced to renege on its wage agreement, undermining its own democratic procedures and in November 2003 it began new negotiations with the IMF, with the condition that it must keep its budget spending in line with their conditions. After a long civil society campaign to raise awareness of the need to employ more teachers by the Global Campaign for Education, the IMF did in the end revise its deficit targets, but this is the exception to the rule.

A recent Oxfam paper looked at the trade-offs countries make in reaching severe deficit reductions of 3% or below in relation to health and education spending. They examined 20 countries and calculated how much money these countries could have channeled into health and education had it not been for the need to meet the IMFs fiscal deficit targets. The result was that current expenditure on health and education could have been doubled and in some cases even tripled.

When the Fund is challenged on the matter of budget deficits, its standard reply is that countries must live within their means. This disregards a well-tested economic policy model which allows for expansionary fiscal and monetary policies to enable growth in productive areas. Historically, periods of rapid economic growth in Continental Europe, the USA and Japan were associated with large programmes of public expenditure and even larger budget deficits. Right now the Fund denies governments the ability to borrow domestically on productive areas.

The bottom line is that the Fund needs to ensure that it is not stopping countries from scaling up their spending on development.

Another area of concern is the structural or more institutional conditions the Fund sets. In particular, imposing privatization and trade liberalization, both of which can have harmful poverty impacts and have little to do with achieving macroeconomic stability.

The UK Government in its new conditionality policy set out last year has acknowledged that privatization and trade liberalization policies have had dubious poverty impacts and should not be set as conditions, unless serious analysis of their poverty impacts has been undertaken beforehand. The Fund argues that it has dramatically reduced the number of structural conditions it sets, but progress has varied across countries according to a Eurodad study, with reductions of 50% in some and virtually none in others (Eurodad (2003) Is the IMF pro-poor? ). Numerous countries are still subject to this type of condition. Cameroon, for example, has a water privatization condition as part of its IMF PRGF. Cameroonese trade unions and NGO partners are preparing a mobilization against this, as happened in Ghana a couple of years ago around World Bank driven water privatization.

Process Matters - Ensuring Better Negotiations

The second major area in need of reform is the way the Fund negotiates its lending programs in LICs. The Fund must stop prescribing a one-size-fits-all approach in this area and move towards a scenario building approach. This would entail taking account of specific country conditions and being explicit about the trade offs of different policy approaches. This is clearly not happening right now. A recent study by AFRODAD of IMF low-income programs in seven African countries, revealed that in all but one country, the IMF had failed to provide different scenarios regarding inflation, deficit and public spending targets (Afrodad (2004) Understanding the PRGF and its implications for Development). A recent IMF review also found "little evidence that the staff advises the authorities on a range of available policy options and implementation plans during the process of program development" (2005b:40). Instead, the review noted that "process of program design… tends to be driven more by an interplay between the staff and the authorities' initial views, with the staff exploring the room to accommodate the authorities' preferences rather than proactively developing policy options"(IMF 2005b:40). The review calls on the staff to be more proactive in this area in the future.

Secondly, the Fund needs to carry out, in a much more systematic way then present, poverty social impact analysis (PSIA) on differing macroeconomic policy choices. The Fund did promise to start undertaking more PSIAs in 1999, but progress to date has been dismal. The unit in the Fund charged with undertaking this analysis, for example, has only four people. This is clearly not good enough. Eurodad analysis has also shown that IMF has undertaken very few PSIAs to date, particularly on fiscal policy issues (Eurodad Hayes L. (2005) Open on Impact).

Finally, the Fund has to do more to ensure that negotiations happen in an open and participative manner, with civil society groups and other government line ministries than the finance ministry present. Importantly, the Fund should do more to ensure that its program documents are subject to parliamentary oversight before being signed. All too often citizens are forced to head to the streets to be heard. Between late 1999 and the end of 2002, the World Development Movement documented 238 separate incidents of civil unrest involving millions of people across 34 countries against IMF and World Bank imposed economic policy conditions (World Development Movement (2005) Denying Democracy).

Governance – Need for an Overhaul

Thirdly, and finally, there are major problems with the IMF's governance. Most commentators point to the lack of representation and voice of low-income countries and middle income countries at the top of the organization. This is undoubtedly true, but little is said about other aspects of organization, like the need to allocate greater administrative funding to work in LICs. Currently 75% of lending programs are in LIC, but these programs only receives 11.5 % of administrative funds. There is also a real need to decentralize the IMF further to give greater decision making power to resident representatives who operate within country. Last, but not least, there needs to be more staff recruited from social and political science backgrounds to ensure a cultural change in the way programs are designed and implemented.

Undertaking these reforms would go someway to making the Fund more development friendly. Given that developing countries cannot vote with their feet and exit the IMF, it is imperative the IMF cleans up its act and does the least harm in the developing world.

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