International Monetary Fund: Approach Used to Establish and Monitor
Conditions for Financial Assistance (Letter Report, 06/22/99,
GAO/GGD/NSIAD-99-168).
Pursuant to a legislative requirement, GAO reviewed the International
Monetary Fund (IMF), focusing on how the IMF: (1) establishes financial
arrangements with borrower countries and the types of conditions set
under these arrangements and assess how this process was used for six
borrower countries; and (2) monitors countries' performance and assess
how this process was used for the same six borrower countries, detailing
the conditions met and not met, the reasons why conditions were not met,
and the actions the IMF took in response.
GAO noted that: (1) under IMF's Articles of Agreement, as amended, the
IMF limits financial assistance to those countries with a
balance-of-payments need; (2) continued disbursement of assistance to a
country is based on the IMF's consideration of data on and judgment of
the country's progress in meeting the agreed-upon conditions; (3) the
IMF has developed a broad framework for establishing a financial
assistance arrangement that is to be applied on a case-by-case basis
considering each country's circumstances; (4) the specific conditions
that the IMF and the country authorities establish 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; (5) after a country fulfills any early IMF requirements and the
IMF Executive Board then approves the financial arrangement, the program
is to take effect and the country is eligible to receive its first
disbursement of funds; (6) according to information GAO reviewed for the
six countries in its study, the IMF generally followed this process to
establish the financial assistance package and the conditions for the
assistance; (7) the underlying causes and magnitude of the
balance-of-payments difficulty varied among the countries but generally
stemmed from concerns about their continued access to external
financing; (8) the IMF's process for monitoring a country's progress
toward overall program goals and compliance with program conditions is
designed to respond to an individual country's progress and situation;
(9) according to IMF staff, many disbursements are conditioned only on
the determination by IMF staff that the country has met prenegotiated
quantitative criteria; other disbursements are subject to reviews by the
IMF Executive Board; (10) the process for conducting IMF Board reviews,
which involves the borrower country and the IMF, is designed to
incorporate data on a country's economic performance as well as the
judgment of the IMF Executive Board and staff; (11) according to the
information GAO reviewed, the monitoring of the IMF's conditionality
program in the six countries in GAO's study was generally consistent
with this approach; (12) IMF missions to each country reviewed the
country's economy and documented the country's progress in satisfying
conditions; and (13) in some cases, the IMF determined that country
progress in meeting the conditions had not been sufficient, and its
response varied depending on the specifics of the condition and the
judgment of the IMF staff and Executive Board on the country's overall
progress.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: GGD/NSIAD-99-168
TITLE: International Monetary Fund: Approach Used to Establish
and Monitor Conditions for Financial Assistance
DATE: 06/22/99
SUBJECT: Foreign governments
International economic relations
Foreign financial assistance
Balance of payments
International trade regulation
Funds management
International organizations
Economic analysis
Eligibility determinations
IDENTIFIER: Argentina
Brazil
Indonesia
Korea
Russia
Uganda
International Monetary Fund
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INTERNATIONALMONETARY FUND Approach Used toEstablish and Monitor
Conditions forFinancial Assistance
United States General Accounting OfficeGAO Report to Congressional
Committees June 1999
GAO/GGD/NSIAD-99-168
United States General Accounting Office General Government
DivisionWashington, D.C. 20548
Page 1 GAO/GGD/NSIAD-99-168 IMF Financial Assistance June 22, 1999
Congressional Committees: To facilitate congressional oversight of
U.S. policy concerning theInternational Monetary Fund (IMF), the
Omnibus Appropriations Act for 1999 required us to report on the
conditions the IMF establishes with itsborrower countries.
1 IMF member countries may request financial
assistance from the IMF when they face or anticipate balance-of-
paymentsproblems, that is, when they have difficulty obtaining the
financial
resources needed to meet their payments to nonresidents. IMF staff
andthe borrower country agree upon the financial assistance and
policy changes that the country intends to undertake as conditions
for thatassistance. Upon approval from the IMF's Executive Board,
2 the country
gains initial access to the financial assistance.3
The objectives of this report are to (1) describe how the IMF
establishesfinancial arrangements with borrower countries and the
types of conditions set under these arrangements and assess how
this process wasused for six borrower countries; and (2) describe
how the IMF monitors countries' performance and assess how this
process was used for the samesix borrower countries, detailing the
conditions met and not met, the reasons why conditions were not
met, and the actions the IMF took inresponse. We reviewed the most
recent IMF financial arrangements for the following six borrower
countries: Argentina, Brazil, Indonesia, Republic ofKorea
(hereafter referred to as Korea), the Russian Federation (Russia),
1 The Omnibus Appropriations Act for Fiscal Year 1999 (P.L. 105-
277, Oct. 21, 1998) appropriated about
$18 billion for the IMF and required us to report on a seven-point
mandate for reviews of the IMF. Weare addressing this mandate in
three reports-- this report on the terms and conditions of IMF
financial
assistance; one addressing the IMF's financial condition, to be
issued by September 30, 1999; and thethird addressing borrower
countries' trade policies, to be issued in June 1999
(GAO/NSIAD/GGD-99- 174, June 22, 1999). 2 The Executive Board is
the IMF's primary decision-making body. The Board comprises 24
Executive Directors who are appointed or elected by member
countries or by groups of member countries. 3 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 equivalentamount 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
report, we will use the terms"disbursement" and "loan" to refer to
"purchases," and "repayments" to refer to "repurchases." We use
the term "arrangement" to describe the broad concept of IMF's
financial assistance to countries and theassociated conditions
that are intended to address the underlying causes of the
countries' need for financial assistance. We use the term
"program" to describe the conditions, which are the policychanges
or reforms, as outlined in the documents countries prepare in the
context of their IMF financial assistance.
B-281768 Page 2 GAO/GGD/NSIAD-99-168 IMF Financial Assistance and
Uganda. We selected these countries because they are
geographicallydiverse and represent a mix of borrowers that were
having actual or potential balance-of-payments difficulties.
Several of these countries werein the midst of a financial crisis
at the time they requested assistance. Unless otherwise noted,
data in this report are current as of April 30, 1999. The IMF's
process for establishing and monitoring financial arrangementswith
member countries gives it wide latitude in assessing a country's
initial request for assistance, establishing terms and conditions
for thatassistance, and determining the country's continued access
to IMF resources. Under its Articles of Agreement, as amended, the
IMF limitsfinancial assistance to those countries with a balance-
of-payments need. In practice, the IMF has broadly interpreted
this provision to encompass awide array of financial difficulties.
Continued disbursement of assistance to a country is based on the
IMF's consideration of data on and judgmentof the country's
progress in meeting the agreed-upon conditions. The IMF has
continued making disbursements to countries that have not met all
keyconditions when it decided that the country had made sufficient
progress. However, when the IMF determined that a country's
progress in meetingkey conditions was insufficient, disbursements
have been delayed and have not been resumed unless or until, in
the IMF's judgment, satisfactoryprogress has been achieved.
Over time, the IMF has developed a broad framework for
establishing afinancial assistance arrangement that is to be
applied on a case-by-case basis considering each country's
circumstances. This process, based onthe IMF's analysis of country
data and projections of future economic performance, gives the IMF
considerable latitude in establishing thebalance-of-payments need,
the amount and timing of resource disbursements, and the
conditions for disbursements. Under its Articles ofAgreement, as
amended, the IMF provides financial assistance only to those
countries with a balance-of-payments need. These Articles do
notprecisely define "need," and, according to IMF documents, the
IMF's Executive Board has been reluctant to establish guidelines
that would addgreater specificity to the Articles' general
criteria. The broad interpretation of need has enabled it to
consider countries' circumstances and changes inthe international
monetary and financial system, such as the increasing amounts and
variability of capital flows between countries. The
specificconditions that the IMF and the country authorities
establish are intended to address the immediate and underlying
problems that contributed to thecountry's balance-of-payments
difficulty, while ensuring repayment to the IMF. These conditions
can include a variety of changes in a country'sfiscal, monetary,
or structural policies; changes in structural policies may
Results In Brief
B-281768
Page 3 GAO/GGD/NSIAD-99-168 IMF Financial Assistance include
revisions to financial market regulation or tax policies.
Politicalconstraints and economic uncertainty can make these
sensitive, difficult negotiations. After a country fulfills any
early IMF requirements, known as"prior actions," and the IMF
Executive Board then approves the financial arrangement, the
program is to take effect and the country is eligible toreceive
its first disbursement of funds.
According to information we reviewed for the six countries in our
study,the IMF generally followed this process to establish the
financial assistance package and the conditions for the
assistance. The underlyingcauses and magnitude of the balance-of-
payments difficulty varied among the countries but generally
stemmed from concerns about their continuedaccess to external
financing. In some cases, the concerns were embedded within a
larger set of reasons for IMF assistance, including
continuedsupport for the countries' economic reform programs.
Thus, the specific financing arrangement and conditions also
differed, as exemplified by theprograms for Korea and Argentina.
* Korea's program provided substantial funding at the earliest
stage of theprogram to counter an ongoing balance-of-payments
crisis in late 1997
resulting from substantial losses in Korea's foreign currency
reserves andthe depreciation of the won, Korea's currency. The
main goals for the program's monetary policy were to limit the
depreciation of the won andcontain inflation. Structural reforms
were centered in the corporate, financial, and international
sectors as well as in the labor market.
* In contrast, Argentina's 1998 program was designed as a
precaution againsta potential balance-of-payments problem that
could result from external
economic shocks; its program was concerned principally with
maintainingfiscal discipline and enacting labor market and tax
reforms that were intended to maintain investor confidence and
strengthen the economy'scompetitiveness.
The IMF's process for monitoring a country's progress toward
overallprogram goals and compliance with program conditions is
designed to respond to an individual country's progress and
situation. According toIMF staff, many IMF disbursements are
conditioned only on the determination by IMF staff that the
country has met prenegotiatedquantitative criteria; other
disbursements are subject to reviews by the IMF Executive Board.
The process for conducting IMF Board reviews,which involves the
borrower country and the IMF, is designed to incorporate data on a
country's economic performance as well as thejudgment of the IMF
Executive Board and staff. IMF staff reviews a
B-281768 Page 4 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
member's economic performance and implementation of policy
changesthat were negotiated as conditions of the financial
assistance; then the staff formally reports to the IMF Executive
Board at regularly scheduledintervals for each assistance program.
In situations where conditions have not been met, the staff
formally or informally advises the IMF ExecutiveBoard. The staff
may recommend that the Executive Board grant a waiver for the
nonobservance of the unmet conditions. If there is no
waiver,additional financial assistance is not to be made available
to the country. At that time, the program is effectively suspended
until there is anagreement between IMF staff and the country that
is approved by the IMF Executive Board. This agreement may mandate
policy changes before anyfurther assistance is granted and change
the conditions for future assistance. According to the information
we reviewed, the monitoring of the IMF'sconditionality program in
the six countries in our study was generally consistent with this
approach. IMF missions to each country reviewed thecountry's
economy and documented the country's progress in satisfying
conditions. In some cases, the IMF determined the countries had
madesufficient progress in meeting program conditions so that
additional funds could be made available. In other cases, however,
the IMF determined thatcountry progress in meeting the conditions
had not been sufficient, and its response varied depending on the
specifics of the condition and thejudgment of the IMF staff and
Executive Board on the country's overall progress. Some examples
of this flexibility are the following:
* The IMF Executive Board granted Argentina, Uganda, and Russia
waiversfor nonobservance of specific conditions at various points
during their
programs. These waivers were based on the IMF's judgment that
there wassufficient overall progress in implementing the program
and that deviations from meeting required conditions were minor.
Access tofunding was not delayed in these cases.
* The IMF Executive Board delayed disbursements to Brazil,
Indonesia, andRussia at various points during their current
programs. In most of these
cases, waivers were granted for nonobservance of particular
conditions,and/or the country agreed to additional conditions as
part of the IMF's decision to resume disbursements. For Brazil and
Indonesia, the mostrecent delays lasted until the IMF determined
that the country had made sufficient overall progress in meeting
the program requirements; however,in Russia's case, the program
was terminated at Russia's request in March 1999. In April 1999,
IMF staff and Russian authorities announced they hadreached
agreement on an economic program that IMF management hoped
B-281768 Page 5 GAO/GGD/NSIAD-99-168 IMF Financial Assistance to
be able to recommend to the IMF Executive Board in support of a
newarrangement. As of June 16, 1999, the IMF Board had not
approved the new arrangement. The IMF and borrower countries may
also negotiate changes in conditionsto respond to unanticipated
developments. For example, the IMF and Korea revised Korea's
program several times during its first 2 months. TheIMF
acknowledged that the initial program was "overly optimistic" as
economic conditions worsened; Korea continued to have access
tofinancial assistance during these renegotiations.
The International Monetary Fund, established in 1945, is a
cooperative,intergovernmental, monetary and financial institution.
As of April 1999, it had 182 members. The IMF's first purpose is
the promotion ofinternational monetary cooperation. Its Articles
of Agreement (as amended), or charter, also provide that it may
make its resources availableto members experiencing balance-of-
payments problems; this is to be done under "adequate safeguards."
Making resources available to counterbalance-of-payments problems
is intended to shorten the duration and lessen the degree of these
problems and avoid "measures destructive ofnational or
international prosperity."
Member countries govern the IMF through the Executive Board--
theIMF's primary decision-making body.
4 The IMF Executive Board comprises
24 Executive Directors who are appointed or elected by one or more
IMFmember countries. The U.S. Executive Director, for instance,
represents
the United States at the IMF. When a country joins the IMF and
later whenIMF members agree to increase the IMF's capital, the
country pays a quota or a capital subscription to the
organization. The quota serves severalpurposes: (1) the funds paid
to the IMF contribute to the pool of funds that the IMF uses to
lend to members facing financial problems and (2) theamount of
quota paid determines the voting power of the member.
5 The
IMF calculates the quota by assessing each member country's
economicsize and characteristics--economically larger countries
pay relatively
larger quota amounts. The United States pays the largest quota and
thus
4 The IMF's Board of Governors is the top policy-making body of
the IMF and generally meets once a year. The members are usually
ministers of finance, heads of central banks, or officials of
comparablerank. The Executive Board is responsible for conducting
the business of the IMF and exercises the
powers delegated to it by the Board of Governors. 5 The quota has
also, traditionally, been the basis for determining how much the
contributing member can borrow from the IMF under stand-by and
extended arrangements-the more a country contributes,the more that
it can borrow, other things being equal. For example, the
guideline on access limits for
stand-by or extended arrangements is 100 percent of each country's
quota annually or 300 percentcumulatively, but these limits may be
exceeded in "exceptional circumstances."
Background
B-281768
Page 6 GAO/GGD/NSIAD-99-168 IMF Financial Assistance has the
largest single share of voting rights. The IMF also has access
tolines of credit provided by member countries under the General
Arrangements to Borrow and, more recently, under the New
Arrangementsto Borrow.
6
As part of the IMF's mission to promote economic and
financialcooperation among its members, the IMF may provide
financial assistance to countries facing actual or potential
balance-of-payments difficulties thatrequest such assistance.
Balance-of-payments difficulties may have shortterm, as well as
longer-term aspects. The IMF's approach to alleviating acountry's
balance-of-payments difficulties is intended to address both
aspects, as needed. As such, the IMF's approach has two
maincomponents--financing and conditionality--that are intended to
address both the immediate crisis as well as the underlying
factors that contributedto the difficulties. Although financing is
designed to help alleviate the short-term balance-of-payments
crisis by providing a country with neededreserves, it may also
support the longer-term reform efforts by providing needed
funding. Similarly, although conditionality, usually in the form
ofperformance criteria and policy benchmarks, is intended to
primarily address the underlying causes of the balance-of-payments
difficulties overthe medium term, it can also assist in
alleviating the immediate balance-ofpayments problems by, for
example, reducing the country's aggregatedemand, including
imports.
The access to and disbursement of IMF financial assistance is
conditionedupon the adoption and pursuit of economic and
structural policy measures the IMF and recipient countries
negotiate.7 This IMF "conditionality" aimsto alleviate the
underlying economic difficulty that led to the country's balance-
of-payments problem and ensure repayment to the IMF. As thereasons
for and magnitude of countries' balance-of-payments problems have
expanded (due, in part, to the growing importance of
externalfinancing and changes in the international monetary system
since the
6 The General Arrangements to Borrow are long-standing
arrangements under which 11 industrial
countries stand ready to lend to the IMF to finance purchases that
aim at forestalling or coping with asituation that could impair
the international monetary system. Under the New Arrangements to
Borrow, which became effective in November 1998, 25 member
countries or their financial institutionsstand ready to lend to
the IMF under circumstances similar to those covered by the
General Arrangements to Borrow. 7 As described in footnote 3, IMF
financing is not generally in the form of a loan but is rather a
purchase or repurchase of currency. As such, the IMF does not
consider the establishment of aconditionality program to be a
"negotiation." Rather, the member explains the economic reform
program in the documents it prepares in the context of its request
for financial assistance and the IMFExecutive Board decides
whether to support the program. The decision takes the form of the
"arrangement," which notes certain aspects of the member's program
that will be conditions forcontinued IMF financing under the
arrangement.
B-281768 Page 7 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
1970s), conditionality has also expanded. According to IMF
staff,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 andopening the economy to
outside competition--that take longer to implement and are aimed
at increasing the capacity for economic growthbecame an important
part of conditionality. More recently, the financial crises in
Mexico (1994-95) and in Asia and Russia (1997-99) have resultedin
an increased focus on strengthening countries' financial sectors
and the gradual opening of the economy to international capital
flows. The main instruments used by the IMF to provide financial
assistance are
* Stand-by Arrangements (SBA), that provide short-term assistance
forproblems of a temporary nature;
* extended arrangements, under the Extended Fund Facility (EFF),
thatprovide longer-term balance-of-payments assistance for
problems arising
from structural maladjustments; typically, when established, a
programlists the general objectives for the first year; objectives
for subsequent years are spelled out in program reviews;
* a Supplemental Reserve Facility (SRF), provided under an SBA
orextended arrangement, that provides assistance for exceptional
balance
of-payments problems owing to a large and short-term financing
needresulting from a sudden and disruptive loss of market
confidence reflected in pressure on the capital account and
reserves; it is likely to be used whenthe magnitude of capital
outflows may threaten the international monetary system; and
* an Enhanced Structural Adjustment Facility (ESAF), which is the
principalmeans for providing financial support (highly
concessional, or low
interest, loans) to low-income countries facing protracted
balance-of-payments problems.
8
The first three arrangements are funded through the IMF's
generalresources account (GRA). The ESAF is funded through
separate
8 These IMF financing instruments were used for the countries in
our study. The IMF has other
instruments, including the recently approved contingent credit
line, that we do not discuss in thisreport.
B-281768 Page 8 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
resources.9 A country may also draw on its "reserve tranche," that
is, callon funds that initially represented about one-quarter of
its quota.
10 Except
for the highly concessional ESAF loans, the country pays market-
basedinterest rates on money it receives.
11 The SRF is a new facility that charges
a higher amount for its use than other IMF instruments. According
to theIMF, for a member country to use this facility, there should
be a
reasonable expectation that the implementation of strong
adjustmentpolicies and adequate financing will result in the early
correction of its difficulties. IMF financial assistance may be a
part of a larger package of financialassistance committed to
countries in crisis. Brazil, for example, received commitments for
a package that included about $18 billion to be providedby the IMF
and approximately $4.5 billion each from the World Bank and the
Inter-American Development Bank-primarily to provide
improvedsocial safety nets and banking reform. Additional
bilateral sources agreed to provide $14.5 billion in financing,
primarily to guarantee creditsextended to Brazil from the Bank for
International Settlements. The resulting package for Brazil
amounted to more than $41 billion incommitments.
