Analysing the Unintended Consequences of Foreign Aid

IMF Loan Amendment: Improve Institutions for Economic Development

Author: Parth Raval

BGIF Intern

Introduction and History

When the government of a country has to borrow from the International Monetary Fund (IMF), it is obliged to adjust its economic policies in line with those suggested by the IMF to overcome the problem that had initially led the country to seek financial aid. The financial crisis could have either arisen from domestic factors (such as poor economic policies and a weak financial system) or external factors (such as a natural disaster or global financial crisis).

These policy adjustments act as IMF conditions to grant the loan and ensure that the receiving country is able to repay the loan to the IMF. The adjustments can interfere with macroeconomic policies like reduced government borrowing, higher interest rates, privatisation, corruption control, bureaucratic changes, and so on. For instance, in the 1990s, one of the conditionalities imposed by the IMF on Kenya was to remove its controls on the flows of capital. The stronger the economic reforms, the greater are the chances for the government to withstand the responsibilities and ownership associated with loans. These conditionalities include macroeconomic structural policies, and specific tools to monitor the goals designed by the country in cooperation with the IMF. They are streamlined and tailored according to the needs of the government, IMF programme characteristics, and initial macroeconomic conditions.

Some of the conditionalities imposed on the government are requirement to have formal approval of budget, consistent with the loan programme’s fiscal framework and minimum net requirement of reserves. Over the last ten years, the IMF’s crisis lending policies have been at the forefront of debates on IMF reform. Critiques have questioned the objectives of IMF crisis lending, while others have been concerned with the “moral hazard” that such lending may generate, as well as the nature and extent of IMF conditionality.

From 1947 until the mid-1950s, IMF allowed member nations to borrow without explicit conditions by members simply presenting a case, and the Fund would let a member draw a loan based on the merits of that case. The Stand-By Arrangement of 1952 provided the countries with a window of time over which they could draw from the Fund without having to make a new request. Successful adjustment in the context of a Fund supported programme meant preventing a crisis and, therefore, averting its unpleasant effects on third parties.

The Status Quo

The objective of conditionalities is to prevent the government from falling into the loop of a debt trap, and in particular, to ensure that it solves its Balance of Payment (BOP) problems. BOP is a statement of all transactions that take place between a country and the rest of the world over a period of time. The conditionality safeguards the further dissemination of loans by the IMF as it guarantees that BOP of these borrowing countries is strong enough to make the repayments possible. The end goal of the loans is to restore the country’s macroeconomic stability and strengthen BOP.

Despite the restrictive conditionalities, borrowing countries willingly accept the loans as it provides a breathing room for the quick rebound in the economy. Since the global economy is now interdependent due to trade and investment, factors like recession and natural disasters do not only destabilise one nation’s economy but also that of several others that are dependent on it. This domino effect comes as a chain in the entire global economy due to the increasing globalization and its consecutive effect on interdependent economies through trade. When the IMF lends along with conditionalities, it safeguards the vulnerable countries from causing further threats to a stable world economy. This means that once the vulnerable countries’ economic imbalance is stabilised through adjustment loans, it eventually prevents the other possible imbalances that could occur in the dependent economies of those vulnerable countries.

IMF as an Economic Catalyst

The donor countries and the IMF Board prefer that IMF-supported programmes be a package of policy measures that are combined with approved financing, and intend to achieve external adjustments and macroeconomic stabilisation. As per IMF statistics, the global debt has risen to a record level of US$ 152 trillion, which is nearly double the global GDP.

The IMF has US$ 215 billion on hand and the remaining US$ 100 billion as gold reserves; this amounts to ten times the money that the poor countries will ever be allowed to borrow. With the Special Drawing Rights (SDR) – supplementary foreign-exchange reserve assets defined and maintained by the IMF – it plans to create another US$ 250 billion reserves.

Backed by such a massive reserve, IMF acts as a strong economic catalyst to uplift struggling economies and claims its conditionalities as a means to correctly stabilise them. Assistance to African countries during the financial crisis of 2008 is a case in point. In response, the IMF made billions of dollars available to countries like Ghana with an extremely low-interest rate. As a result, Ghana’s economic growth rate increased to 9% in 2011, and continues to be Africa’s leading market. An inflation of 20.7% in 2009 declined to 9.38% by 2010. Furthermore, the macroeconomic impact of most programmes appears to have been generally positive, and social spending has usually been largely protected and has, in some cases, increased (Review of Conditionality, 2011).

Behind the Veil of IMF

Since 1986, IMF has gradually emerged as one of the most influential international institutions, with 2,500 staff deliberating on the economic wellbeing of over 1.4 billion people in 75 developing countries. Over the years, however, the IMF conditionality has played a controversial role, resulting in either protest or refusal of assisted programmes in Turkey, Pakistan, Argentina,  Haiti, Jordan, Egypt, Sri Lanka, and Tunisia, among others. In 2016-17 alone, at least 20 of 26 member countries on whom conditionalities was imposed blame the IMF for tax restructuring, subsidies cutbacks, wage reforms, and an increased cost of living. The practice of IMF imposed conditionality on borrower countries undermines sovereignty, democratic decision-making, and ownership over reforms.

The conditionality introduces austerity in the policies of countries, which impacts the eco-political situation by cutting government spending and/or raising tax in order to reduce government budget deficits. The IMF austerity tends to affect the government’s ability to provide public services, their capacity to fulfil their human rights obligations towards citizens, increased unemployment rates, and reduced consumption due to low household disposable income from tax increment, ultimately affecting their citizens’ living standards and the GDP.

