Brief History of Fund Conditionality
Scott R. Sidell
This selection was excerpted from Scott Sidell’s book The IMF and Third-World Political Instability: Is There a Connection? published in 1988. Sidell is a financial market analyst in the trading and securities division of a major U.S. bank headquartered in New York City.
In 1944, the IMF was jointly established by forty-four member nations in an effort to promote international monetary stability and to facilitate the expansion and balanced growth of world trade. Article I of the fund’s charter called on the IMF to make financial resources available to members, on a temporary basis and with adequate safeguards, to permit them to correct payments imbalances. In 1952, the principle of conditionality was implicitly incorporated into the fund’s lending policies. Conditionality was conceived to encourage policies that would make it more likely for a member country to be able to cope with its balance of payments problem and to repay the fund within three to five years.
The inception of the practice of conditionality accompanied the birth of the “standby arrangement.” In its infancy, the standby arrangement was intended to be a precautionary device to ensure access on the part of members who had no immediate need for such resources in the near future. The standby arrangement, however, matured quickly into a device for linking economic policies to financial assistance. The standby arrangement can be described as a “line of credit outlining the circumstances under which a member can make drawings on the fund” (Guitian 1981, 14).
On 20 September 1968, the fund decided to incorporate the practice of conditionality explicitly into its charter. Before this date, the concept of conditionality had generally been referred to in a vague manner. The amendments to the fund’s Articles of Agreement in 1968 ended this confusion by introducing, for the first time, clear language that outlined the fund’s position with respect to conditionality.
Until the mid-1970s, the typical conditions placed on the use of fund resources involved policies that influenced the level and composition of aggregate demand. During this period, excess demand was perceived as the most important cause of inflation, currency overvaluation, and ultimately payment difficulties. The expeditious elimination of excess demand was viewed as an essential condition for restoring payments equilibrium. This position has often been referred to as the .
The monetarist approach views excess demand as the root cause of inflation and exchange-rate disequilibrium. Its goal is the rapid alleviation, typically in one year or less, of inflation and the restoration of exchange-rate equilibrium vis-…-vis policies that alter the size and composition of aggregate demand. Monetarist policies generally call for
1. Control of the money supply
2. Reduction of the government deficit
3. Exchange-rate devaluation
4. Deregulation of prices
5. Reduction of consumer subsidies
6. Elimination of tariff and nontariff trade barriers
In the mid-1970s, the monetarist strategy gave way to a more structural, longer-run approach. The introduction of this new approach to payments adjustment was precipitated by the growing recognition, both within and outside the fund, that payment imbalances could no longer be expected to be corrected within one year. In response to this recognition, the fund increased its support for programs that called for adjustment over a longer period. In 1974, the fund established the “extended fund facility,” which was designed to provide members with up to three years of financial support. In addition, the fund decided in 1979 to allow standby arrangements to be extended for up to three years. This development was accompanied by growing support for more comprehensive programs designed to affect the balance of payments through changes in supply as well as in demand. These programs continued to rely on the typical monetarist instruments but in a more gradual manner. In addition, they called for more-structural, supply-oriented policies such as reducing the size of the public sector, channeling resources away from the public sector and into the private sector, creating financial intermediaries, promoting savings, and discouraging wasteful investment by increasing real interest rates. To facilitate the success of these enlarged programs, the fund increased by six times the amount of resources that member countries were allowed to borrow. The “enlarged access policy” of 1981 authorized members to accumulate a maximum of up to 600 percent of their donation (quota) to the fund.