An IMF program can also serve as a catalyst for debt relief from
othercreditors. For example, to qualify for debt relief from the
Paris Club of creditor governments,12 countries must reach
agreement with the IMF on areform program. The Paris Club
conditions its debt relief on countries'
9 Under the IMF's Articles of Agreement, as amended, financing
under the GRA is not in the form of
loans, as noted in footnote 3. Financing from the ESAF is in the
form of loans and is governed by theESAF Trust Instrument adopted
under Article V, Section 2(b). The ESAF Trust's primary source of
financing is lending from contributor countries. 10 A member's
reserve tranche position is equal to the difference between a
member's quota and the IMF's holdings of its currency. This
amount was initially equal to one-quarter of its quota
subscription.The position changes as the IMF uses its holdings of
the member's currency in its financing activities.
A reserve tranche position is part of a member's external
reserves, upon which the member can drawany time without being
required to take specific policy actions.
11 The interest rate charged by the IMF is not necessarily what
the borrowing country would have to pay on the open market.
Rather, it is determined by reference to a combined market
interest rate,which is a weighted average of yields or rates of
short-term instruments in the capital markets of the
members whose currencies comprise the special drawing right (SDR).
The special drawing right is areserve asset created by the IMF and
a unit of account that the IMF uses to denominate all its
transactions. Its value comprises a weighted average of the values
of the euro (representing thecurrencies of France and Germany),
Japanese yen, pound sterling, and U.S. dollar. The rate of charge
is set in relation to the IMF's cost of financing and includes an
amount to cover the IMF's administrativeexpenses, the financial
consequences of charges that members have not yet paid, and an
addition to the IMF's precautionary balances. 12 The Paris Club is
an informal group of creditor countries that meets, on an as-
needed basis, to negotiate debt relief efforts on official debt.
B-281768 Page 9 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
implementation of economic and structural reforms under IMF-
supportedfinancing programs. Part of the motivation for Russia's
IMF arrangement in 1996 was to facilitate its debt rescheduling
from the Paris Club. The IMF's general framework for establishing
a financial assistancearrangement is intended to be applied on a
case-by-case basis that considers each country's individual
circumstances. This process gives theIMF considerable latitude in
establishing the balance-of-payments need, the amount and timing
of resource disbursements, and the conditions fordisbursements.
Under its Articles of Agreement, as amended, the IMF limits
financial assistance to those countries with a balance-of-
paymentsneed. However, the Articles do not precisely define
"need," and, according to IMF documents, the IMF's Executive Board
has been reluctant toestablish guidelines that would add greater
specificity to the charter's general criteria. The specific
conditions that the IMF and the countryauthorities negotiate are
intended to address the underlying problems that contributed to
the country's balance-of-payments difficulty, while
ensuringrepayment to the IMF. These conditions include a variety
of changes in a country's fiscal, monetary, or structural
policies. After the countrycompletes any "prior actions"
13 and the IMF Executive Board approves the
financial arrangement, the program is to take effect and the
country iseligible to receive its first disbursement of funds. We
found that the IMF
generally followed this process for the six countries we reviewed.
The formal process the IMF generally uses to establish countries'
financialarrangements is outlined in figure 1. IMF staff, the IMF
Executive Board members, and country authorities may also consult
informally at any stagethroughout this process.
13 Prior actions--policy measures that the IMF views as key to the
effectiveness of a country's
program--may have to be implemented before the IMF Board approves
an IMF arrangement ordisbursement. Such actions are particularly
important if severe imbalances exist or in cases where the
record of policy implementation has been weak.
The IMF's Process forEstablishing Programs Incorporates Country-
specific Data and Analysis as Well as IMFJudgment
The IMF's Process forEstablishing Financial Arrangements With
MemberCountries
B-281768
Page 10 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Note: This
figure summarizes the process the IMF generally uses to establish
financial arrangementswith member countries. In the case of
monitoring, this flowchart focuses on disbursements that require
review by the IMF Executive Board. Countries may receive IMF
funding disbursementswithout IMF Executive Board action, if they
meet quarterly performance criteria in between scheduled IMF
Executive Board reviews.
Source: GAO analysis of IMF documents.
Figure 1: The Formal Process Generally Used to Establish and
Monitor an IMF Financial Arrangement
B-281768
Page 11 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
Establishment of an IMF financial arrangement begins with
discussionsbetween IMF staff and country officials and continues
through the IMF
B-281768 Page 12 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
Executive Board's approval of the arrangement. If a member
countrydetermines that it is experiencing or could experience a
balance-ofpayments problem, it can initiate discussions with IMF
staff that may leadit to request IMF financial assistance. These
discussions can occur at any time, including during the country's
annual consultation with the IMF orthrough informal consultations
requested by the member. At these consultations, IMF staff and
country authorities discuss economic dataand policies as well as
the
* nature of the country's balance-of-payments difficulty,
* amount of financing expected to be provided by various sources
and theamount that may be requested from the IMF,
* instruments under which the IMF resources could be provided,
* potential schedule for reviewing countries' performance and
disbursingfunds, and
* likely conditions for assessing countries' performance under
the program.
IMF staff noted that key tasks during country missions to conduct
thenegotiations are (1) the collection of extensive data
describing the country's economic conditions and (2) an analysis
of those data torecommend the amount and timing of the IMF
financial assistance and conditionality. The IMF's review of a
country's economy is an iterativeprocess that is often based on
country-provided data, projections of key macroeconomic variables,
and judgment by the IMF staff and countryofficials.
The design of an IMF program is complicated, and negotiations
betweenIMF staff and country authorities can be difficult for
several reasons. First, the countries are facing an adverse or
uncertain economic situation.Second, the negotiators may disagree
on the type, pace, or feasibility of the reforms needed to help
overcome the difficulty. In some cases, neededreforms reflect
long-standing problems and are difficult to undertake due to
political constraints. For example, reforms may entail changes to
laborpractices opposed by unions or removal of tax preferences
benefiting certain sectors. Third, conditionality and financing
are based, in part, onprojections of key variables such as
estimated growth rates and access to external financing. Fourth,
in some cases, the country may lack reliabledata for analyzing the
current situation or making projections.
B-281768
Page 13 GAO/GGD/NSIAD-99-168 IMF Financial Assistance IMF staff
and country authorities may or may not reach agreement on apackage
of financing and conditionality. If they do not reach agreement,
then the member may seek other means for addressing its
difficulty. If theyreach agreement, the arrangement is presented
to the IMF Executive Board for approval. IMF staff generally
brings to the IMF Board onlyarrangements it believes the IMF Board
will accept. After the country satisfies any required "prior
actions" and the IMF Executive Boardapproves the arrangement, the
arrangement will take effect and the country can get funds from
the IMF. Under the IMF's Articles of Agreement, as amended, the
IMF considers anyof the following three elements to be a basis for
providing financial assistance14 from the GRA:
* the country's balance of payments,
* the country's reserve position, and
* developments in its reserves.
However, the Articles do not precisely define the elements or
providecriteria for assessing need. While the IMF Executive Board
has not established guidelines that would add greater specificity
to the Articles'general criteria, over time the IMF has developed
a broad framework that serves as a basis for analyzing a country's
economy and forming judgmentsregarding the existence and magnitude
of balance-of-payments deficits and the adequacy of international
reserves. The first element--the country's balance of payments--
represents theeconomy's external financing requirement and equals
the sum of a member's current and capital account balances. The
current accountprimarily includes exports and imports in goods and
services; transfers; and income payments, such as interest
payments. The capital accountprovides summary data on the changes
in the net foreign assets of domestic residents arising from
transactions such as external borrowing orrepayments, foreign
direct investment, portfolio investment (equity and
14 For a country to access funds through the GRA, its balance-of-
payments need can be ongoing at the
time IMF financial assistance is sought, or a precautionary
program can be negotiated prior to theactual emergence of a
balance-of-payments need. A country does not have to demonstrate a
balance-of
payments need at the time it requests an IMF arrangement, but it
is expected to demonstrate needbefore receiving a financial
disbursement.
The IMF Has a BroadFramework for Assessing Countries' Balance
ofPayments
B-281768
Page 14 GAO/GGD/NSIAD-99-168 IMF Financial Assistance bonds), and
short-term capital movements.15 The second element--thecountry's
reserve position--refers to the amount of resources (hard
currency, reserve position in the IMF, special drawing rights, and
monetarygold) that can be used to pay for imports and make
payments on external debt. IMF documents indicate that the third
element--developments in thereserve position--has a very narrow
application. This element is intended to ensure that members of
the IMF whose currency is a reserve currency(such as the United
States) would be able to use IMF resources when requested, despite
the absence of a need as outlined in the first twoelements.
16
The IMF's framework has enabled it to consider countries'
individualcircumstances and changes in the international monetary
system. These include increased capital flows between countries
and changes in thecomposition and source of those flows as well as
the shift in the primary recipients of IMF financial assistance
from industrialized countries todeveloping countries.
17 Given such considerations, decisions about a
country's need for IMF resources have become more difficult.
Accordingto IMF documents, determining need based solely on the
overall balance
of-payments position is relatively clear-cut because the balance
is either insurplus or deficit. Assessing need based on whether a
country's foreign reserves are sufficient requires a greater
degree of judgment because noprecise criteria define the
appropriate level of reserves. In determining the sufficiency of a
country's reserves, the IMF can adjust the definition
of"sufficient" reserves to account for such country-specific
factors as the volume and variability of exports and imports, the
size and variability ofcapital flows, the amount of short-term
liabilities, and the nature of the country's exchange rate
regime.18 Significant declines in the foreign reserve
15 In the IMF's monthly publication International Financial
Statistics, changes in a country's reserves
are not included in the capital account. 16 This element is
designed to cover situations in which a country may not have a
balance-of-payments deficit or a weak reserve position but may
still have a need because of a development in its reserves.For
example, the IMF Board was concerned that the first two concepts
would preclude members of the
European Economic Community (the predecessor to the European
Union) from requesting IMFassistance in discharging obligations
among each other. By virtue of their currency being a reserve
asset, the use of their currency in foreign transactions would not
result in a balance-of-payments deficitor weak reserve position by
such countries, although difficulties in the external environment
may still require some support. 17 As late as 1977, developed
countries accounted for about 50 percent of credit outstanding
from the GRA. Since 1988, developed countries have had no
outstanding credit from the GRA. 18 In principle, a country with a
fixed exchange rate could be expected to need a higher level of
reserves to assist in defending the rate than a country that
allowed its currency to float. However, in practice,such
distinctions are difficult to make. Most IMF members have adopted
some type of floating
exchange rate regime, with the degree to which the currency is
allowed to float depending on domestic
B-281768 Page 15 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
position may be of concern if they indicate that a country may
havedifficulty financing its imports or repaying its external debt
in the future. IMF documents indicate that the Executive Board has
been reluctant toestablish guidelines that would add greater
specificity to the general criteria for balance-of-payments need
set forth in the Articles ofAgreement, as amended. Members of the
IMF Board have been concerned that "codification" of the concept
of need would create unnecessaryinflexibility. For this reason,
they urged that the concept of need should continue to be applied
on a case-by-case basis. As a result, application ofthis concept
involves considerable data analysis as well as judgment.
The IMF uses somewhat different criteria for low-income
countriesrequesting resources under the ESAF. In contrast to the
criteria for demonstrating a need for GRA resources, when
assessing whether amember that meets income and other criteria for
ESAF eligibility has a protracted balance-of-payments problem,
emphasis is to be placed on thecomponents of its balance of
payments rather than solely on its overall balance-of-payments
position. According to IMF staff, the underlyingbalance-of-
payments problems of many low-income countries did not necessarily
result in conditions similar to those reflecting the GRA
criteria;that is, an actual balance-of-payments deficit or low
reserves. For this reason, emphasis would have to be placed on
those indicators that wouldnormally evidence "poor external
performance." Such indicators include a deterioration in the terms
of trade and diminished access to capitalmarkets. Moreover,
protracted balance-of-payments problems would often be reflected
by exchange rate restrictions, payments arrears, or prolongeduse
of IMF resources.
19 As with the GRA criteria, the IMF Executive Board
agreed to continue to use flexibility in applying the ESAF
criteria. SomeBoard members have expressed the opinion that a low-
income country, by
definition, has a protracted balance-of-payments problem. Once a
balance-of-payments need is established under the GRA or ESAF,the
country may be eligible to receive IMF financing. IMF staff and
country authorities will estimate the total amount of financing
the country requiresas well as the amounts that may be provided by
the IMF and other sources. The IMF's share is based on several
factors, including the member's
and external developments. For example, owing to a rundown in its
reserves, a country may allow itscurrency to float more freely
until adjustment policies take effect and reserves are rebuilt.
19 In addition, for an ESAF arrangement to be approved, a country
generally must have a protracted balance-of-payments problem.
However, the country is not required to have a present need when
itactually requests a disbursement.
B-281768 Page 16 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
resource needs, IMF quota, outstanding IMF resources, and
previousperformance in using IMF financing; the strength of its
adjustment program; and its capacity to repay the IMF. While the
IMF has discretion indeciding the total amount of resources it
will provide to a country, disbursements are to be limited to the
amount needed by the country. Ifthe IMF later discovers that a
country drew IMF funds without a need for those funds (that is,
the information on which the financing need wasdetermined was
later found to be incorrect), it can undertake remedial action.
The IMF Executive Board encourages countries to request its
assistanceearly and to undertake corrective actions early in order
to minimize the potential costs and disruption of correcting the
underlying causes of abalance-of-payments problem. However, a
number of factors--including the belief that the problem is
temporary or can be solved without officialassistance, or the
concern that political and social problems may arise from needed
structural changes--can cause some countries to hesitate inasking
for IMF assistance. For example, Korea did not draw on IMF
resources until its reserves had fallen substantially. Once the
IMF staff has determined the balance-of-payments needs of amember
and its eligibility to draw resources, the IMF must be satisfied
that the member can meet its repayment obligations to the IMF and
that thepolicy measures agreed to are sufficient to overcome the
member's balance-of-payments problem. The IMF does this, in part,
throughconditionality. Fundamental weaknesses in the underlying
economy, such as a large budget deficit and/or high inflation, or
in the structure of thefinancial or corporate sectors, may
contribute to the balance-of-payments problem of a country.
Conditionality may vary with each country'sindividual program as
it seeks to address these weaknesses. As such, according to the
IMF, there is no "rigid and inflexible" set of operationalrules in
the establishment of a country's conditionality program. The
process is one of negotiation between the country authorities and
the IMFto reach agreement on a number of issues, ranging from
economic assumptions to the speed and magnitude of structural
reforms. The IMF arrangement often occurs within the context of
the country'slarger reform efforts. As a result, not all of a
country's policies or reform efforts may be included as conditions
of the IMF arrangement. Forexample, some structural reforms and
trade liberalization measures may be mentioned in the arrangement
reached between the IMF and thecountry authorities, but only the
actions the IMF judges to be particularly important for achieving
program objectives will become performance
IMF Conditionality Focuseson Fiscal, Monetary, and Structural
Reforms
B-281768
Page 17 GAO/GGD/NSIAD-99-168 IMF Financial Assistance criteria and
benchmarks within the arrangement. IMF officials noted
thatachieving performance criteria is not the ultimate goal of
conditionality; rather, the performance criteria are selected as
clearly observable andmeasurable indicators that a country is
making progress toward the overall program goals, such as
strengthening the balance of payments andreducing inflation. The
IMF uses two types of performance criteria that generally must be
met for members to qualify for disbursements. The firstare
quantitative performance criteria, or macroeconomic indicators,
such as monetary and budgetary targets. The second are structural
performancecriteria, or quantifiable/observable actions that
demonstrate progress toward the borrower country's structural
reform goals. Benchmarks arepoints of reference against which
progress may be monitored but disbursements are generally not
dependent on meeting them. Benchmarksare not necessarily
quantitative and frequently relate to structural variables and
policies, such as tax reform and privatizing state-owned
enterprises. IMF conditionality tends to focus on three areas:
fiscal, monetary, andstructural. These three areas are designed to
support a general framework that aims to strengthen the balance-
of-payments position, achieve market-based growth, and decrease
the role of the government in a country's economy. Borrower
country IMF arrangements generally consist of acombination of
efforts in these three areas, which depend on the country's
particular circumstances. According to the IMF, poor fiscal
management in a member's economygenerally has been a major factor
underlying such problems as high inflation, large current account
deficits, and sluggish growth. Large andpersistent budget deficits
may tend to overheat the economy, contributing to high inflation
(especially when financed by the printing of money),excess
imports, and low domestic savings. IMF staff and the member
country negotiate ways to address this fiscal deficit, including
institutingreductions in government spending and increases in tax
revenues. Numerical targets for the fiscal level consistent with
these reforms areoften part of a country's quantitative
performance criteria.
Similarly, IMF staff and the member country will negotiate
monetarypolicy changes as part of the conditionality package. The
underlying goals of these conditions are typically strengthening
the balance-of-paymentsposition, safeguarding or rebuilding
international reserves, restoring market confidence, reducing
sizeable exchange rate changes, restraininggrowth in domestic
credit, and/or reducing inflation. For example, limits may be
imposed on the increase in short-term debt owed or guaranteed
bythe government; this may be done in an effort to restrict the
ability of a
B-281768 Page 18 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
government to use short-term external financing to meet reserve
targets orfinance fiscal deficits. Another performance criterion
that is frequently used is a limit on the net domestic assets of
the central bank. By limitingthe resources made available by the
central bank to the economy, the growth of the money supply is
slowed and inflation is lessened. Frequently,the country and the
IMF reach agreement on the minimum level of foreign reserves that
the country may hold; such a requirement reduces thecountry's
ability to manage its exchange rate through interventions in the
foreign currency market. The performance criterion on
internationalreserves is a key indicator of progress toward
external viability.
According to IMF staff, the presence of pervasive structural
problems in amember's economy and the need to ensure the
sustainability of a country's reform effort require that
structural policy changes be included within theoverall
conditionality negotiated. These structural problems encompass a
broad array of issues, including inefficient state enterprises,
traderestrictions, and lack of transparency in the financial and
corporate sectors. Reforms in these areas are included as part of
a country'sstructural benchmarks, which the country is strongly
encouraged to satisfy, although the benchmarks do not have the
same significance as theperformance criteria. However, in certain
instances, structural changes may be established in a precise
quantitative manner and made part of acountry's structural
performance criteria.
Once the financial arrangement has been negotiated, it is
presented to theIMF Executive Board for approval. The IMF Board
generally accepts the recommendations of the staff, largely
because the staff brings to the IMFBoard only proposals that the
staff believes the Board will accept. The decision to approve an
arrangement depends on a judgment by the IMFstaff, management, and
Executive Board that the program is sufficient to overcome the
country's balance-of-payments difficulty and the country willbe
able to repay the IMF. After the country completes any prior
actions and the IMF Executive Board then approves the arrangement,
thearrangement will take effect and the country becomes eligible
for its first disbursement of IMF funds. The country is then
expected to implement thepolicy measures agreed to under the
arrangement.
(See app. I for more information on the IMF's process for
establishingfinancial arrangements.)
B-281768
Page 19 GAO/GGD/NSIAD-99-168 IMF Financial Assistance According to
the IMF documents we reviewed, the IMF generally followedthe
process described previously in establishing the financial
assistance arrangements with each of the six countries that we
reviewed. In eachcase, the balance-of-payments problem was
described and the conditionality program was intended to address
the underlying problemsof the individual countries as defined by
IMF staff and country authorities. Our analysis showed that, to
varying degrees, the balance-of-paymentsproblems of the six
countries we studied stemmed from concerns regarding the access of
the countries' public and private sectors toexternal financing. In
addition, the reform programs of each country generally addressed
the areas of concern identified by country and IMFofficials as
contributing to the balance-of-payments problems. Moreover, the
type of financial arrangement each country received, the time
period ofthe arrangement, and the total amount of financing the
IMF agreed to provide were based on the IMF's analysis of the
needs and circumstancesof the individual countries. In determining
the potential amount of IMF assistance, the IMF also considered
the country's outstanding IMFresources in relation to its quota.