In Cameroon, for instance, six of fifteen conditionalities required privatisation in different sectors such as telecommunications, and the postal and airline sectors. However, after price liberalisation and removal of subsidies, the Cameroon’s airline company started backfiring the expectation. The attempt to privatise Cameroon Airlines clearly shows that processes leading up to privatisation are not necessarily respectful of minimum good governance standards, unless regulatory measures intended to ensure transparency are in place. Once again, pressure from the IMF to privatise may not have yielded the expected results.

Furthermore, despite Mexico’s bailout in 1995 by the IMF, its aftermath proved to be devastating for Mexicans. Mexico’s citizens suffered a sharp decline in their standard of living, Mexico added US$ 560 billion to its total external debt, and Mexico’s weak banking sector (a major cause of the crisis), is still in urgent need of restructuring.

Gambling on the Free Market

Larry Elliot has openly stated that the World Bank and IMF won’t admit their policies are the problem. IMF loan programmes have often undermined internal structures, held down wages and led to drastic job cuts in the public sector. The condition to reform a country’s structural adjustment has been controversial as the direct effect is visible in economic setbacks. Not only do the conditions have a huge impact on the economy but also has implications on the democratic institutions and freedoms of that country.

Neoliberalism postulates that only a free market allows efficiency, economic growth, income distribution, and technological progress to occur. It is sceptical of state intervention in the economy. In that given note, when the government tries to rout the civil disorders that arise from structural adjustments in the presence of such conditionalities, the government seizes their democratic rights. Some economists of IMF, too, agree that its austerity policies often do more harm than good due to the ensuing higher state intervention.

Asymmetric Voting rights

A common criticism of the IMF’s internal structure is that it disproportionately serves the Western interest. This is because member countries that are able and willing to invest more money with the IMF get greater voting rights.

For instance, the US has nearly 1⁄5th of all available votes; US$58 billion in contributions has equalled to 16.74 percent of total votes. G7 countries have more than 40 percent voting rights, whereas countries such as India and Russia barely have 2.5 percent voting right each. If reform is to be implemented under the IMF, it accounts for 70% total votes, and not 70 different countries.

Even though the conditionalities are designed and implemented by the IMF, the Board members under this veil call the shots anyway. Since developing countries approach the IMF in dire need, they are left with no choice but to agree to policies prescribed by the IMF, regardless of how these may affect the eventual wellbeing of that country.

Case studies: Inequality through IMF’s Conditionalities

During the Asian financial crisis of 1997, many countries such as Indonesia, Malaysia, and Thailand were required by the IMF to pursue a tight monetary and fiscal policy in order to reduce the budget deficit and strengthen exchange rates. However, these policies caused a minor slowdown to turn into a serious recession with higher unemployment.

In 2001, Argentina was forced into a similar policy of fiscal restraint, which led to a decline in investment in public services which arguably damaged the economy. A similar situation was seen in Kenya in the 1990s, when the IMF intervened in the Central Bank’s workings by removing controls over the flow of capital. This data is proof that IMF conditionalities are contributing to increased poverty and income inequalities, and exposing countries to threats of debt vulnerability. The IMF currently runs debt programmes in 50 countries, each of which face the possibly of experiencing the same fate as those before them.

Sub-Saharan Africa is another case in point. In the 1980s, the developing countries’ debt crisis started when Mexico declared its inability to meet its financial obligations. Since then, the World Bank and IMF started weaving the policies of Structural Adjustment Programs (SAPs) as a mechanism to improve the financial condition of the borrowing countries.

However, such adjustments did not reduce poverty at all; in fact, more conditionality was imposed to cover good governance, transparency, and so on. Contrary to what was expected, Africa’s poverty rose sharply and external debt increased more than 500 percent. A large amount is still invested to cover up that external financial obligation. Basic amenities of health, education, and safe drinking water are not affordable in African countries, since around US$ 229 billion was transferred from there to the western countries under SAPs as debt. Domestic industry was unable to grow and thrive there, as even primary commodities were import-based due to trade liberalisation policies. Currency devaluation is favourable only when the export of a country exceeds its import, but even basic commodities in Africa are imported.

In Mali, the IMF and World Bank enacted structural changes in the privatisation of the cotton sector, despite opposition. Cotton farmers were devastated. A quarter of all IMF structural conditionality still promotes privatisation and liberalisation reforms, which, in some cases, have proven to be damaging, and have often had disastrous consequences for the poor (Shula, 2012).

Possible Solutions

After analysing from both the donor and receiver’s perspective, I believe that the intent of the IMF’s conditionality guidelines is appropriate for the safety measures of giving a loan, but amendments are a must so that conditionalities themselves do not go against the well-being of borrowing countries.

IMF conditionalities can be amended with improved and enhanced risk diagnostics of the programmes, contextual alignment of conditionality with the country’s interests. IMF-supported programmes should consider macro- and micro-level social issues within countries as well. Furthermore, the programme ownership and transparency for the borrower countries should be enhanced.

IMF has been criticised because the results of their policies are often presented in statistics that mean little to people losing their jobs, watching things get more expensive, and only a tiny fraction of the population getting richer. Since there is deviation in the desire of what kind of conditions should be applied in the loan conditionality between the donor and borrower countries, there is a need to revise the policies in order to remove the inequality among the countries through common consensus of all the countries. The common consensus and proper equality measures can either be achieved through collective bargaining of the borrowing countries on voting rights or proper negotiations from each of these member countries before they sign up for loans such that they get to voice conditionalities they approve of without having to fear the power of the IMF.


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