IMF Conditionality Can Signal Policy Credibility to Markets

• Pages: 81-83

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IMF conditionality-the remedial policy measures that member countries agree to take in conjunction with the use of IMF financing-has evolved over time. The IMF and its full membership have long held an interest in seeing conditionality used to ensure that imbalances are corrected and the IMF's resources recycled. The sentiments of borrowing members have been more mixed and are often shaped by the degree to which they internalize the benefits that conditionality promotes.

Access to international capital markets has placed a whole new emphasis on credible domestic policies and predictable government actions and has brought about a new perspective on IMF conditionality. In Conditionality as an Instrument of Borrower Credibility -a new IMF Paper on Policy Analysis and Assessment-Pierre Dhonte reviews the evolution of conditionality and looks at the implications, for member countries and for the IMF, of this new attention to policy credibility and predictable government actions.

Evolution of Conditionality

The IMF provides financing to give confidence to borrowing members that they can rely on cooperative policies to redress imbalances. In the early days of IMF financing, resources were lent under the umbrella of a widely accepted set of rules. "Transitory balance of payments needs were to be remedied by adjustment," Dhonte notes, "with contingent financing provided as a backup to weather the storm. Appropriate corrective measures were key." Financing reassured the member, while conditionality reassured the IMF that constructive measures would be pursued and its resources repaid.

In the 1970s, after the collapse of the par value system, industrial countries turned to the capital markets for their financing needs.

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Developing countries-many with diverse economic philosophies and development strategies-could also call on abundant bank lending. Market credibility was not yet an issue. Those that turned to the IMF, however, often came to perceive conditionality as being imposed on them.

The debt bubble burst in 1982, effectively changing this dynamic. The IMF's financing came to be seen as catalytic, suggesting that its conditionality gave confidence not only to the IMF but also to other creditors that appropriate corrective steps were being taken. Two developments in the 1990s, Dhonte says, further altered perceptions of the IMF's conditionality:

By endorsing IMF...