Table 1 outlines the current IMF financial arrangements for the
six borrower countries.
The IMF GenerallyFollowed its Process in Establishing the
SixArrangements
B-281768
Page 20 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Country Type
of arrangement Date of arrangement Expiration ofarrangement Total
amount agreed($ in millions)a
Total amountdisbursed (as of April 30, 1999)($ in millions)
Argentina EFF Feb. 4, 1998 Feb. 3, 2001 $ 2,822 0 Brazil SBA/SRF
Dec. 2, 1998 Dec. 1, 2001 17,668 $ 9,570 Indonesiab SBA/EFF Nov.
5, 1997 Nov. 5, 2000 12,267 9,215Korea SBA/SRF Dec. 4, 1997 Dec.
3, 2000 21,026 19,305
Russiac EFF/SRF Mar. 26, 1996 Mar. 25, 1999 17,915 10,486 Uganda
ESAF Nov. 10, 1997 Nov. 9, 2000 136 76
a The amounts were initially calculated in SDRs. Because the value
of the SDR relative to the U.S.
dollar changes daily, the dollar value of amounts converted from
SDRs also changes daily. For thistable, we used the 1998 average
SDR conversion rate of $1.3565.
b The information presented includes the 3-year SBA agreed to in
November 1997 and the EFF agreed to in August 1998. The SBA was
terminated and replaced with the EFF. c Russia terminated this
arrangement with the IMF in March 1999. In April 1999, IMF staff
and
Russian authorities announced they had reached agreement on an
economic program that IMFmanagement hoped to be able to recommend
to the IMF Executive Board in support of a new
arrangement. As of June 16, 1999, the IMF Board had not approved
the new arrangement. The totalamounts listed include funding under
the Compensatory and Contingency Financing Facility (about $2.8
billion) and increased EFF funding (through the SRF) agreed to by
Russia and the IMF in July1998.
Source: IMF documents.
(These arrangements are described in greater detail for each
country inapps. II to VII.)
Table 1: Current Financial Arrangements Agreed to by the IMF and
Six Borrower Countries
B-281768
Page 21 GAO/GGD/NSIAD-99-168 IMF Financial Assistance According to
our analysis, the balance-of-payments problems of the sixcountries
we studied were due to concerns about the countries' continued
ability to obtain external financing. In the cases of Korea,
Indonesia, andBrazil, concerns over severely diminished reserves
and continued access to external financing were clearly identified
as important factors in theinitial set of documents that
recommended the establishment of an IMF financial arrangement in
these countries. In the cases of Argentina, Russia,and Uganda,
concerns over continued access to external financing were not as
clearly defined but were embedded within a larger set of reasons
forIMF assistance, including continued support for the countries'
economic reform programs. Nonetheless, the information provided by
IMF staff andcountry authorities was sufficient to determine that
a potential balance-ofpayments problem existed in each of these
three countries. Our analysis also indicated that the individual
IMF programs were gearedtoward the specific IMF assessment of the
needs of the six countries, as shown in table 2.
B-281768
Page 22 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Country
Reasons IMF assistance requested Balance-of-payments problem
Underlying causes of the problemArgentina - Precautionary program
to support
reforms and maintain marketconfidence - Widening current account
deficit andits potential financing - Strong import demand coupled
withrecent weaknesses in the export sector- Uncertain investor
confidence given
international environmentBrazil - Loss of foreign investor
confidence - Protect the exchange rate regime - Declines in
current account- Foreign reserves declined sharply - Large and
growing governmentbudget deficits- Substantial short-term private
sector
debt in need of refinancing Indonesia - Sudden currency
depreciation- Loss of financial market confidence - Substantial
fall in the capital accountresulting in a sharp decline in
reserves - Weaknesses in financial sector- Structural impediments
in economy,
such as import monopolies- Substantial short-term private sector
debt in need of refinancingKorea - Usable foreign reserves
declined sharply- Sharp currency depreciation - Substantial short-
term private sectordebt - External financial
conditionsdeteriorated
- Capital flight- Sharp drop in reserves - Weaknesses in corporate
andfinancial sectors
- Market confidence turnedoverwhelmingly negative - Foreign
exchange reserves declinedas central bank provided support to
prevent domestic banks from defaultingon foreign debt Russia -
Federal budget deficit- Inflation
- Need to transition to amarket-based economy and to build
required institutions and legalframework - Need for comprehensive
debtrestructuring
- Current account is expected toweaken over next several years -
Need to achieve medium-termbalance-of-payments viability -
Stabilize ruble exchange rate
- Inability to collect tax revenues- Excessive government spending
- Culture of nonpayment of taxes- Weak banking system - Lack of an
institutional and legalframework to support market economy -
Bunching of debt obligationsanticipated - Inadequate level of
reserves- Net capital outflows Uganda - Maintain macroeconomic
stability- Support structural and institutional
reforms- Support economic liberalization
- Projected current account deficits- Uncertain financing from
official creditors
- Fragile external position- Vulnerability to external shocks -
Uncertainty over revenue measures- Substantial expenditure
pressures - Deterioration in terms of trade
Table 2: Basis for and Key Initial Conditions in Current IMF
Financial Arrangements With Six Countries
B-281768
Page 23 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Country
Overall key goals Fiscal performancecriteria Monetary
performancecriteria Key structural reformsArgentina - Maintain
investor confidence
- Complete structural reforms- Promote sustained growth in
production and employment- Reduce the vulnerability of the economy
- Limit governmentdeficit, debt, and expenditures
- Decrease net domesticassets of central bank Benchmarks:- Tax
reform
- Labor market reforms- Privatization - Government administration
Brazil - Quickly arrest the rapid growth ofpublic sector debt
- Maintain existing exchange rateregime - Safeguard international
reserves
- Limit public sectordebt - Limit net domesticassets of central
bank Benchmarks:- Pension and tax reforms
- Improvements in the budgetaryprocess - Administrative reform-
Reduction in the number of stateowned banksIndonesia - Restore
market confidence - Reverse decline in externalfinancing - Correct
underlying weaknessesin the financial sector and remove structural
impedimentsin the economy
- Limit short-termgovernment borrowing and newpublicly guaranteed
debt- Limit on overall Central Bankbalance
- Limit net domesticassets of central bank and stock of basemoney
- Set minimum level ofnet international reserves
Performance criteria:- Financial sector restructuring - Trade
liberalization and domesticderegulation - PrivatizationBenchmarks:
- Corporate, financial, regulatory,and government reforms Korea -
Restore investor confidence- Build international reserves
- Set the stage for resuming andsustaining growth - Contain
inflation
None - Limit net domesticassets of central bank
- Set minimum level ofnet international reserves - Set minimum
chargeon foreign exchange given to Koreancommercial banks or their
overseas branches
Benchmarks:- Financial sector restructuring - Corporate governance
reform- Capital account liberalization - Increased transparency
Russia - Achieve financial stabilizationwhile transitioning to a
market
based economy- Lay basis for sustained growth
- Limit governmentbudget deficit - Increasegovernment cash
revenues
- Limit net domesticassets of monetary authority- Set minimum
level of net internationalreserves of monetary authority- Limit
credit to the government
Benchmarks:- Tax administration - Banking system- Privatization -
Natural monopolies- Social safety net - Budget system and process
Uganda - Promote broad-based economicgrowth
- Liberalize and diversify economy- Promote good governance -
Promote structural reforms
- Limit claims of thebanking system on the government- Limit
short-term government debt andnonconcessional government debt- Set
minimum spending on socialareas
- Limit net domesticassets of banking system and short-termdebt of
the central bank - Set minimum level ofnet international reserves
Prior action:- Remove 3 import bans Performance criterion:-
Increase taxpayer audits Benchmarks:- Privatization of public
sector enterprises- Bank inspections - Government restructuring-
Taxpayer audits Source: GAO analysis of IMF and borrower country
documents outlining initial arrangements.
B-281768 Page 24 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The
purpose of the programs was to address the immediate or
potentialbalance-of-payments problem of each country as well as
the underlying factors that IMF staff and country officials
identified as contributing tothat problem. The fiscal, monetary,
and structural objectives of all six countries' arrangements had
the goal of helping to improve the medium-term economic growth
and/or bolster investor confidence in order to continue to finance
or reduce the balance-of-payments deficit or to buildreserves.
However, within the context of these general goals, the magnitudes
and definitions of the performance criteria and the specifics
ofstructural reforms differed across the countries.
The financing of each package addressed the balance-of-
paymentsproblem of each country. In the cases of the three
countries with significant losses in their reserves (Brazil,
Indonesia, and Korea), theamount of the IMF financing was
substantial and frontloaded, meaning that the countries were to
receive much of the funding early, with theintent of providing a
signal to market participants that the commitment to these
countries was strong. In the three remaining countries,
IMFfinancing was designed to be more evenly distributed throughout
the duration of the program. The financing for Russia and Uganda
was to beprovided in relatively equal installments over the life
of the program to assist in addressing the reforms agreed to under
the program. Argentina'sfinancing was viewed as a precautionary
line of credit, available only if necessary. Korea and Argentina
exemplify the differences that can exist betweencountries'
financial arrangements with the IMF. The IMF's approach to the
financial crisis in Korea was intended to address the country's
immediateneed for financing as well as the underlying causes
identified by IMF staff and country authorities as contributing to
the balance-of-paymentsdifficulties. The IMF arrangement in Korea
was heavily frontloaded, with the country receiving much of the
agreed-to financing at the beginning ofthe arrangement, in order
to address the country's immediate need to replenish depleted
reserves. The country faced balance-of-paymentsproblems primarily
due to significant capital outflows. Korean banks had a large
amount of foreign debt, composed substantially of short-
termexternal loans that needed frequent refinancing. As market
confidence fell, the willingness of external creditors to roll
over (that is, refinance) thedebt declined rapidly. The attempt by
the government to support the former exchange rate rapidly
depleted the foreign reserves by providingcreditors with the hard
currency that they ultimately withdrew as shortterm debt matured.
As reserves reached precariously low levels, Korea
B-281768 Page 25 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
abandoned its attempt to support the exchange rate, moved to a
flexiblerate, and sought IMF support. The conditions outlined in
the IMF arrangement were intended to addressimmediate concerns as
well as the underlying causes of the balance-ofpayments
difficulties as determined by IMF staff and Korean authorities.The
immediate causes were a loss of market confidence, depleted
foreign reserves, and a rapidly depreciating currency. The
arrangement'simmediate goal was to restore calm in the markets and
contain the inflationary impact of the currency's depreciation by
providing substantialfinancing and requiring a tightening of
monetary policy. In terms of longerterm changes, IMF staff and
Korean authorities identified weaknesses inthe corporate and
financial sectors as underlying causes for the difficulties.
Specifically, increases in corporate bankruptcies (caused bylarge
debt burdens and excess capacity) and nonperforming (unpaid) loans
exacerbated weaknesses in the banking system. Weaknesses in
thebanking systems included a focus on maximizing revenues (not
profits) and limited experience in managing risk, combined with
lax prudentialsupervision. As a result, under Korea's IMF
arrangement, compared to other countries' arrangements, greater
emphasis was placed on structuralreforms--particularly corporate
and financial restructuring.
Unlike Korea's IMF arrangement, Argentina's arrangement addresses
apotential, rather than existing, balance-of-payments problem.
Although Argentina enjoyed good access to capital markets and
employed a strategyto lengthen the maturity of its debt and borrow
when interest rates were low, it faced an uncertain future due to
deteriorating conditions in theinternational financial environment
and the effect this likely would have on its future access to
capital markets. To address this potential problem,Argentina and
the IMF reached agreement on a precautionary program, with
Argentina agreeing to access IMF resources only if
externalconditions made it necessary.
20
The government and the IMF identified fiscal discipline and
structuralreforms (particularly in tax systems and labor markets)
as two of the most crucial elements of Argentina's program. In
Argentina, the goal ofmaintaining fiscal discipline is to reduce
the federal government deficit, stimulate domestic saving, and
strengthen confidence in the continuedviability of the
convertibility regime, under which Argentine pesos are exchanged
at a 1-to-1 rate with U.S. dollars. Reducing the amount of
thegovernment's deficit lowers the amount of funds the government
needs to
20 As of May 31, 1999, Argentina had not drawn funds under the
current arrangement.
B-281768 Page 26 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
borrow from domestic and external creditors, therefore freeing
upresources for other uses and decreasing the government's
dependence on external borrowing. Argentina's government is
limited in its ability to printmoney (pesos) to finance its
deficit because under its currency board arrangement, the
government has agreed to exchange each Argentine pesocirculating
in the economy with a U.S. dollar if requested.
21 Consistent with
this, the quantitative performance criteria agreed to under the
IMFarrangement emphasize fiscal issues and are intended to limit
the federal
government's budget deficit and government debt levels. Monetary
issuesare not emphasized as strongly due to the government's
limited power to affect the money supply and interest rates.
Structural reforms aimed at, forexample, decreasing the costs of
labor and lowering taxes on production are aimed at making the
economy more competitive, with the goal ofreducing the trade
deficit and thus the current account deficit.
The IMF's process for monitoring conditionality is intended to
respond toindividual country progress in meeting required
conditions. After the IMF Executive Board approves the
arrangement, the country is expected toimplement the conditions.
The programs are subject to periodic reviews, at which time
decisions are made on future fund disbursements. In caseswhere the
IMF determines the country has made sufficient progress in meeting
the program's conditions, the next disbursement will be
madeavailable. The IMF Executive Board may grant waivers for
nonobservance of conditions and approve access to funds for
countries that do not meetall required conditions if, according to
the IMF, it concludes that the deviation was minor and the country
had made sufficient progress inimplementing the program. However,
if the IMF staff concludes that a country has not made sufficient
progress in implementing policies andmeeting conditions it
considered essential, it may recommend that disbursements be
delayed or funds withheld. In these cases, the IMF Boardis
generally not asked to make a negative decision; rather, the
review is not completed and it is not formally brought before the
Board for a decision atthat time. IMF staff and Executive
Directors told us that these cases are
21 A currency board has governed Argentina's monetary policy since
1991. Under the currency board
arrangement, the central bank maintains a sufficient level of U.S.
currency in international reserves toguarantee the convertibility
of all outstanding Argentine pesos at the official exchange rate
(1 peso
equals 1 dollar), known as the "convertibility regime." While this
arrangement provides comfort toforeign investors that their
investments are protected from fluctuations in the exchange rate,
the currency board significantly reduces the discretion of central
bank authorities to influence Argentina'smoney supply. Argentina's
money supply rises and falls with the level of international
reserves. For example, the domestic money supply will contract if
investors choose to convert their pesos into U.S.dollars following
a loss of confidence. Also, a balance-of-payments deficit that
reduced reserves would contract the money supply, raise interest
rates, and reduce aggregate demand, including that forimports.
This self-correcting adjustment process can increase unemployment
in response to such factors as reduced investor confidence in
world markets.
The IMF's Process forMonitoring Conditionality IsIntended to
Respond to Individual BorrowerCountry Progress in Implementing
ItsProgram
B-281768
Page 27 GAO/GGD/NSIAD-99-168 IMF Financial Assistance discussed
with the Executive Board informally and in "country
matter"sessions. The IMF's process for monitoring the conditions
included in supportprograms allows for program modifications,
depending on a country's individual circumstances. Modifications
are usually summarized inupdated program documents. The programs
in each of the countries we reviewed were modified, in some cases
frequently, for a variety of reasons.In some instances,
modifications were made because of the effect unforeseen internal
or external factors had had on the country's ability tomeet the
conditions in the program. In other instances, the IMF determined
the initial conditions were not feasible or realistic. As
illustrated in figure 1, once the IMF Executive Board has approved
aprogram, the country is expected to implement its conditions. IMF
staff monitors the program continually, and the program is subject
to periodicreviews by the IMF Executive Board in order to evaluate
if the country's progress in meeting the conditions under the
program justifies thecontinuation of disbursements. In some cases,
disbursements depend only on a determination by the IMF staff that
the country has met prenegotiatedcriteria. As such, according to
IMF staff, for most programs, review by the IMF Executive Board is
not required prior to each quarterly disbursement.For these
programs, semiannual reviews by the IMF Executive Board are the
more typical approach. In these cases, IMF staff reviews whether
thecountry has met its performance criteria quarterly and, if they
have been met, a disbursement can follow without a full IMF Board
review. Largerprograms, such as several we studied, tend to have
tighter monitoring, and reviews can be held quarterly, bimonthly,
or monthly. Futuredisbursements are contingent on the outcome of
these reviews. In order for a country to be eligible for the next
disbursement, the review has to beconsidered "complete." IMF staff
missions to the country review the country's progress in meeting
the program's performance criteria andother structural reforms
with country officials. Progress is outlined in documents provided
to the Executive Board by both country authoritiesand IMF staff.
IMF staff appraises a country's progress and makes a
recommendation to the Executive Board. According to IMF staff,
thisprocess involves a considerable amount of judgment and allows
for a number of options depending on the country's performance and
the effectof both internal and external events on that
performance.
If the IMF Executive Board determines that a country has made
sufficientprogress in meeting the program's conditions, the next
disbursement, as specified in the arrangement, will be available
for release. However,
The IMF's Monitoring of aBorrower Country's Program Is a Process
ThatInvolves IMF Staff, Country Officials, and the IMFExecutive
Board
B-281768
Page 28 GAO/GGD/NSIAD-99-168 IMF Financial Assistance according to
IMF staff, it is fairly common for one or more of theprogram's
conditions to be missed, including performance criteria. When this
happens, IMF staff and country officials discuss the causes behind
themissed criteria and changes that may be needed in the program.
According to an IMF official, if the staff concludes that the
deviation is minor andself-correcting or the underlying objectives
of the program can be met despite the deviation, they may
recommend to the IMF Executive Boardthat it grant the country's
request for a waiver and be eligible for the next disbursement.
However, if the staff concludes that the reform program isnot on
track and that the criteria were missed because the country was
not sufficiently pursuing an agreed-upon policy, the staff will
not recommendapproval of a waiver at that time and will instead
delay or suspend the completion of the country's review.
Negotiations between the two partiescan continue if and until the
two sides reach agreement on how to restart the existing program
or initiate an entirely new program, or the borrowercountry
requests that the program be terminated. When the staff is assured
that the country is once again committed to reform (sometimes
byundertaking "prior actions"), it can recommend to the Executive
Board that waivers be granted for the previously unmet conditions,
and thereview be completed. Upon IMF Executive Board approval, the
country is eligible to receive the next disbursement. The
documents we revieweddemonstrated that this process was generally
followed for the six countries in our study, as summarized in
table 3.
B-281768
Page 29 GAO/GGD/NSIAD-99-168 IMF Financial Assistance IMF
Executive Boardreviews completed under currentarrangement Reviews
completedwith no waiversrequested Waivers granted withoutdelays in
completingreview or disbursing funds Delays in completingreviews
and disbursingfunds Observations ArgentinaSince the arrangement
was approved in Feb.1998, three reviews were completed in Sept.
1998,March 1999, and May 1999.
Two One - In March 1999, theIMF Board approved a
waiver because Argentina'sfederal government deficit exceeded the
quantitativeperformance criterion. IMF staff concluded that
theamount by which the criterion was exceeded wasminor and that
the nonobservance was due tocircumstances outside the government's
control.
None In the course of its threereviews, the IMF Board
has determined thatArgentina has met all performance
criteriaexcept the one noted under "waivers." The IMFnoted that
Argentina performed in asatisfactory manner in a relatively
turbulentinternational economic environment. BrazilSince the
arrangement
was approved in Dec.1998, one set of reviews was completed in
March1999.
None None One - The first andsecond review,
scheduled for completionin February 1999, was delayed until
March1999.
a The IMF Board
granted a waiverfor the government's
nonobservance of theceiling on net domestic assets of the
centralbank.
The review was delayeduntil the IMF and Brazil agreed to changes
in theprogram to reflect the impact of the newcurrency regime. The
IMF said Brazil has madesubstantial progress in implementing
itsstructural and fiscal program. IndonesiaSince the initial
arrangement wasapproved in Nov. 1997, six reviews have
beencompleted.
Two None The IMF delayedcompletion of four
reviews for severalreasons, including lack of progress in
meetingmonetary criteria, privatizing stateenterprises, and
merging troubled banks. The IMFreleased funds after it determined
thatIndonesia had made sufficient progress inimplementing the IMF
conditions.
There were ninerevisions to the initial program, reflecting
thecontinuing evolution of the program. The IMFhas been concerned
about the government'sstability and its commitment toimplement
reforms.
Table 3: IMF Monitoring of Current Financial Arrangements With
Six Countries, as of April 30, 1999
B-281768
Page 30 GAO/GGD/NSIAD-99-168 IMF Financial Assistance IMF
Executive Boardreviews completed under currentarrangement Reviews
completedwith no waiversrequested Waivers granted withoutdelays in
completingreview or disbursing funds Delays in completingreviews
and disbursingfunds Observations KoreaSince the initial
arrangement wasapproved in Dec. 1997, seven reviews have
beencompleted.
Five Two - In December 1998and April 1999, the IMF
Board approved waiversallowing more time for the government to
completerequired structural performance criteria. Theseactions
have since been completed, according to IMFofficials.
None Korea's programchanged substantially to
reflect the deeper-than-expected recession. Korea has
madesubstantial progress in implementing financialsector policy
changes and has begun repayingits IMF borrowings. RussiaSince the
initial arrangement wasapproved in March 1996, 12 reviews
werecompleted through June 1998.
Five Two reviews were completedafter the IMF Board granted
waivers for Russia'snonobservance of performance criteria. Inthese
instances, the government missed theperformance criteria on the
government deficit orrevenue targets.
The IMF delayeddisbursements and/or program approval fivetimes.
The delays occurred because Russiahad gotten too far off program
regarding thegovernment deficit and revenue targets. Also,there
were delays because Russia had toimplement prior actions and/or
there werecabinet changes.
The substantive reasonsfor Russia's failure to meet key
goals,according to IMF officials, have been a lack ofpolitical
will to collect taxes and a pervasiveculture of nonpayment of
taxes. In March 1999, theprogram was terminated at Russia's
request; theIMF and Russia are currently negotiatingterms for a
new program. UgandaSince the arrangement was approved in Nov.1997,
two reviews were completed in April 1998and Nov. 1998.
One One - In April 1998, the IMFBoard approved a waiver for
the quantitative performancecriterion that limits government
obligations tothe banking sector, judging that non-observance
wasdue to a reversible technical factor rather than a failure
ofpolicy.
Following a February1999 IMF staff mission that found
thegovernment missed five of nine performancecriteria,
disbursements have been delayedpending the findings of the staff
mission thatreturns in June 1999. Government officialsexpect to
meet the criteria then.
IMF and U.S. Treasuryofficials have described Uganda as
generallyexhibiting a strong commitment to economicreform. Recent
developments indicate agreater emphasis by the IMF on increasing
prioritysocial-sector spending, improving privatizationefforts,
and new concern over increases in militaryspending. Note: More
detailed discussions of these programs and IMF monitoring of
compliance with terms andconditions are contained in the country-
specific appendixes to this report. aAccording to IMF staff,
Brazil's first and second reviews were completed simultaneously
because Brazil received funds under two different IMF policies, an
SBA and an SRF, and drew from thesesources simultaneously. If they
had been drawn sequentially, the reviews would have been completed
separately. Source: GAO analysis of IMF documents.
B-281768
Page 31 GAO/GGD/NSIAD-99-168 IMF Financial Assistance As
previously discussed, during the review process, if the IMF
determinesthat a country has met all of the performance criteria,
the country is eligible to receive its next IMF disbursement. If
IMF staff believes that thecountry has satisfactorily implemented
the requirements for the period under review but that all criteria
were not met, it can recommend that theIMF Executive Board grant
the borrower country's request for a waiver of nonobservance of
those unmet criteria. Generally, in these cases, thedeviations are
determined to be minor, of a technical nature, or temporary. The
granting of such waivers generally happens fairly quickly, and
accessto the next disbursement is not delayed. In addition to
reviewing a country's progress on performance criteria, its
progress toward meetingindicative targets and structural
benchmarks is also considered in the review process and the
decision to approve the next disbursement. For example, Argentina
requested a waiver for the IMF Board review inMarch 1999 because
its federal government deficit slightly exceeded its target. This
situation was primarily due to adverse external factors. In
thisinstance, the federal government deficit, estimated at $3.85
billion in 1998 (1.1 percent of gross domestic product [GDP]),
exceeded its ceiling byabout $350 million, or around 0.1 percent
of GDP. According to the Argentine government, its efforts to
contain expenditures could notcompensate fully for the revenue
shortfall. The shortfall mainly reflected the slowdown of economic
activity in the second half of 1998 and itsadverse effect on
taxes, particularly the value-added tax. IMF staff viewed the
deviation as minor and as not detracting from overall
fiscalperformance. Hence, they recommended the waiver be granted;
in March 1999, the IMF Executive Board approved the waiver. In
another example, Uganda requested a waiver for nonobservance of
onequantitative performance criterion during its April 1998 IMF
Board review. In this instance, the quantitative performance
criterion was a limit on thenet claims on the government by the
banking system. During the review period that ended in December
1997, the Ugandan governmentexperienced a temporary shortfall in
its checking accounts with the banking system, thereby causing it
to miss the performance criterion.According to IMF documents, the
shortfall was due to government payments being made sooner than
expected. IMF staff recommended thewaiver be granted because they
viewed this nonobservance as minor and of a technical nature
rather than a policy violation; the IMF ExecutiveBoard approved
the waiver in April 1998. The shortfall was corrected within a
short period of time.
The IMF Executive BoardMay Approve Access to Funds if Overall
Progress IsSufficient
B-281768
Page 32 GAO/GGD/NSIAD-99-168 IMF Financial Assistance During the
review process, instances in which the country did not meetkey
quantitative or structural performance criteria may be considered
significant enough to delay or suspend disbursements. According to
IMFstaff, a country's record in implementing performance targets
and benchmarks influences this determination. Under these
circumstances,IMF staff recommends to IMF management that the
review not be completed. If IMF management concurs, the staff will
likely informallybrief the IMF Board, but the IMF Board will not
be asked to make a formal decision on the program's continuation
at that time. Depending on thesituation, IMF staff may continue to
work with country officials to negotiate new terms of the program
so that it can be restarted or so a newprogram can be initiated.
If country officials and IMF staff are unable to agree on terms,
it is possible that the program will lapse. Indonesia's program is
an example of a situation in which disbursementswere delayed
several times. The Indonesian IMF program began with Executive
Board approval in November 1997, with completion of the
firstreview scheduled for mid-March. The IMF, however, delayed
Indonesia's disbursements from mid-March to early May 1998 due to
the IMF staff'sdetermination that Indonesia had not made
sufficient progress in carrying out its program. The first review
was completed in May 1998, withIndonesia meeting none of the
quantitative performance criteria and one of the required
structural performance criteria. IMF staff recommended andthe
Executive Board granted Indonesia's request for waivers of
nonobservance of these criteria based on actions taken by the
government,and disbursements resumed. At this time, the IMF moved
from quarterly to monthly reviews of Indonesia's program.
Disbursements were also delayedin the process of completing
several subsequent reviews.
Brazil's program is a more recent example of a delay in
disbursements. Theprogram began in November 1998, with the first
disbursement occurring in early December. In January 1999, the
government of Brazil was forced todevalue and then float its
currency. Up until that time, Brazil's currency was pegged to the
U.S. dollar, and maintenance of the exchange rate wasan objective
of Brazil's IMF program. Because Brazil received funds under two
different IMF policies and drew from these sources
simultaneously,the first and second reviews were scheduled to
occur simultaneously. Completion of this set of reviews and the
second disbursement wereinitially scheduled to occur no later than
the end of February 1999. The change in the currency regime
required substantial revision to theprogram, thus delaying until
late March completion of the review. Brazil's program was modified
to reflect new economic and exchange ratecircumstances. Brazil
missed one of its quantitative performance criteria
The IMF May Delay orWithhold Funds if Sufficient Progress Is Not
Made
B-281768
Page 33 GAO/GGD/NSIAD-99-168 IMF Financial Assistance (a ceiling
on net domestic assets in the central bank). The Executive
Boardgranted Brazil a waiver for the nonobservance of this
performance criterion, agreed to the program modifications, and
approved completionof the first and second review on March 30,
1999, thus opening the way for Brazil to receive the next
disbursement of funds. Russia's program is an example of one in
which the IMF delayeddisbursements and program approval, reduced
the amount of the disbursement, and ultimately suspended the
program. The IMF delayedfour disbursements: one in June and two in
September and October 1996, and then another in November 1997.
Russia received no funds betweenFebruary and May 1997, pending
approval of the 1997 program, which was delayed until May 1997,
based on Russia's successful completion of prioractions. The
delayed approval of the 1998 program, due to cabinet changes and
difficulty in meeting the revenue package, meant that Russia
receivedno funds between January and June 1998. The program was
finally approved in June 1998, based on implementation of prior
actions. In July1998, the IMF approved additional funds to Russia
but reduced the amount of the initial disbursement from $5.6
billion to $4.8 billion due to delays ingetting two measures
passed in the Duma (the lower house of the Russian parliament).
The IMF was scheduled to release the next disbursement inSeptember
1998, but Russia had deviated so far from the program that the IMF
made no further disbursements. Ultimately, according to the IMF,
itdelayed disbursements because of Russia's poor tax collections,
reflecting a lack of government resolve to collect these revenues.
However,throughout Russia's program, the IMF staff expressed the
view that Russia's key senior authorities were committed to the
program and shouldbe supported; therefore, the IMF Executive Board
continued to approve disbursements. In March 1999, Russia
requested that the program beterminated. In April 1999, IMF staff
and Russian authorities announced they had reached agreement on an
economic program that managementhoped to be able to recommend to
the IMF Executive Board in support of a new arrangement. As of
June 16, 1999, the IMF Board had not approvedthe new arrangement.
Modifications to a borrower country's program are usually based on
anagreement between the IMF and country officials summarized in
updated program documents. In these cases, such agreements outline
modifiedperformance criteria, indicative targets, and benchmarks.
IMF and country officials may modify conditions contained in
borrowercountry programs for a variety of reasons, depending on
individual country circumstances. Two reasons for modifications of
programs are (1) the
Conditions May Be Modifiedfor a Variety of Reasons
B-281768
Page 34 GAO/GGD/NSIAD-99-168 IMF Financial Assistance effect of
unanticipated internal and external factors on the
country'sability to fulfill the required conditions and (2) the
determination that the initial conditions were not realistic or
feasible. In many instances, there isoverlap between these two
reasons. Unanticipated internal factors generally reflect events
over which the government had less control than ithad hoped.
Examples include the inability of the government to enact required
legislation, or other political turmoil. Unforeseen external
factorsare generally changes in the global economic environment
that affect the ability of a borrower country to fulfill the
macroeconomic conditions of itsprogram. Examples include such
things as a decline in investor confidence and/or capital flows, a
decrease in demand for or price of primary exports,default by a
major debtor, a recession or other economic problems in another
country to which one's economy is closely tied, and
naturaldisasters like droughts and floods. Unrealistic or
unfeasible conditions can result when a country's problem is
misdiagnosed or when the impact ofcertain conditions is different
from what was expected.
Developments in the early stages of Indonesia's current program
are anexample of an instance in which unanticipated internal
events made it difficult for Indonesia to fulfill the conditions
it had agreed to. Theseevents included (1) circumvention of
government decrees to dismantle cartels and open up markets, (2)
the government's consideration of acurrency board (which was not
part of the program), (3) social unrest, and (4) the resignation
of the president. Indonesia experienced a significantloss of
investor confidence that resulted in a run on the banks, the
reduction of foreign credit lines, and a continuing depreciation
of thecurrency. The IMF and Indonesia revised the economic program
a number of times before the situation stabilized. Brazil is
another example in which unanticipated internal events resultedin
program revisions. The maintenance of the exchange rate regime was
an objective of the country's IMF program. Brazil turned to the
IMF forassistance in September 1998, when its currency came under
pressure as a result of the Russian crisis, and it experienced a
significant loss ofreserves. This reserve loss decelerated after
the negotiations began, but, according to Brazilian officials,
Brazil's currency came under additionalpressure for a variety of
reasons after its IMF program had started. These reasons included
three internal setbacks that were out of the government'scontrol,
including the defeat in Brazil's congress of two tax measures
deemed crucial to the fiscal adjustment program and the reluctance
of anumber of Brazilian state governors to fulfill their financial
obligations to the government. To try to stem the additional loss
of reserves, theBrazilian government found it necessary to devalue
and then float the
B-281768 Page 35 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
currency. The IMF program was then revised to reflect the new
economicsituation and currency regime. In Korea, a significant
external factor that limited its macroeconomicperformance, in the
view of the IMF, was the continued Japanese recession. According
to an IMF assessment, the weakening of the Japaneseyen affected
Korea's export competitiveness by making Korea's exports more
expensive in comparison with Japanese exports. In addition, it was
acontributing factor in worsening and lengthening Korea's own
recession.
Reassessment of initial conditions can take place because these
conditionsare later determined to be unfeasible or unrealistic due
to economic factors that were not well known at the time. For
example, Treasury andIMF officials told us the IMF projections for
Korea were overly optimistic at the beginning of the program.
These estimates were based on Korea'spast strong growth and did
not accurately project the "rolling financial crisis" throughout
Asia. Also, the true state of Korea's financial sector wasnot
clear when Korea's initial program was designed. Part of Korea's
agreement with the IMF was to improve transparency (openness) in
itsfinancial reporting, but as greater information became
available, investor confidence dropped when the market learned
more about the level ofusable international reserves, corporate
debt, and banks' nonperforming loans. Apart from waivers and
reviews, quantitative performance criteria andindicative targets
can be changed by means of "adjusters" that are included in some
country programs. Adjusters are prenegotiated to account
forspecific actions and assumptions about economic and financial
movements. We found that there were basically two types of
adjusters inthe agreements we reviewed: adjusters due to
unexpected external events that temporarily affect a key variable
and adjusters due to in-countrypolicy changes that affect a key
variable or the measurement of that variable. The first type of
adjuster automatically changes the level of a
quantitativeperformance criterion when there are unexpected
changes--generally outside of the country's control--to one or
more key variables. Therationale is that occasionally countries
may fail to reach a particular quantitative performance criterion
due to fluctuations in economicconditions outside their control
and that temporary changes in key variables should not derail an
IMF agreement. Also, some adjusters aredesigned to take into
account the effect of positive as well as negative external
developments on the quantitative performance criteria. For
B-281768 Page 36 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
example, Uganda's program had a quantitative performance criterion
thatset a minimum level for net international reserves. This
minimum level was based on an assumed level of inflows of funds
from bilateral andmultilateral lending agencies. An adjuster was
added to the quantitative performance criterion in order to adjust
the required minimum levelupward (or downward) in the event that
creditors provided more (or less) debt relief than was expected.
The second type of adjuster automatically changes the level of
aquantitative performance criterion when policymakers choose to
make changes in their monetary or fiscal policy instruments in a
manner thatwould either directly or indirectly affect the target
variables. For example, an IMF official noted that a common
performance criterion in programs isa maximum permissible level of
net domestic assets of the central bank, usually included as part
of a strategy to target the growth of the moneysupply. However,
other policy decisions can affect the level of the money supply.
For instance, decreases in the required reserve ratio
(theproportion of the total value of deposits that a commercial
bank must keep either in its vault or in an account at the central
bank) may increasecommercial bank liquidity and the money supply.
Thus, frequently the quantitative performance criteria include an
adjuster that automaticallydecreases the performance criterion for
the net domestic assets of the central bank when the required
reserve ratio is reduced to offset potentialincreases in the money
supply. This adjuster is intended to prevent policy changes from
compromising the achievement of overall programobjectives, such as
price stability or low inflation.
Our objectives were to (1) describe how the IMF establishes
financialarrangements with borrower countries and the types of
conditions set under these programs and assess how this process
was used for sixborrower countries; and (2) describe how the IMF
monitors countries' performance and assess how this process was
used for six borrowercountries, detailing the conditions met and
not met, the reasons why conditions were not met, and the actions
the IMF took in response. Tomeet our objectives, we obtained
access to IMF officials and documents (public and nonpublic)
through the Department of the Treasury andthrough the staff of the
U.S. member of the IMF Board of Executive Directors. These
documents describe the IMF's background, policies, andpractices.
We reviewed borrower country documents outlining IMF arrangements
and conditionality, including letters of intent,22 and
22 Letters of intent are prepared by the member country. They
describe the policies that a country
intends to implement in the context of its request for financial
support from the IMF.
Objectives, Scope, andMethodology
B-281768
Page 37 GAO/GGD/NSIAD-99-168 IMF Financial Assistance documents
presented to the IMF Executive Board, such as staff reports
onarrangements. We also reviewed several IMF assessments of its
operations, including reviews of ESAF and the IMF's response to
the Asianfinancial crisis.
We discussed the IMF's process for establishing and monitoring
theconditions of its financial arrangements with officials of the
IMF, U.S. government agencies, and borrower governments. To obtain
additionalinformation from in-country officials, in February 1999,
we requested access to Department of State cables related to the
most current IMFarrangement and economic and financial conditions
in each of the six countries. According to State, it identified
and reviewed over 550 cablesthat were determined to be responsive
to our request. Due to the volume of the cables and the limited
time in which to review them, State wasunable to provide timely
access for us to analyze the content of many of these cables and
meet the legislatively required reporting date. We alsoobtained
information from nongovernmental and academic organizations. We
did not evaluate the appropriateness or effectiveness of the
IMF'sterms and conditions.
We reviewed the most recent IMF financial arrangements for the
followingsix borrower countries: Argentina, Brazil, Indonesia,
Republic of Korea (Korea), the Russian Federation (Russia), and
Uganda. We selected thesecountries because they are geographically
diverse, represent a mix of borrowers that were having actual or
potential balance-of-paymentsdifficulties at the time they
requested IMF financial assistance, and have varying histories
with the IMF. Several of these countries were in the midstof a
financial crisis at the time they requested assistance. Three
countries--Argentina, Russia, and Uganda--had successive IMF
financialarrangements, whereas two other countries--Indonesia and
Korea--had not had IMF financial arrangements for about 10 years
before their mostcurrent arrangements.
The information contained in this report is based on the
implementation ofcountries' programs from their inception through
April 1999, unless otherwise noted. We conducted our review in
Washington, D.C., between November 1998and April 1999 in
accordance with generally accepted government auditing standards.
B-281768
Page 38 GAO/GGD/NSIAD-99-168 IMF Financial Assistance We recognize
that the IMF's actions have been subject to debate andcriticism.
An evaluation of these criticisms is clearly outside the scope of
this report. We identify some of these criticisms in appendix
VIII. We requested comments on a draft of this report from the
Under Secretary(International) of the Department of the Treasury
and the Managing Director of the International Monetary Fund. The
Treasury providedwritten comments on a draft of this report, which
are reprinted in appendix IX. These comments characterized the
report as balanced andinformative. The Treasury did note its
concern that our discussion of flexibility in monitoring and
implementing IMF programs could bemisunderstood. The Treasury
commented that while the IMF's process does incorporate
flexibility and latitude, "there is a fundamental linkbetween
program implementation and program support." We agree that IMF's
process is designed to allow adjustment to a country's program
inappropriate cases, taking into account changing circumstances.
We provide many examples of such adjustments in our description of
thearrangements for six borrower countries. Also, in response to
the Treasury's concern, we added clarifying language to the
Results in Brief tonote that the resumption of IMF disbursements
following a delay depends on IMF judgment that there has been
satisfactory progress in meeting keyconditions. For a full
discussion of the process, see appendix I of this report. Both the
IMF and the Treasury provided technical and clarifyingcomments,
which we incorporated where appropriate. We also asked responsible
Department of State officials to review the accuracy of the in-
country information in the draft. They provided technical and
clarifying comments, which we have incorporated where appropriate.
We are sending copies of this report to Senator Connie Mack,
Chairman,Representative Jim Saxton, Vice Chairman, and Senator
Charles Robb and Representative Fortney Pete Stark, Ranking
Minority Members, JointEconomic Committee; Senator William Roth,
Chairman, and Senator Daniel Moynihan, Ranking Minority Member,
Senate Committee onFinance; Senator Phil Gramm, Chairman, and
Senator Paul Sarbanes, Ranking Minority Member, Senate Committee
on Banking, Housing, andUrban Affairs; and Representative Benjamin
Gilman, Chairman, and Representative Sam Gejdensen, Ranking
Minority Member, HouseCommittee on International Relations. We are
also sending copies of this report to the Honorable Robert Rubin,
the Secretary of the Treasury; theHonorable Madeleine Albright,
the Secretary of State; the Honorable Jacob Lew, Director, Office
of Management and Budget; and the Honorable
Agency Comments andOur Evaluation
B-281768
Page 39 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Michel
Camdessus, Managing Director, IMF. Copies will be made availableto
others upon request. This report was prepared under the direction
of Susan S. Westin, AssociateDirector, Financial Institutions and
Markets Issues, and Harold J. Johnson, Jr., Associate Director,
International Relations and Trade Issues. Pleasecontact either Ms.
Westin at (202) 512-8678 or Mr. Johnson at (202) 512- 4128 if you
or your staff have any questions about this report. Other
majorcontributors are acknowledged in appendix X.
Nancy R. KingsburyActing Assistant Comptroller General General
Government Division
Henry L. Hinton, Jr.Assistant Comptroller General National
Security and InternationalAffairs Division
B-281768
Page 40 GAO/GGD/NSIAD-99-168 IMF Financial Assistance LIST OF
CONGRESSIONAL COMMITTEES The Honorable Jesse A. HelmsChairman The
Honorable Joseph R. Biden, Jr.Ranking Minority Member Committee on
Foreign RelationsUnited States Senate
The Honorable Ted StevensChairman The Honorable Robert C.
ByrdRanking Minority Member Committee on AppropriationsUnited
States Senate
The Honorable Jim LeachChairman The Honorable John J.
LaFalceRanking Minority Member Committee on Banking and Financial
ServicesHouse of Representatives
The Honorable C.W. Bill YoungChairman The Honorable David R.
ObeyRanking Minority Member Committee on AppropriationsHouse of
Representatives
Page 41 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Page 42
GAO/GGD/NSIAD-99-168 IMF Financial Assistance
Contents
Letter 1 Appendix IThe IMF's Process for
Establishing andMonitoring Countries' FinancialArrangements
46
Appendix IIThe IMF's Financial Arrangement withArgentina
57
Appendix IIIThe IMF's Financial Arrangement withBrazil
72
Appendix IVThe IMF's Financial Arrangement withIndonesia
85
Appendix VThe IMF's Financial Arrangement WithSouth Korea
116
Contents
Page 43 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Appendix
VIThe IMF's Financial Arrangement withRussia
136
Appendix VIIThe IMF's Financial Arrangement withUganda
159
Appendix VIIICriticisms of the IMF 175 Appendix IXComments from
the Department of theTreasury
178
Appendix XGAO Contacts and StaffAcknowledgments
180
Glossary 181
Contents
Page 44 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
Abbreviations BCB Brazil Central Bank CBR Central Bank of Russia
CCFF Compensatory and Contingency Financing Facility EFF Extended
Fund Facility ESAF Enhanced Structural Adjustment Facility ESF
Exchange Stabilization Fund GDP gross domestic product GRA General
Resources Account HIPC Heavily Indebted Poor Countries IBRA
Indonesian Bank Restructuring Agency IMF International Monetary
Fund INDRA Indonesian Debt Restructuring Agency SBA Stand-by
Arrangement SDR Special Drawing Rights SRF Supplemental Reserve
Facility STF Systemic Transformation Facility VAT Value Added Tax
Page 45 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
Appendix IThe IMF's Process for Establishing and Monitoring
Countries' FinancialArrangements
Page 46 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The process
that the International Monetary Fund (IMF) generally uses
toestablish and monitor financial assistance arrangements is
intended to be flexible and applied on a case-by-case basis to
address the specificbalance-of-payments problems of member
countries. The IMF staff and the member country begin the process
by assessing the country's overalleconomy, balance-of-payments
position, ability to finance any balance-ofpayment deficit, and
potential need for IMF financial assistance. If thecountry decides
to seek IMF financing, the IMF staff and the country negotiate an
arrangement that describes the amount of financing, the typeof
financing instrument, and the schedule for review. The IMF staff
and the country also negotiate conditions--the policy measures
that the countryintends to fulfill in order to continue to access
IMF funds. After the arrangement is negotiated, the IMF Executive
Board discusses andapproves it.
IMF staff conduct periodic reviews to monitor the country's
progress inmeeting the IMF program conditions. The frequency of
the reviews depends on the type of financial arrangement that the
country is under andthe nature of its problem. The IMF uses both
data and judgment in assessing the extent of the country's
progress in meeting programconditions. If it determines that the
country is on track in implementing its program conditions,
additional allotments of funds can be made available.In cases
where the IMF determines deviations from the program are
significant, it can delay or withhold funding unless and until, in
itsjudgment, the country has made further progress.
When a member country faces an actual or potential balance-of-
paymentsproblem, it may consult with the IMF to analyze
information on the economy and discuss various methods of managing
the problem. Thesediscussions may lead the country to request IMF
financial assistance in order to alleviate the imbalance. If the
IMF and the country do not reachfinal agreement on a financial
assistance arrangement, the country may seek other means to
address the difficulty. Discussions can occur at anytime,
including during the country's annual "Article IV" consultation
with the IMF or during informal consultations as requested by the
member.1
1 The Article IV consultation is an annual review of members'
macroeconomic circumstances
conducted as part of the IMF's "surveillance" responsibilities as
spelled out in its Articles ofAgreement, which is its charter. The
Articles also call on each member to provide the IMF with the
information needed for such surveillance.
Country OfficialsConsult With the IMF
Appendix I The IMF's Process for Establishing and Monitoring
Countries' Financial Arrangements
Page 47 GAO/GGD/NSIAD-99-168 IMF Financial Assistance To aid in
the IMF's assessment of a country's overall economic situationand
to determine the magnitude of potential financial assistance
required by the country, IMF staff evaluates the balance-of-
payments problem anddetermines the financial support measures that
would assist in correcting the imbalance. The IMF staff's review
of the state of a member's economyis an iterative process and is
based on country-provided data, assumptions about key
macroeconomic variables, and judgment by the IMF staff andcountry
officials. To do this, the IMF staff examines the following four
related sectoral statistical systems over the medium term of 3 to
5 yearswith the assumption that the government will follow its
stated policies: (1) national income and product accounts for
gross domestic product (GDP),(2) government financial accounts for
the fiscal sector, (3) consolidated banking system accounts for
the monetary sector, and (4) externalaccounts for the balance-of-
payments position.
In order to analyze these four sectors, an IMF team (IMF mission)
travelsto the country to review the situation within the country.
The team begins the analysis by reviewing the data previously
collected from countryofficials for the most recent Article IV
consultation as well as other requested information provided by
the country. The information includesdata on the country's balance
of payments; fiscal variables, such as government expenditures and
receipts; and monetary variables, such asmonetary reserves and
bank deposits, stock of currency, and interest rates. In addition,
it includes country authorities' projections for areas such asreal
GDP growth and inflation; real sector indicators, such as
employment levels, manufacturing, production, agriculture, and
service sectors; budgetplans for government expenditures; and
subsidies for public enterprises.
As part of the process of analyzing a country's economy and
determiningthe balance-of-payments position, the IMF staff
verifies the countryprovided information, searching for both
consistency and contradictions inthe information. According to an
IMF official, data inconsistencies may be discovered in a variety
of ways. For example, if IMF staff believed that thecountry-
provided trade data were inaccurate, it would cross-check that
country's trade data with similar data of a neighboring county
with whomit trades in order to verify whether the information was
accurate. In other cases, if the data suggested that the
manufacturing level in a country hadincreased and at the same time
indicated that electricity usage had decreased, the staff would be
alerted to the inconsistency and would seekto verify the data. In
such instances, the IMF team would work with government employees
in ministries or agencies to calculate and verify theinformation.
According to an IMF official, this type of analysis is, by
necessity, undertaken on a case-by-case basis, and it would be
difficult to
Country Officials andthe IMF Analyze the Country's Situation
Appendix I The IMF's Process for Establishing and Monitoring
Countries' Financial Arrangements
Page 48 GAO/GGD/NSIAD-99-168 IMF Financial Assistance develop a
universal set of standards for verifying such information. Forthis
work, the IMF relies on its mission chiefs, who have acquired
knowledge and experience in each country to assist in verifying
the data. According to an IMF official, determining the balance-
of-payments positionis central to both the analysis of the economy
and the determination about whether the country would be eligible
for IMF financial support. Theconcept of a balance-of-payments
need is broadly defined in the IMF's Articles of Agreement and
includes (1) the country's overall balance ofpayments, (2) the
country's foreign reserve position, and (3) developments in its
reserve position. IMF documents state that these three elements
areregarded as separate, and a member's representation of a
balance-ofpayments need can be based on any one of them. The first
element--thecountry's overall balance of payments--represents the
economy's external financing requirement and equals the sum of a
member's current andcapital account balances. The current account
primarily includes exports and imports of goods and services. The
capital account provides summarydata on the changes in net foreign
assets of domestic residents arising from such transactions as
external borrowing or repayments (borrowingfrom or repaying
foreign sources), foreign direct investment, portfolio investments
(both equity shares and bonds), and short-term capitalmovements.
The second element--the country's reserve position--refers to the
amountof resources (convertible currency, special drawing rights,
2 and gold) a
country has to support its imports and external debt payments.
Thereserves are under the control of the monetary authority. The
third
element--developments in the reserve position--has a very
narrowapplication and is intended to ensure that members of the
IMF whose currency is a reserve currency (such as the United
States) would be able touse IMF resources when requested, despite
the absence of a need as outlined in the first two elements.3
2 The special drawing right is a reserve asset created by the IMF
and a unit of account that the IMF uses
to denominate all its transactions. 3 It is designed to cover
situations in which a country may not have a balance-of-payments
deficit or a weak reserve position but still has a need because of
a development in its reserves. For example, theExecutive Board was
concerned that the first two concepts would preclude members of
the European
Economic Community, (the predecessor to the European Union) from
requesting IMF assistance indischarging obligations among each
other. By virtue of their currency being a reserve asset, the use
of their currency in foreign transactions would not result in a
balance-of-payments deficit or weak reserveposition by such
countries, although difficulties in the external environment may
still require some support.
Appendix I The IMF's Process for Establishing and Monitoring
Countries' Financial Arrangements
Page 49 GAO/GGD/NSIAD-99-168 IMF Financial Assistance According to
an IMF official, determining an actual balance-of-paymentsneed is
easier than projecting a potential balance-of-payments need. This
is because the process of assessing an economy is subject to
manyassumptions and uncertainties, including factors within and
outside of the country's control. For example, in the case of
Russia, the IMF documentsestablishing the 1996 extended
arrangement do not explicitly describe the underlying balance-of-
payments need. However, the IMF documents dopresent a clear case
for the role that IMF funding was to play in catalyzing debt
rescheduling and encouraging the inflow of private capital to
avoid apotential balance-of-payments problem. In 1996, Russia had
a basic weakness in its external accounts due in part to short-
term capitaloutflows and an inadequate level of reserves.
Furthermore, many debt service obligations were expected to occur
between 1996 and 2000, addingmore stress to Russia's external
accounts. An IMF financial arrangement in 1996 was seen as
critical for Russia to avoid a potential balance-of-payments
problem. The IMF arrangement helped Russia obtain debt
rescheduling to reduce the future burden on the federal budget
andimprove Russia's access to private capital markets.
Analyzing the nature, source, and severity of any existing or
potentialbalance-of-payments problem involves assessing data about
the balance-ofpayments deficit and the country's ability to
finance it. To determine thenature of the imbalance, the IMF
determines whether the problem is short term or longer term. For
example, a short-term problem could be a cyclicalor seasonal
imbalance caused by the falling price of a primary export. A
longer-term imbalance might be caused by underlying or
structuralweaknesses in the economy, such as an unsustainable
government budget deficit. The IMF staff also determines to what
extent the reasons for theimbalance are within the government's
control, along with the dimensions and urgency of the problem,
including the availability of financing. After the balance-of-
payments gap analysis is complete and if the countrydecides to
seek IMF financial assistance, the country officials and IMF staff
begin to discuss IMF financing as well as the conditions for
thecountry program.
4 However, according to the IMF, in order to adapt
programs to individual country circumstances, it has no inflexible
set ofoperational rules for establishing a country's program.
Nonetheless,
Deputy Managing Director of the IMF, said that staff enter
intonegotiations with detailed instructions, agreed upon within
the IMF staff
4According to the IMF, it provides financial resources to members
under certain conditions designed to
encourage what it views as appropriate economic adjustment and
ensure that the member's use of IMFcredit is temporary and that it
will have the capacity to repay the IMF on time.
Appendix I The IMF's Process for Establishing and Monitoring
Countries' Financial Arrangements
Page 50 GAO/GGD/NSIAD-99-168 IMF Financial Assistance offices and
then by IMF management. This IMF official stated thatnegotiations
are often long and sometimes contentious, involving several rounds
of discussions. The disagreements tend to be over difficult
issues,for example, whether the budget needs to be tightened, the
inflation rate should be reduced less rapidly, or the agreed-upon
balance-of-paymentsdeficit can be larger.
To address the balance-of-payments problem, typically the IMF
useseconomic models to project the potential impact of a variety
of adjustment measures to develop several scenarios of possible
program elements.Based on these scenarios, the IMF staff and the
country negotiate what they view as the appropriate mix of fiscal
and monetary adjustment,structural reforms, and financing required
to achieve their overall goals; these goals can include an
increase in economic growth or in investorconfidence.
5
For example, for the external sector, two independent projections
ofimports need to be made and reconciled. The first is based on
the demand for imports, derived from information including the
projected level ofoutput and relative prices, and the second is
based on the capacity to import, derived from the target change in
international reserves andprojections of other components of the
balance of payments. For example, if the demand for imports is
greater than the country's capacity to import,the basic options
for adjustment may include the following: (1) seek additional
foreign exchange, (2) lower the initial target for
netinternational reserves, (3) reduce the initial projection for
output to lower the demand for imports, or (4) some combination of
the above. Similariterative analyses are also carried out for the
fiscal and monetary sectors.
The IMF staff and the country negotiate an arrangement that
describes (1)the amount of financing expected to be provided by
various sources and the amount that may be requested from the IMF;
(2) the instruments underwhich the IMF resources could be
provided, for example, Stand-by Arrangement (SBA) or Extended Fund
Facility (EFF); and (3) the potentialschedule for reviewing a
country's performance and disbursing funds. The IMF has many
instruments through which it provides financing to member
5 IMF financing is not generally in the form of a loan but rather
is a purchase or repurchase of currency.
As such the IMF does not consider the establishment of a
conditionality program to be a "negotiation."Rather, the member
explains the economic reform program in the documents it prepares
in the
context of its request for financial assistance and the IMF Board
decides whether to support theprogram. The decision takes the form
of an "arrangement," which notes certain aspects of the member's
program that will be conditions for continued IMF financing under
the arrangement.
Appendix I The IMF's Process for Establishing and Monitoring
Countries' Financial Arrangements
Page 51 GAO/GGD/NSIAD-99-168 IMF Financial Assistance countries.
Table I.1 illustrates IMF instruments used by the six IMFmember
countries discussed in this report. Instruments Purpose
Duration/Disbursements/ Repayments ReviewsRegular arrangements
Stand-by Arrangements Used by Indonesia,Korea, and Brazil
Short-term, balance-of-paymentsassistance for deficits of a
temporary or cyclical nature
1-3 years/quarterly/ within 3-1/4 - 5 years ofeach drawing
Periodic reviews provided that appropriatemonitoring of
macroeconomic developments would be ensured, normallythrough
quarterly performance criteria. Staff prepare an analysis and
assessmentof the performance under programs Extended
arrangements,under EFF
Used by Argentina,Indonesia, and Russia - Established in
1974,likely to be beneficial for developing countries inparticular
Longer-term, balance-of-paymentsassistance for (1) deficits
arising from structural maladjustments in productionand trade and
widespread cost and price distortions and (2) an
economycharacterized by slow growth and an inherently weak
balance-of-paymentsposition that prevents pursuit of an active
development policy. Can providelarger total amounts of assistance.
3-4 years/quarterly or semiannually/ 4-1/2 - 10 years of
eachdrawing
Periodic reviews, typically quarterlyperformance criteria. Country
provides annual reports on progress made, andpolicies and measures
to be followed, including any modifications.
Special facilitiesSupplemental Reserve Facility (SRF) Used by
Brazil, Korea,and Russia
- Opened in 12/97,provided under SBA or extended arrangement
Exceptional balance-of-paymentsproblems owing to a large, short-
term financing need resulting from a suddenand disruptive loss of
market confidence reflected in pressure on the capitalaccount and
reserves. Likely to be used where the magnitude of outflowsmay
threaten the international monetary system.
1 year/2 or more drawings/ within 1- 1-1/2 years fromdate of
disbursement but may be extended anotheryear, including surcharges
Reviews done in conjunction with SBA orextended arrangement.
Compensatory andContingency Financing Facility(CCFF)
Used by Russia -Opened in 1988 tocombine the CompensatoryFinancing
Facility with contingency financing
Helps members deal with temporarycurrent account shocks that are
largely beyond their control. A "compensatory"element is available
in case of shortfalls in export earnings or excesses in
cerealimport costs. A "contingency" element helps members with
existingarrangements keep their programs on track when faced with
adverse currentaccount shocks.
Significant limits onamounts; defined methodology fordetermining
whether CCFF is needed and, if so,type and amount.
Disbursements linked tophasing of existing arrangement. For
thecompensatory element, disbursements normally inone installment.
For the contingency element,disbursements linked to phasing of
existingarrangements. Repayment is in 3-1/4 to 5 years.
Board review at the time of request and, inthe case of the
contingency element, on the occasions stipulated in the
underlyingarrangement.
Table I.1.: Frequently Used IMF Financing Instruments
Appendix I The IMF's Process for Establishing and Monitoring
Countries' Financial Arrangements
Page 52 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Instruments
Purpose
Duration/Disbursements/ Repayments ReviewsConcessional facility
Enhanced StructuralAdjustment Facility (ESAF) Used by Uganda
Principal means for providing financialsupport (highly
concessional loans) to low-income members facing
protractedbalance-of-payments problems.
3 years/semiannually/ repaid in 10 equal semi-annual installments,
beginning 5-1/2 years andending 10 years after date of each
disbursement.
Quarterly monitoring of financial andstructural benchmarks.
Semiannual performance criteria are set forkey quantitative and
structural targets.
Source: GAO analysis of IMF documents. In addition, the country
and the IMF staff negotiate the likely conditions tobe used to
assess a country's performance under the arrangement. These
conditions are generally intended to advance the country's
largerobjectives-such as a reduced balance-of-payments problem,
higher economic growth, and lower inflation--as well as the reform
effortsundertaken to achieve those objectives.
"Performance criteria" (quantitative and structural) and "prior
actions" areconditions that a country is required to meet and that
the IMF uses to monitor the country's performance and determine
whether it is eligible fordisbursements of resources. "Benchmarks"
and "indicative targets" are other measures the IMF uses to
monitor a country's progress; however,disbursements are not
generally dependent on meeting them. "Quantitative performance
criteria" are clearly defined numeric targets
(macroeconomicindicators), such as a specified ceiling on the
government's budget deficit or on the net domestic assets of the
central bank. According to IMF staff,"structural performance
criteria" must be accurately and unambiguously defined so that no
subjective judgment is involved in determining whetherthey have
been met. For example, a structural performance criterion could be
that a country has to solicit bids to privatize three state-
ownedenterprises by a prespecified date.
A prior action is a particular policy measure that is considered
to beessential to the effectiveness of an adjustment program.
Prior actions may be negotiated by IMF staff and country officials
as part of the country'sinitial arrangement or during subsequent
program reviews; they generally have to be implemented before an
IMF arrangement or a disbursement offunds is approved. An example
of a prior action is the issuance of a regulation or other forms
of legal reform. Other measures used to assess a country's
progress include benchmarksand indicative targets. They may relate
to macroeconomic variables or to specific policy commitments, such
as changes in key structural areas of
Appendix I The IMF's Process for Establishing and Monitoring
Countries' Financial Arrangements
Page 53 GAO/GGD/NSIAD-99-168 IMF Financial Assistance the economy.
Benchmarks can be difficult to define and are best explainedas a
set of specific target measures to be accomplished by a certain
date, used by the IMF to assess progress toward an overall goal.
In general,benchmarks could include targeted structural changes
for tax policy and administration reform, financial sector reform,
or exchange system reform.For example, to achieve the overall goal
of strengthening a country's banking system, the IMF and the
country may agree to a structuralbenchmark, such as enacting legal
reforms for bankruptcy or developing a bank recapitalization plan.
Indicative targets are quantitative targets set onmany of the
standard goals of macroeconomic policy and could include targets
set on the balance of payments, the rate of inflation, or the
publicdeficit.
After the arrangement is negotiated, it has to be accepted by the
IMFManaging Director before it is brought before the IMF Executive
Board. According to an IMF official, the Executive Board generally
accepts therecommendations of the staff, largely because the staff
brings to the Executive Board proposals that the Board will
accept. Generally, theExecutive Board is briefed formally or
informally during the negotiation process, and board decisions are
made on a consensual basis. Sincenegotiations with a country
continue throughout the life of a program, the Executive Board
will often use a meeting to send signals about what it willand
will not accept in the future.
After the IMF arrangement is approved by the Executive Board,
thecountry is then expected to implement the agreed-upon
conditions in the IMF program. To determine whether the program is
on track and thecountry is eligible to receive the next
disbursement of funds, the IMF staff conducts periodic reviews of
the programs. The review schedule is builtinto the arrangement
between the country and the IMF. For the reviews, a team of IMF
staff and country officials assesses the program status,including
the country's overall economic conditions and performance with
respect to criteria, prior actions, and benchmarks. According to
the IMF, reviews are typically held on a semiannual basis,although
disbursements can be made if countries achieve the quarterly
performance criteria and prior actions. Some countries,
however,including those suffering a financial crisis or receiving
funds from the Supplemental Reserve Facility (SRF), tend to have
tighter monitoringbecause funding tends to be heavily front-loaded
and disbursed within a year. In these cases, the program reviews
can be held monthly orbimonthly. SRF funding is for countries with
exceptional balance-of
The IMF ExecutiveBoard Discusses and Approves Program
IMF Staff and CountryOfficials Review Program Status
Appendix I The IMF's Process for Establishing and Monitoring
Countries' Financial Arrangements
Page 54 GAO/GGD/NSIAD-99-168 IMF Financial Assistance payments
problems owing to a large, short-term financing need resultingfrom
a sudden and disruptive loss of market confidence. The IMF staff
monitors the program continuously and the program issubject to
periodic reviews by the IMF Executive Board in order to evaluate
if the country's progress in meeting the conditions under
theprogram justifies the continuation of disbursements. In some
cases, IMF disbursements are conditioned only on the determination
by IMF staff thatthe country has met prenegotiated quantitative
criteria. According to the IMF, for most programs, review by the
IMF Executive Board is notrequired prior to each quarterly
disbursement. For these programs, semiannual reviews by the IMF
Executive Board are the more typicalapproach. In these cases, IMF
staff review whether the country has met its performance criteria
quarterly and, if so, a disbursement can followwithout a full IMF
Board review.
Larger programs tend to have tighter monitoring and all
disbursements aresubject to reviews by the IMF Executive Board. In
these cases, through its monitoring, the IMF staff believes that
the country has satisfactorilyimplemented the program or the staff
believes that the country has not satisfactorily implemented the
program. In the first case, the review is"completed" and the
borrower country is eligible to receive an additional
disbursement. In the latter case, review completion is delayed and
thecountry is not eligible to receive a disbursement at that time.
Satisfactory progress can be judged in one of two ways. If the IMF
staffbelieves that the country has met all of the performance
criteria and considers the review "complete," the staff presents
the results of thereview to the Executive Board. In addition, the
IMF and the country may negotiate a new or revised set of criteria
and benchmarks. Upon theExecutive Board's approval, the country is
eligible to receive the next disbursement of IMF funds. In other
instances, the IMF staff could conclude that the country did
notmeet all performance criteria but that most deviations were
minor and did not affect the country's overall performance. The
staff would thengenerally recommend to the Executive Board that a
waiver be granted and the review would be completed on time. A
country's inability to meet aperformance criterion could be due to
* cyclical or seasonal problems that are self-correcting;*
the difficulty in making economic projections, that is, if key
factors, suchas the money supply were underestimated;
Appendix I The IMF's Process for Establishing and Monitoring
Countries' Financial Arrangements
Page 55 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
* unanticipated events, for example, a tumultuous political
environment; or*
an incorrect assessment of the cause or solution to the problem.
After the IMF Executive Board grants the waiver, the country is
eligible toreceive IMF funds.
The IMF staff considers that a country has not made satisfactory
progresswhen key conditions are not met and deviations are
significant. In these cases, "completion" of the review and
disbursements are generally delayedand are not resumed unless and
until, in the IMF's judgment, satisfactory progress has been
achieved. During the delay period, country officials andIMF staff
negotiate the steps necessary to complete the review and make
funds available. According to IMF staff, if the country did not
meet theperformance criteria because it is unwilling or unable to
do so, the IMF will negotiate with the authorities to determine
the nature of the problemand possible corrective measures. In
these instances, the IMF may request that the country demonstrate
its commitment to the program byundertaking a specific prior
action before it recommends the Executive Board grant waivers for
nonobservance of the unmet criteria and"complete" the review.
In other cases where the country has not met key performance
criteria, theIMF staff may determine that deviations are so
significant that it is not possible to negotiate steps to get the
program back "on track." When thishappens, the IMF staff generally
concludes that it is not in a position to complete the review and
notifies IMF management. If managementconcurs with the
recommendation, staff briefs the Executive Board on the situation.
The review will not be completed at that time and
disbursementswould be delayed. In these cases, the IMF staff and
the country may negotiate ways to restart the existing program or
initiate a new program. Insome cases, for example, in Russia, some
deviations from the program may be significant enough that the IMF
delays or withholds furtherdisbursements for a considerable length
of time, and the program lapses.
Apart from waivers and reviews, quantitative performance criteria
andindicative targets can be changed by means of "adjusters" that
are included in some country programs. Adjusters are prenegotiated
to account forspecific actions and assumptions about economic and
financial movements. There are two types of adjusters: (1)
adjusters related tounexpected external events and (2) adjusters
due to in-country policy changes. The first type of adjuster
automatically changes the level of aquantitative performance
criterion when there are unexpected changes-- generally outside of
the country's control--to one or more key variables.
Appendix I The IMF's Process for Establishing and Monitoring
Countries' Financial Arrangements
Page 56 GAO/GGD/NSIAD-99-168 IMF Financial Assistance For example,
in Uganda's program, an adjuster was added to thequantitative
performance criterion that set a minimum level for net
international reserves in the event that creditors provided more
(or less)debt relief than was expected. The second type of
adjuster automatically changes the level of a quantitative
performance criteria when policymakers choose to make changes in
their monetary or fiscal policy instruments in a manner that would
either directly or indirectly affect thetarget variables. It is
intended to prevent policy changes from compromising the
achievement of overall program objectives, such asprice stability
or low inflation.
Appendix IIThe IMF's Financial Arrangement with Argentina
Page 57 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The current
3-year IMF Extended Fund Facility (EFF) arrangement agreedto in
February 1998 is intended to be precautionary, meaning that
Argentina will draw IMF resources only if external conditions make
itnecessary. At the time it negotiated the arrangement, Argentina
was not experiencing an actual balance-of-payments problem. The
IMF expressedconcern about the sizable current account deficits
expected over the next few years--although these deficits reflect
to a large extent the growth ofproductive investment--and the
economy's vulnerability to changes in external market conditions.
The IMF arrangement of about $2.8 billion isintended to support
the government's medium-term economic reform program for 1998-
2000. Given Argentina's dependence on external capital,the
arrangement is also focused on maintaining investor confidence in
the country's economy.1 Because of the recent adverse external
developmentsstemming, in part, from Brazil's financial crisis, the
IMF and the Argentine government agreed to adjust the performance
criteria in May 1999. As ofMay 31, 1999, Argentina had not drawn
resources under the arrangement.
2
According to the Argentine government, the policy measures
outlined inthe IMF arrangement represent the government's
priorities. Argentina's program with the IMF contains quantitative
performance criteria underwhich the government agreed to limit the
federal government budget deficit, central bank assets, and
government debt. The goals of the fiscaldeficit criteria are to
reduce the federal government deficit, stimulate domestic saving,
and strengthen confidence in the continued viability ofthe
currency regime. The monetary program is intended to strengthen
confidence in the banking system by maintaining a sound financial
systemand providing for an adequate cushion of liquidity. The
structural benchmarks include reforms in the labor market, tax
system, public sectorbudgeting and operations, health system, and
judicial system as well as further progress in privatizing the
remaining institutions. The governmentand the IMF identified
fiscal equilibrium and structural reform (particularly in tax
systems and labor markets) as two of the most crucialelements in
the program.
1 For additional information on investor confidence, see
International Financial Crises: Efforts to
Anticipate, Avoid, and Resolve Sovereign Crises (GAO/GGD/NSIAD-97-
168, July 7, 1997). 2 In late 1998, in response to turbulence in
international capital markets, Argentina received World Bank and
Inter-American Development Bank loans totaling approximately $2
billion, with another $2.5billion due in early 1999. The loans
were intended to be precautionary and part of the effort to
mitigate
the social and economic impact of unsettled international
financial markets and to advance thecountry's reform agenda. The
World Bank loans are to be used for reforms in banking, capital
markets, access to credit, regulatory institutions, and
intergovernmental fiscal relations; to help meet criticalforeign
exchange needs of the government; and as a line of defense for
banking liquidity.
Summary
Appendix II The IMF's Financial Arrangement with Argentina
Page 58 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The IMF
Executive Board reviewed the current program three times(based on
IMF staff documents that provided data on and assessments of a
country's performance), completing the first and third reviews
with nowaivers requested from the Argentine government, granting a
minor technical waiver during the second review, and concluding
that Argentinahad made progress in achieving structural reform.
Under the first review in September 1998, Argentina met all of its
performance criteria and madeprogress in completing several
structural reforms, with the exception of not fully passing labor
market legislation. In the second review, Argentinamet all but one
of its performance criteria. Argentina requested a waiver because
the target for lowering the federal government deficit was
notreached. IMF staff viewed the deviation as minor, primarily due
to adverse external factors, and as not detracting from overall
fiscal performance; theIMF Executive Board granted the waiver. The
Argentine government noted that, significantly, the structural
deficit for 1998 was smaller than that of1997. The government's
efforts to contain expenditures did not fully compensate for the
fall in revenue. In response, the fiscal deficit criterionfor the
next review was raised. During the second review, the IMF
determined that Argentina made progress in carrying out several
structuralreforms. The government implemented most of the tax
reforms but was only able to pass some of the intended labor
market reforms. Under thethird review, the IMF Executive Board
determined that Argentina met the performance criteria as of March
1999 and agreed to adjust some of theperformance criteria for the
next review in light of deteriorating external conditions. The key
events concerning Argentina's current EFF areoutlined in table
II.1.
Appendix II The IMF's Financial Arrangement with Argentina
Page 59 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Year Month
Event1997 December Argentina requested EFF and proposed
performance criteria and structural benchmarks. 1998 February IMF
Executive Board approved 3-year EFF totaling about $2.8
billion.September IMF Executive Board completed first review of
EFF, as scheduled. The IMF Board determined that
Argentina met all performance criteria and made progress in
structural reforms.October Argentina accessed capital markets,
among the first emerging market countries to do so after the
Russian financial crisis in August.November The World Bank
approved $3 billion in loans to Argentina intended to mitigate the
impact of unsettled international financial markets and advance
reforms.December The Inter-American Development Bank approved a
$2.5 billion loan to Argentina designed to counteract global
financial shocks resulting from the crises in Asia and Russia.1999
January Argentina issued a policy memorandum and letter of intent:
- saying it met all but one of the IMF performance criteria
(fiscal deficit level) as of December 1998. Thegovernment made
efforts to limit government expenditures but could not fully
compensate for revenue shortfalls.- describing the policies the
government intended to implement in 1999 under the EFF. The
policies remained broadly the same. Brazil, Argentina's largest
trading partner, floated its currency, thus making exports to
Brazil moreexpensive because the currency depreciated. March IMF
Executive Board completed second review of Argentina's program, as
scheduled. The IMF Boarddetermined that Argentina met all 1998
performance criteria except one and granted a waiver for
nonobservance of the fiscal deficit criterion. IMF staff noted
that the deviation was minor and did not detractfrom the country's
overall fiscal performance.
IMF Executive Board agreed to performance criteria and structural
benchmarks proposed by Argentina inJanuary. The level of the
fiscal deficit criterion for the next review was raised because
the government missed the amount for the previous quarter due to
deteriorating external conditions.May Argentina requested an early
review and modification of its 1999 performance criteria to
address adverse external conditions. IMF Executive Board completed
third review. The IMF Board found that Argentina had met all of
itsperformance criteria as of March 1999 and agreed to adjust the
performance criteria for the next review in light of external,
cyclical changes.
Sources: Documents from the IMF, World Bank, Inter-American
Development Bank, and Argentinegovernment.
Table II.1: Chronology of Key Events Concerning Argentina's
Current IMF Arrangement
Appendix II The IMF's Financial Arrangement with Argentina
Page 60 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Argentina
has undergone radical changes since 1991 when it enacted
theConvertibility Law, which established the currency board
arrangement. Under this system, the central bank maintains a
sufficient level of U.S.currency to guarantee the convertibility
of all outstanding Argentine pesos at the official exchange rate
(1 peso equals 1 U.S. dollar).3 The currencyregime is seen as
greatly helping to reduce Argentina's inflation from over 1,000
percent in 1990 to less than 1 percent in 1998, instill fiscal
andmonetary discipline, build investor confidence, and contribute
to economic growth. The government also undertook major
structuralreforms between 1992-94, including substantial
privatization, deregulation, trade liberalization, and pension
reform. The Argentine governmentdescribed the time from 1991-98 as
periods of sustained growth interrupted by external shocks,
including the Mexican financial crisis in1995 and the Asian,
Russian, and Brazilian crises in 1998. Argentina has had
successive IMF programs since 1983. The previous arrangement wasan
IMF Stand-by Arrangement of over $900 million from April 1996 to
January 1998. According to IMF staff and the Argentine government,
Argentina registereda strong macroeconomic performance in 1997.
The economy grew very rapidly, the unemployment rate fell, and
inflation was virtually zero. Thefiscal position improved as
programmed, and there were no major difficulties in financing a
widening of the current account deficit. Theprudent borrowing
strategy (preborrowing at lower interest rates, stretching out
maturities) followed by the public sector, and thestrengthening of
the banking system achieved in recent years, allowed Argentina to
weather the turbulence that affected international capitalmarkets
in 1997 without major immediate consequences for the economy.
Nonetheless, Argentina and the IMF decided an IMF financial
assistance
3The currency board has governed Argentina's monetary policy since
1991. The currency board limits
the government's ability to affect the money supply and exchange
rates. While this arrangement provides comfort to foreign
investors that their investments are protected from fluctuations
in theexchange rate, the currency board significantly reduces the
discretion of central bank authorities to
influence the operation of Argentina's money supply. Argentina's
money supply rises and falls withchanges in the demand for the
peso, with, for example the domestic money supply contracting if
investors insist on converting their pesos into dollars. This
arrangement ensures that Argentina will nothave a balance-of-
payments problem, since an "unsustainable" current account deficit
will self-correct as investors refuse to finance it, the money
supply contracts, interest rates rise, and aggregate
demanddeclines, thus reducing imports and the current account
deficit. However, this adjustment process could be very painful
and occur due to factors unrelated to the Argentine economy, such
as (1) adecline in export revenue, and thus a widening current
account deficit, due to the economic contraction in a major
trading partner such as Brazil; or alternatively, (2) generally
reduced willingnessof creditors to invest in developing economies
stemming from the financial crises in Asia, Russia, and Brazil.
Argentina has the ability to partially mitigate this effect by
relaxing its exchange rate guarantee(holding up to one-third of
its dollar reserves in government-issued, dollar-backed
securities); however, such an approach could undermine the
investor confidence generated by the currency board.
MacroeconomicContext When Current IMF ArrangementNegotiated
Appendix II The IMF's Financial Arrangement with Argentina
Page 61 GAO/GGD/NSIAD-99-168 IMF Financial Assistance program was
necessary because of risks to the economy posed by eventsin
international financial markets. Argentina and the IMF Executive
Board reached agreement on the current3-year EFF arrangement in
February 1998. This arrangement is intended to be precautionary,
meaning that Argentina will draw IMF resources only ifexternal
conditions make it necessary. The government noted that the
agreement is of great significance because the IMF's review of
Argentina'saccounts provides information to investors on the
country's economic progress. The arrangement of about $2.8 billion
is intended to support thegovernment's medium-term economic reform
program for 1998-2000 and to help maintain investor confidence.
When Argentina negotiated thisarrangement, the country did not
have an actual balance-of-payments problem. The country's current
account deficit had been increasingprimarily due to its widening
trade imbalance, with rising imports outpacing exports, but was
funded with external capital. Foreign directinvestment covered
over 50 percent of the deficit in 1997 and was estimated to cover
about 40 percent of the deficit in 1999. The IMFexpressed concern
about the sizable current account deficits expected over the next
few years--although these deficits reflect to a large extentthe
growth of productive investment--and the economy's vulnerability
to changes in external market conditions. The policies implemented
to meetthese targets were intended to promote sustained growth in
production and employment, increase public saving, and reduce the
vulnerability ofthe economy to disturbances on international
financial markets. As of May 31, 1999, Argentina had not drawn
resources under the current EFFarrangement.
The current EFF arrangement includes quantitative conditions
andstructural benchmarks for the period 1998-2000. Consistent with
the IMF's approach, the government and the IMF negotiated the
performance criteriaand structural benchmarks for the first year
of the EFF; criteria and benchmarks for subsequent years have been
negotiated on an annual basis.As agreed to for 1998, Argentina's
program with the IMF contained quantitative performance criteria
that limited the federal governmentbudget deficit, central bank
assets, and government debt. The structural benchmarks for
Argentina included reforms in the labor market, taxsystem, public
sector budgeting and operations, health system, and judicial
system as well as the completion of the privatization program.
Thegovernment and the IMF identified fiscal equilibrium and
structural reform (particularly in tax and labor) as two of the
most crucial elements of theprogram.
Current ArrangementIntended to Be Precautionary
IMF Program Focusedon Fiscal Conditions and Structural Reforms
Appendix II The IMF's Financial Arrangement with Argentina
Page 62 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The
Argentine government is on record as strongly supporting
theconditions under the IMF program because they reflect the
government's own priorities. According to the Argentine
government, disagreementsbetween the IMF staff and Argentina
officials have been minor. One area of disagreement has been the
significance of the current account deficit.While IMF staff is
concerned about Argentina's increasing current account deficit,
some government economic officials are less so. They contend
thatthe current account deficit should not be overemphasized since
it is due, in part, to investment-led growth and since external
investors have beenwilling to finance it, thus signaling their
confidence in Argentina's economy. As shown in table II.2, three
of the four quantitative performance criteriafocused on
Argentina's fiscal policy. The fourth--limits on central bank
assets--targeted Argentina's monetary policy.
Dec. 1997 -Mar. 1998 Dec. 1997-June 1998 Dec. 1997-Sept. 1998 Dec.
1997-Dec. 1998 Dec. 1998-Dec. 1999
a Dec. 1999-Dec. 2000a
Quantitative performance criteriaCumulative federal government
deficit $ -1,400 $ -1,800 $ -2,750 $ -3,500 $ -2,650 $ -1,000
Cumulative change in net domestic assets ofthe central bank -470 -
530 -800 -800b -- -- Net cumulative disbursements of public
sectordebtc 2,900 5,200 6,800 5,700d -- -- Net cumulative increase
in short-term debt 2,000 2,000 2,000 2,000 -- --Indicative targets
Expenditure targete 10,200 19,450 29,550 38,800 -- --Combined
deficit of the federal government and provinces -- -2,175 -- -
4,250 -3,250 -1,200
aThe criteria for 1999-2000 were proposed by the government but
were not subject to IMF approval
since, under an EFF, only the targets for the first year of the
program are set. bThe criterion could be adjusted by $200 million
(to -$600 million) to reflect a temporary increase in
the amount of government securities purchased from commercial
banks. According to IMF staff, the"adjuster" accounts for central
bank purchases of government securities from commercial banks in
order to meet commercial banks' temporary liquidity needs during
December. The central bank willsell the securities back to the
commercial banks in January. cThe criterion limits the total
increase in public-sector debt (external and internal). dThe
criterion could be adjusted by up to $2 billion in overborrowing
by the public sector and deposited in the central bank. According
to IMF staff, the "adjuster" accounts for preborrowing by
thepublic sector to meet 1999 financing needs. The IMF does not
want to penalize the government for
the preborrowing strategy, under which the government borrows
funds at lower interest rates andlonger maturities when possible,
that has helped Argentina weather uncertainty in capital markets.
eThe expenditure target sets the maximum level of government
spending, excluding interest. Sources: IMF and Argentine
government documents.
Quantitative PerformanceCriteria Focused on Fiscal Levels
Table II.2: Argentina's Quantitative Performance Criteria and
Indicative Targets, 1998-2000, (Dollars in Millions, U.S.), as
Agreedto in February 1998
Appendix II The IMF's Financial Arrangement with Argentina
Page 63 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The goals of
the fiscal deficit criteria were to reduce the overall
federalgovernment deficit while increasing spending in social
areas, stimulate domestic saving, and strengthen confidence in the
continued viability ofthe currency convertibility regime. The $3.5
billion deficit represents about 1 percent of GDP, which was
estimated at about $340 billion for 1998. Themonetary program was
intended to strengthen confidence in the currency board and the
banking system by maintaining a sound financial system
andproviding for an adequate cushion of liquidity that could
compensate for the limited role of the central bank as a lender of
last resort. Under the current EFF, the Argentine government
agreed to meet thefollowing structural benchmarks by the end of
1998:
Tax reform
* Submit to the Argentine congress a tax reform program before
mid-1998for approval before the end of 1998. Tax reforms were
intended to improve
the efficiency and equity of the tax system and promote
thecompetitiveness of the economy. The reforms were aimed at
contributing to a reduction in labor costs by cutting employers'
payroll contributions,diminishing distortions in corporate and
individual taxes, broadening the income tax base, applying the
value-added tax to products not currentlytaxed, introducing a
single tax to replace the value-added and income taxes due from
small businesses, strengthening tax auditing procedures,and
modifying customs codes in line with MERCOSUR (the Southern Common
Market, or customs union) and World Trade Organization norms.The
changes were generally focused on decreasing taxes on production
and increasing taxes on consumption.* Implement the first stages
of a program to strengthen tax administrationby revising penalties
and interest on past due tax obligations to help
normalize relations between taxpayers and tax authorities,
privatizingcollection of past due taxes, and introducing pre-
shipment inspection of imports for the short term.
Labor market reform
* Implement labor reforms before mid-1998-a precondition for
theconclusion of the first review. Increased flexibility in the
labor market was
intended to decrease unemployment, strengthen
economiccompetitiveness, and ultimately ensure the viability of
the currency convertibility regime. The reforms were to
significantly reduce the costs ofdismissing employees, eliminate
statutes that impede the renegotiation of
Structural BenchmarksCovered Many Areas
Appendix II The IMF's Financial Arrangement with Argentina
Page 64 GAO/GGD/NSIAD-99-168 IMF Financial Assistance labor
contracts (expired labor contracts remain legally binding if there
isno agreement to renegotiate them between employers and unions)
and inhibit entry into certain professions, eliminate certain
temporary laborcontracts, decentralize labor negotiations, and
promote increased competition among union-run health care
organizations.
Public sector administration
* Reform budgeting operations. The government was to submit a
multiple-year budget for income, expenditure, and results covering
a 3-year period,
with the goal of providing transparency, efficiency, and control
forbudgetary administration.
* Take measures to promote efficiency in public spending,
especially ineducation, public health services, and the social
security and social
assistance systems, and improve the quality of public
sectoradministration. The measures were to include governance
rules for public employees outlining obligations and increasing
penalties for corruption.
Social sector reform
* Conclude reforms to the public social security system to help
increase theefficiency of expenditures.
* Continue reforms to the health insurance system for retirees
and healthcare organizations (public and private), as agreed with
the World Bank, in
order to strengthen health care, contain the demand for high-cost
hospitalcare, and promote efficiency in health services.
Judicial
* Take steps to speed up rulings in court cases involving taxes
and financialguarantees and collateral.
Privatization
* Grant leases for airports, telecommunications frequencies, and
powerstations.
* Draft proposals to privatize Banco de la Nacio'n, the country's
largest bank.
Appendix II The IMF's Financial Arrangement with Argentina
Page 65 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
Financial/corporate governance
* Revise legislation to help financial institutions more quickly
executeguarantees and collateral, and to develop a legal and
supervisory
framework for financial derivatives.* Approve new antitrust
laws.
The IMF Executive Board completed the first review of
Argentina'sprogram in September 1998, as scheduled. It found that
all applicable quantitative performance criteria were met in March
and June 1998 andthat substantial progress had been made in the
implementation of structural reforms, with the notable exception
of labor market reforms.Argentina's congress passed some of the
intended labor market reforms; it passed legislation lowering
dismissal costs but did not pass legislationintended to make the
collective bargaining process more flexible. The IMF Board urged
the Argentine authorities to take further steps in regard tolabor
market reform, noting that the reform recently approved by
Argentina's congress fell short of what would be necessary to
enhancelabor market flexibility and reduce labor costs adequately.
The IMF Board also expressed concern over the possible adverse
impact of the Russiandebt crisis on Argentina's access to external
financing and urged the authorities to maintain firm macroeconomic
policy to help promote a rapidimprovement in market confidence.
According to IMF and Argentine documents for the second
review,completed as scheduled in March 1999, Argentina met all but
one of its quantitative performance criteria4 (for which a waiver
was granted) andmade progress on structural reforms. The waiver
was requested because the federal government deficit, estimated at
$3.85 billion in 1998 (1.1percent of GDP), exceeded its ceiling by
about $350 million, or around 0.1 percent of GDP.5 However, IMF
staff viewed the deviation as minor,primarily due to adverse
external factors, and as not detracting from overall fiscal
performance. The government noted that, significantly,
thestructural deficit for 1998 was smaller than that of 1997. The
IMF Executive Board granted the waiver. According to the
Argentinegovernment, its efforts to contain expenditures could not
compensate fully for the revenue shortfall. The shortfall mainly
reflected the slowdown of
4 At the time of the second review, the IMF adjusted two other
performance criteria--addressing
central bank assets and public sector debt--in line with
previously agreed-to levels due to factorsbeyond the government's
control.
5 The government also noted that the indicative target on
aggregate provincial deficit is estimated to have exceeded the
ceiling by 0.2 percent of GDP, reflecting the combined effects of
the tax revenueshortfall and higher than programmed expenditures
by some provinces.
First Review: Argentina MetAll Performance Criteria; Mixed
Progress onStructural Reforms
Second Review: ArgentinaMet Most Performance Criteria; Mixed
Progress onStructural Reforms
Appendix II The IMF's Financial Arrangement with Argentina
Page 66 GAO/GGD/NSIAD-99-168 IMF Financial Assistance economic
activity in the second half of 1998 and its adverse effect
ontaxes, particularly the value-added tax. The government noted
that debt limits were met in the context of tighter conditions in
international capitalmarkets. A larger than anticipated share of
the deficit was financed using public sector deposits and receipts
from asset sales. Argentina made progress in several areas of
structural reform, accordingto IMF and country documents. The
government implemented most of the tax reforms but was only able
to pass some of the intended labor reforms.The government
implemented tax reforms that, among other things, expanded the
bases of the income and value-added taxes and improved
taxadministration by enhancing tax audit procedures and hastening
the resolution of court cases involving tax enforcement. Regarding
laborreforms, Argentina's congress approved a law to reduce
dismissal costs and eliminate most forms of temporary labor
contracts with decreasedsocial security contributions. Reforms
regarding collective bargaining were not passed. While IMF staff
stressed the importance of makingArgentina's labor market more
flexible--particularly given the uncertainty about continued
access to foreign financing and trade levels--they told usthat
they do not expect the government to complete the remaining labor
reforms before the fall 1999 elections. As such, according to IMF
staff, theemphasis on labor reforms is likely to be eased.
Argentina continued making reforms to budgeting operations, public
sector administration, andthe public hospital system.
Restructuring of the health-care system continued, as agreed with
the World Bank. The government completedleasing arrangements for
airports and continued working on leasing arrangements for
telecommunications frequencies, which were delayed byjudicial
challenges, and power stations. It concluded reforms to the public
social security system. In January 1999, the government outlined
its proposed objectives, criteria,and benchmarks for the second
year of the arrangement. The government intends to continue to
focus its economic policies on promotingsustainable growth in
output and employment, addressing priority social needs, and
maintaining low inflation and a viable external position.
Thegovernment noted that in light of the presidential election
scheduled for October 1999 and the uncertainty of the adverse
internationalenvironment, it recognized the critical importance of
maintaining disciplined and restrained macroeconomic policies,
further improvingpublic finances, strengthening the financial
system, enhancing competitiveness, and deepening structural
reforms. In March 1999,Argentina and the IMF reached agreement on
the quantitative performance
New Criteria andBenchmarks
Appendix II The IMF's Financial Arrangement with Argentina
Page 67 GAO/GGD/NSIAD-99-168 IMF Financial Assistance criteria and
structural benchmarks for monitoring the country's progressduring
1999, as shown in table II.3.
Jan. 1999 -Mar. 1999 Dec. 1997-Sept. 1998 Dec. 1998-Dec. 1999 Dec.
1999-Dec. 2000 Quantitative performance criteriaCumulative federal
government deficit $ -1,300 $ -1,675 $ -2,300 $ -2,950 Cumulative
ceiling on noninterest expenditures of the federalgovernment 9,500
18,800 28,700 38,050
Cumulative change in net domestic assets of the central banka -200
-325 -590 -690Net cumulative disbursements of public sector debt
b 2,500 5,200 5,200 4,000
Net cumulative increase in short-term debt 1,000 1,000 1,000
1,000Indicative target
Combined deficit of federal government and provinces -- -2,475 --
-4,400
aThe criterion will be adjusted upwards by the equivalent to any
purchase from the IMF. The
measurement of net domestic assets throughout the year will be
adjusted to reflect any differencebetween the end-1998 stock of
swaps and projected levels. The measurement for December 1999
will also be adjusted downward for up to $300 million to account
for temporary liquidity needsreflected in an equivalent increase
in swaps. bThe measurement of disbursements will be adjusted to
reflect any difference between actual privatization receipts and
projected levels.
Sources: IMF and Argentine government documents. The estimated
cumulative federal government deficit between January1999 and
December 1999 was increased from $2.65 billion to $2.95 billion
(0.8 percent of GDP) to reflect the criterion missed in the
previous quarter.The ceiling on the noninterest expenditures of
the federal government was changed from an indicative target to a
quantitative performance criterionbecause, according to IMF staff,
there was concern about the sufficiency of tax revenues. Many of
the new structural benchmarks continue ongoing reforms. By
thethird review (August 1999) the Argentine government is to
* present a proposal to reform the system of tax-revenue sharing
with theprovinces. In light of the fiscal deficit, IMF staff
stressed the importance of
achieving this reform. The reform of the tax-sharing arrangement
betweenthe government and the provinces is intended to strengthen
the provinces' own revenue-raising capacity and design a more
equitable, transparent,and flexible system of intergovernmental
transfers.
* lease telecommunication frequencies.*
implement new monitoring systems for the external debt and the
financesof provincial administrations.
Table II.3: Argentina's Quantitative Performance Criteria and
Indicative Target for 1999, (Dollars in Millions, U.S.), as of
March1999
Appendix II The IMF's Financial Arrangement with Argentina
Page 68 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
* implement the enabling regulations for the labor statute for
small- andmedium-size firms.
* submit to the Argentine congress a proposal to transform the
Banco de laNacio'n into a state-owned corporation. This benchmark
represents a
change from the government's original intention to privatize the
bank.When it appeared that congress would not approve the
privatization of the bank, the authorities decided to propose the
transformation of the bankinto a state-owned corporation that
could include private capital and management, be listed in the
stock exchange, and thus be subject toincreased public disclosure
requirements.
* submit to the Argentine congress a proposal to further reform
socialsecurity.
* complete the sale of the first package of shares of the
National MortgageBank.
Also, by August 1999, the Argentine congress is to approve
* the proposed changes to the central bank charter and the
financial entitieslaw, which are intended to improve banking
supervision and risk
assessment of financial institutions; and* the fiscal
responsibility law, which sets limits on governmentindebtedness,
constrains the growth of public expenditure, and establishes
a fiscal stabilization fund to smooth out the impact of cyclical
fluctuationsor external shocks on tax revenue. The government
intends to improve the efficiency of social spending in education
and social protection programs.
By the fourth review (Feb. 2000), the Argentine government is to
* implement the tax administration program aimed at, among other
things,shifting to a new electronic tax filing and collection
system; strengthening
auditing procedures; and amending the customs code, after
congressionalapproval, to incorporate MERCOSUR (the Southern
Common Market, or customs union) norms and new World Trade
Organization valuation rules;and
* eliminate the 3 percent import surcharge to the common external
tariff.
Also by this time Argentina's congress is to approve the social
securityreform and new law for Banco de la Nacio'n.
Appendix II The IMF's Financial Arrangement with Argentina
Page 69 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The key
factors affecting Argentina's short-term macroeconomic outlookwere
the need for improvements in trade and the continued availability
of private-sector capital. Argentina recorded a satisfactory
macroeconomicperformance in 1998, in a relatively difficult
international macroeconomic environment. However, the economy
slowed considerably in the secondhalf of 1998, in response to the
tightening of external financing conditions in the wake of
Russia's and Brazil's financial crises and the slowdown inexport
earnings. For 1998, GDP growth was estimated at about 4.2 percent,
down from 7 1/4 percent in the first half of the year. Since mid-
January 1999,the external macroeconomic environment (trade and
investment) has deteriorated because of adverse events in Brazil.
The program agreed to inMarch 1999 (including quantitative
performance criteria for 1999) was negotiated in December 1998,
consistent with the external environment atthat time. Argentina
and IMF officials noted that the country had weathered the
turbulence in external markets well; however, given theuncertain
environment, the government and the IMF agreed to reexamine the
program and modify it, if needed. The third review was conducted 3
months ahead of schedule in order toreevaluate the assumptions
underlying the 1999 program and modify the performance criterion
in light of the deterioration in the externalenvironment since the
program was negotiated. Despite the decline in Argentina's
economic activity and current account balance,
preliminaryinformation indicated that the country made progress on
the structural reforms and met the quantitative performance
criteria for end-March 1999.However, GDP in 1999 is expected to
decline by 1.5 percent (from the previously projected gain of 2.5
percent), which is expected to significantlyreduce federal
government revenues from the previous estimate by about $2.5
billion. Argentine government officials and IMF staff noted that
while thegovernment was able to compensate for the revenue
shortfall in the first quarter of 1999, fully compensating for the
total estimated shortfallthrough additional spending cuts would
seriously impair the quality of public services and aggravate the
economic downturn. The governmenttherefore requested an increase
in the 1999 federal deficit performance criterion from $2.95
billion (0.8 percent of GDP) to $5.1 billion (1.5 percentof GDP),
an increase of $2.15 billion, or about 70 percent, from the amount
agreed to in March 1999. The increase reflects about 85 percent of
theexpected shortfall of $2.5 billion, with the government
expected to absorb the remainder. Attaining the new level will
require cuts in governmentexpenditure, including spending for
social programs.
Third Review Accelerated;Performance Criteria Modified
Appendix II The IMF's Financial Arrangement with Argentina
Page 70 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The deficit
level was increased to help ensure that additional
governmentborrowing to finance the deficit does not crowd out
private-sector borrowing or raise uncertainty about the
government's commitment tofiscal discipline. To help achieve the
new target, the ceiling on the noninterest expenditures of the
federal government is to be lowered by$450 million. The debt
ceiling was raised in line with the increase in the deficit in
order to accommodate additional borrowing. The modifiedperformance
criteria are shown in table II.4.
Jan. 1999 -Mar. 1999 Jan. 1999 -June 1999 Jan. 1999 -Sept. 1999
Jan. 1999 -Dec. 1999 Quantitative performance criteriaCumulative
federal government deficit $ -1,300 $ -2,850 $ -4,200 $ -5,100
Cumulative ceiling on noninterest expenditures of the
federalgovernment
a 9,500 18,750 28,450 37,600
Cumulative change in net domestic assets of the central bankb -200
-325 -590 -690Net cumulative disbursements of public sector debt
c 2,500 6,800 7,350 6,150
Net cumulative increase in short-term debt 1,000 1,000 1,000
1,000Indicative target
Combined deficit of federal government and provinces -- -3,750 --
-6,800
aThe amount will be adjusted upward in excess of the projections
of tax refunds. This "adjuster" is
intended to limit delays in granting refunds, which could create
additional revenue and thus createroom for increasing
expenditures. The maximum cumulative adjustment will be $50
million, $250
million, and $450 million in the second, third, and fourth
quarters, respectively. bThe amount will be adjusted upwards by
the equivalent to any purchase from the IMF. The
measurement of net domestic assets throughout the year will be
adjusted to reflect any differencebetween the end-1998 stock of
swaps and the projected level of $275 million. The measurement for
December 1999 will also be adjusted downward for up to $300
million to account for temporaryliquidity needs reflected in an
equivalent increase in swaps. cThe measurement of disbursements
will be adjusted to reflect any difference between actual
privatization receipts and projected levels. The amount of debt
for December 1999 will be adjusteddownward for any borrowing up to
$2.5 billion related to financing requirements for the year 2000
deposited at the central bank. Source: Argentine government
document.
The Argentine government recognized the importance of
reinvigorating thestructural reforms to improve economic
efficiency and strengthen market confidence. Many of the new
structural benchmarks continue or accelerateongoing reforms. By
the third review (May 1999) the Argentine government is to
* present a proposal to reform the system of tax-revenue sharing
with theprovinces.
* implement new monitoring systems for the level and composition
of thefinancing to the provincial administrations.
Table II.4: Argentina's Proposed Quantitative Performance
Criteria and Indicative Target for 1999, (Dollars in Millions,
U.S.), asof May 1999
Appendix II The IMF's Financial Arrangement with Argentina
Page 71 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
* submit to the Argentine congress a proposal to transform the
Banco de laNacio'n into a state-owned corporation.
By the fourth review (November 1999) the Argentine government is
to
* submit to the Argentine congress a proposal to reform social
security.*
implement a new monitoring system for conditions of access
bycommercial banks to external credit lines.
* submit to the Argentine congress a proposal to reform the tax
code.*
lease telecommunication frequencies.
Also by November 1999, the Argentine congress is to approve the
fiscalconvertibility law and the changes to the central bank
charter and the financial entities law.
Appendix IIIThe IMF's Financial Arrangement with Brazil
Page 72 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The
turbulence in international financial markets hit Brazil
especially hardin the fall of 1998. Brazil's capital account came
under serious pressure in the wake of the Russian crisis and
Brazil's foreign currency reservesdeclined substantially. To shore
up confidence in its economy, Brazil negotiated a 3-year program
with the IMF, which was announced inNovember 1998.
1 It consists of a 3-year Stand-by Arrangement (SBA),
supplemented in the first year by the Supplemental Reserve
Facility (SRF),for a total amount equivalent to about $18 billion.
2 The IMF Executive
Board approved Brazil's program on December 2, 1998, and Brazil
receivedits first disbursement of $4.6 billion.
The second disbursement was scheduled for February 1999 after the
IMFcompleted the first and second reviews of Brazil's progress in
implementing the program.3 Because of continued problems in
Brazil'seconomy and a new exchange rate regime after the first
disbursement, Brazil's IMF program needed to be revamped before a
seconddisbursement would be made available. At the time of the
combined SBA and SRF reviews, Brazil did not meet one of four
quantitative performancecriteria (meeting a ceiling on net
domestic assets of the central bank). The IMF Executive Board
granted a waiver for not meeting this criterion andapproved the
revised program on March 30, 1999, thereby opening the way for the
next disbursement. Brazil received $4.9 billion from the IMF
onApril 6, 1999.
The cornerstones of Brazil's IMF program, as announced in
November1998, were strong improvement in Brazil's public finances,
the acceleration of the congressional approval of structural
reforms, and maintenance of itsexchange rate regime that was
pegged to the U.S. dollar. The program combined a large up-front
fiscal adjustment of over 3 percent of grossdomestic product (GDP)
with reforms of social security, public
1 Brazil's IMF program is part of a package of international
financial support totaling about $41 billion.
2 The stand-by credit is equivalent to 600 percent of Brazil's IMF
quota. To help finance Brazil's financial drawings from the IMF
during the first year, the IMF also approved the first activation
of theNew Arrangements to Borrow. The New Arrangements to B orrow
came into effect in November 1998.
According to the IMF, it is designed to supplement resources
available to the IMF to cope with animpairment of the
international monetary system or deal with an exceptional
situation that poses a threat to the international system. Of the
total credit, 70 percent is to be made available under the SRFand
the remainder through the IMF's regular lending facilities.
3 According to the IMF, the completion of the first and second
reviews simultaneously was required due to the fact that Brazil
had received funds under two different policies, a credit tranche
and theSRF. The second disbursement could have been drawn as a
floating (second) tranche in December
1998, if needed, after the first review had it been requested by
the Brazilian government. Had thathappened, the first and second
reviews would not have taken place simultaneously. However, Brazil
did not request a drawing of this floating tranche, and so the
first and second reviews were carried outtogether.
Summary
Appendix III The IMF's Financial Arrangement with Brazil
Page 73 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
administration, public expenditure management, tax policy, and
revenuesharing. Although the Brazilian government was successful
in passing many of the promised fiscal measures or instituting
interim offsettingmeasures, delays in passing some of the fiscal
measures, combined with reports that a state governor was
unwilling to service his state's debt to thefederal government,
further eroded market confidence and resulted in additional loss
of reserves. Brazil was forced to devalue its currency onJanuary
13, 1999, and then float its currency, the real, on January 15,
1999. IMF mission staff began meeting with Brazilian officials in
late January todesign a modified program, which was then announced
in early March.
Brazil's revised program requires strengthened fiscal adjustment
andreplaces the exchange rate as the nominal anchor of the
monetary system with a monetary policy targeted at securing low
inflation. Fiscal policyaims to reduce the net public debt to GDP
ratio to 2 percentage points below the original target of 46.5
percent by the end of 2001. The originalprogram's comprehensive
structural reform agenda, in such areas as social security, civil
service reform, tax policy, budgetary procedures, and
fiscaltransparency, has been enhanced. The government also intends
to accelerate and broaden its privatization program. Table III.1
outlines a brief chronology of key events in Brazil's current
IMFarrangement.
Date Event Aug. 1998
Brazil's capital account comes underpressure in wake of Russian
crisis; significant reserve outflows
Sept. 1998
Brazil began talks with the IMF andannounced that it would prepare
a 3-year fiscal program aimed at stabilizing the netdebt to GDP
ratio.
Nov. 13, 1998
Brazil and the IMF announce agreement onBrazil's 3-year
arrangement and an $18 billion IMF commitment (as part of a
larger$41.5 billion international financial support package)
Dec. 2, 1998
IMF Executive Board approves Brazil'sarrangement, opening the way
for Brazil's first disbursement of $4.6 billion
Jan. 13, 1999
Brazil's central bank widens real tradingband, thereby allowing an
8 percent devaluation ($3 billion currency outflow)
Jan. 15, 1999
Brazil's central bank allows real to float freeof the trading band
in foreign exchange markets (results in an additional 12
percentdevaluation)
Table III.1: Chronology of Key Events inBrazil's Current IMF
Arrangement
Appendix III The IMF's Financial Arrangement with Brazil
Page 74 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
Date Event Feb. 1999 Completion of the first and second reviews
ofthe IMF program scheduled March 8, 1999 Announcement of
agreement between theIMF and Brazil on a revised IMF program
March 30, 1999
IMF Executive Board approves the revisedIMF program, opening the
way for Brazil's second disbursement April 6, 1999 Brazil receives
second disbursement of $4.9billion Source: GAO analysis of IMF and
other documents.
In August 1998, Brazil's capital account came under serious
pressure in thewake of the Russian crisis. The Brazilian
authorities responded with a sharp increase in interest rates;
significant fiscal measures, includingsubstantial spending cuts;
and strengthening of institutional mechanisms to monitor
developments in public finances and take further timelycorrective
actions, if needed. The IMF Managing Director said he was
encouraged by the determination of Brazil's president to give high
priorityto further fiscal reforms. Brazil also began a dialogue
with the IMF to ensure that adequate financial support could be
arranged quickly, ifneeded. The government of Brazil saw the
nature of the IMF program as preventive--to assist the country in
facing a period of deep uncertainty ininternational financial
markets and to enable the government to continue gradual
depreciation of the exchange rate without having to move to
afloating currency system.
A 3-year IMF program was announced in November and approved by
theIMF Executive Board on December 2, 1998. The IMF program
represented one portion of a larger support package totaling about
$41.5 billion madeup of commitments from the World Bank; the
Inter-American Development Bank; and bilateral financing from 20
countries, in most cases to guaranteecredits extended to Brazil by
the Bank for International Settlements.
When the program was announced in November, the IMF stated, in
itspress release, that the program first and foremost addresses
the chief source of Brazil's external vulnerability--namely its
chronic public sectordeficit (5-7 percent of GDP). The reduced
savings of the public sector necessitated a growing resort to
external savings to finance the rise indomestic investment,
leading to an increase in the current account deficit of the
balance of payments from under 0.5 percent of GDP in 1994 to over4
percent of GDP in 1997.
Brazil's November 1998IMF Program IMF Program Announced
Appendix III The IMF's Financial Arrangement with Brazil
Page 75 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The IMF
program is supported by a 3-year SBA, augmented in the first
yearby the SRF, for a total amount equivalent to about $18
billion. Around 70 percent of the funds were to be under the SRF.
Brazil received its firstdisbursement of $4.6 billion in early
December. The second disbursement was scheduled for February 1999
after completion of the first and secondreviews; however, due to
the events in January, it was delayed until after the revamped
program was agreed upon by the IMF Executive Board onMarch 30,
1999.
The November 1998 IMF program had four program objectives:
* a frontloaded fiscal adjustment effort (with most of the fiscal
adjustmentexpected to occur in the first half of 1999) aimed at
arresting quickly the
rapid growth of public sector debt;* maintenance of the exchange
rate regime that existed at the time;* a tightly controlled
monetary policy, aimed at supporting the exchangerate regime that
existed at the time, while safeguarding net international
reserves; and* wide-ranging structural reforms.
The economic program was centered on fiscal adjustment and
structuralreform. The macroeconomic scenario underlying the fiscal
program assumed that confidence would be rebuilt gradually as
measures wereimplemented and began to improve Brazil's fiscal
accounts and as access to foreign financing improved. The initial
program had fiscal, external sector, and monetary targets.
Thesewere a mixture of quantitative performance criteria and
indicative targets.
4
The fiscal targets were
* a performance criterion for the "public sector borrowing
requirement,"which set ceilings on the "cumulative borrowing
requirement" of the
consolidated public sector through June 30, 1999;5
4 Quantitative performance criteria are macroeconomic indicators
that the IMF requires a borrower
country meet in order to qualify for the next disbursement.
Indicative targets are also macroeconomicindicators, which the IMF
uses to monitor a country's performance, but disbursements are not
contingent on their being met. 5 The cumulative borrowing
requirement of the public sector is defined as the sum of the
cumulative borrowing requirements of the federal government, state
and municipal governments, and the publicenterprises; the federal
government includes the central government, the social security
system, and
the Brazil Central Bank (BCB). The respective borrowing
requirements are measured in Brazilian Reais(R$), as the sum of
total net financing from all sources, including, among others,
changes in cash balances of the public sector.
The IMF Arrangement andthe Objectives of the Conditionality
Program
IMF Program ComprisedFiscal, Structural, and Monetary Reforms
Elements of the Fiscal andMonetary Adjustment Program
Appendix III The IMF's Financial Arrangement with Brazil
Page 76 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
* an indicative target that set a minimum on the primary surplus
of theprimary balance of the federal government; and
* an indicative target that set a minimum floor on the
recognition ofnonregistered public sector debt net of
privatization proceeds.
The fiscal quantitative performance criteria were intended to
stabilize theratio of the net public debt to GDP by the year 2000
and then reduce it gradually thereafter. Under these assumptions,
the public sectorborrowing requirement would decline to about 4.7
percent in 1999, to about 3 percent in the year 2000, and to 2
percent in 2001. The bulk of thisadjustment was planned at the
federal level; however, the states and municipalities were
expected to shift their consolidated primary balancefrom an
estimated deficit equivalent to 0.4 percent of GDP in 1998 to a
surplus of 0.4 percent of GDP in 1999, rising to 0.5 percent in
the years2000 and 2001. The main elements behind the assumption of
the state and local governments' primary balance improvement were
theimplementation of the administrative reform laws and the firm
enforcement of their debt restructuring agreements with the
federalgovernment. The fiscal adjustment program had both revenue-
raising and expenditure-reducing measures designed to yield
overall budget savings of3.4 percent of GDP in 1999.
Revenue measures to achieve the indicative target on the primary
balanceof the federal government included
* increases in the financial transactions tax rate from 0.2
percent to 0.3percent with a temporary surcharge of 0.08 percent
for 1999;
* an increase in the rate of the tax on corporate turnovers from
2 to 3percent, one-third of which is to be creditable against the
corporate
income tax;* an increase of 9 percentage points in the
contribution to the public sectorpension plan by civil servants
earning more than R$1,200/month;
* the extension of this contribution to public sector pensioners
(at the rateof 11 percent for those with pensions of R$1,200/month
or less and of 20
percent for the others); and* a number of other measures aimed
mainly at widening the bases ofexisting taxes and contributions,
and eliminating distortions.
Expenditure measures included substantial cuts in discretionary
currentand capital spending and savings expected from
implementation of already approved constitutional reforms of the
civil service and social security.
Appendix III The IMF's Financial Arrangement with Brazil
Page 77 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The external
sector targets were
* a performance criterion on external debt of the nonfinancial
public sector,which set a ceiling on the stock of this debt;
6
* a performance criterion that set a ceiling on new publicly
guaranteedexternal debt;
7
* an indicative ceiling on total short-term external debt
disbursed andoutstanding; and
* a floor on net international reserves in Brazil's Central Bank
(BCB).8
The monetary target was a performance criterion that set a ceiling
on netdomestic assets in the BCB.
9
The goal of monetary policy was continued low inflation. The
BCBintended to continue to apply a flexible interest rate policy
as appropriate while safeguarding foreign exchange reserves, and
to rely on indirectpolicy instruments to guide short-term interest
rates. The government, with the support of the IMF, intended to
maintain the pegged exchangerate regime with a gradual widening of
the exchange rate band and to keep the increase in public sector
external debt within prudent limits, aroundUS$10 billion in 1999.
While Brazil's program does not contain structural performance
criteria, itdid include a variety of structural benchmarks and
measures to address long-standing weaknesses in the budget
process; the tax system and taxadministration; public
administration; social security; and the efficiency of public
expenditure, especially in the social area. Table III.2 outlines
the
6 The nonfinancial public sector includes the central, state, and
municipal governments, the public
enterprises, and the social security system. Excluded from
measured debt stocks are any liabilitiesincurred in the context of
the proposed financing package, either vis-a`-vis the IMF or
bilateral lenders.
7 The limit applies to all private external debt guaranteed by the
public sector. The public sector includes the nonfinancial public
sector (as defined above), the BCB, and the financial public
sector. 8 The net international reserves in the BCB are measured
in terms of the balance of payments concept of the net
international reserves and include gross official reserves minus
gross official liabilities. 9 This performance criterion is to be
calculated on the basis of the following definitions: net domestic
assets in the BCB are defined as the difference between the
monetary base and the net internationalreserves in the BCB valued
in Brazilian Reais (R$). The monetary base consists of currency
issued and
total reserves on demand deposits of financial institutions. Total
reserves on demand deposits includeboth required reserves and free
reserves. The net international reserves are equal to the balance
of payments concept of net international reserves in the BCB. This
performance criterion indicates themaximum level of net domestic
assets in the BCB. There are adjusters applied to the net domestic
asset ceilings (for an increase in the rate of the contribution on
funds transfers; for changes in therequired reserve ratio on
demand deposits; for changes in the reservable base of demand
deposits; and for an unforeseen loss of net international
reserves).
The Program Contained VariedStructural Reforms
Appendix III The IMF's Financial Arrangement with Brazil
Page 78 GAO/GGD/NSIAD-99-168 IMF Financial Assistance various
structural reforms contained in Brazil's November 1998 IMFprogram.
Type of Reform Description Budget process reform
Reforms aimed at strengthening budgetdiscipline at all levels of
government-Fiscal Responsibility Act to be submitted to
theBrazilian Congress by December 1998.
Social security reform
A set of new legislative initiatives to bepresented to the
Brazilian Congress in the first quarter of 1999 based on the
principle ofactuarial balance.
Tax reform
Legislation to be presented to the BrazilianCongress before the
end of 1998 to address weaknesses in Brazil's current indirect
taxsystem, which is viewed as inefficient and unduly complex.
Administrative reform
Passage of enabling legislation alreadysubmitted to the Brazilian
Congress to ensure administrative reform already passedbegins to
produce effects in 1999.
Labor market reform
The government sent to the BrazilianCongress a proposal for
constitutional reform that reduces restrictions on unions
andcreates incentives for public collective bargaining.
Privatization
Programs focused in public utilities (electricalsector; and some
water, gas, and sewage public utilities) and state banks.
Social expenditure programs
The government intends to give priority toprimary education and
basic health care in the allocation of social expenditures,
topromote the more efficient use and financing of health and
education, and to better targetsocial expenditures to the poor.
Banking reforms
Reduction in the share of total deposits ofthe Brazilian financial
system held by state banks to about 7 percent by end-1999.
Allremaining state banks are to be subject to the same regulatory
and supervisory scrutinyas private banks. Legislative and
supervisory framework-considerable strides have been made in
implementing the 25 basic principles of theBasle Committee, and
the government believes that Brazil can be fully compliant bythe
year 2000. Addition of a stand-by facility to the depositinsurance
fund to improve its finances. Measures to speed up the resolution
of failedbanks and to increase asset recovery rates.
Brazilian economic statistics improvements Subscribe to the
Special Data DisseminationStandards as soon as technically
feasible. Source: IMF documents.
Table III.2: Structural ReformsContained in Brazil's November 1998
IMF Program
Appendix III The IMF's Financial Arrangement with Brazil
Page 79 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The
government committed to continue the policy of trade
liberalizationby doing the following:
10
* promoting the integration of the Brazilian economy with those
of itsMERCOSUL (the Southern Common Market, or customs union) and
other
regional trading partners;* increasing trade with countries
outside the region; and* not imposing trade restrictions or
restrictions including for balance ofpayments reasons
The government also said it would continue to promote
thecompetitiveness of Brazil's exports through steps aimed at
leveling the playing field for Brazilian exporters, thus
facilitating access to financingand to export credit insurance.
The following prior actions were included in the November 1998
IMFagreement:
* By end-November 1998, increase the rate of the financial
transactions taxto 0.38 percent for 1999 is to be under
consideration by the Brazilian
Congress.* For completion of the first review (which was
scheduled by month-endFebruary 1999, but could have been advanced
to December 15, 1998),
enact revenue and expenditure measures sufficient to give
confidence thatthe fiscal program targets for 1999 are likely to
be met, and enact the constitutional amendment for social security
reform, for both the privatesector social security system and the
federal public sector social security system. The government of
Brazil was initially successful in implementing many ofthe
elements of the fiscal package that were the core of its program.
Prior to the approval of the Stand-by Arrangement by the IMF
Executive Boardon December 2, 1998, it had successfully guided
through the Brazilian Congress, the constitutional amendment on
social security reform and anincrease in the tax on corporate
turnover. However, the proposed measure to increase the social
security contribution on active civil servants andextend it to
retired ones, was not approved in early December, and the
government's efforts to pass the financial transactions tax were
delayed.These were requirements under the November IMF program. In
response to delays in getting an increase in the financial
transactions tax, the
10 See International Monetary Fund: Trade Policies of IMF
Borrowers (GAO/GGD/NSIAD-99-174, June
22, 1999) for a further description of Brazil's trade-related
conditions.
Trade-related Elements of theProgram Prior Actions Contained inthe
November Program Brazil's Progress inImplementing the Program's
Components
Appendix III The IMF's Financial Arrangement with Brazil
Page 80 GAO/GGD/NSIAD-99-168 IMF Financial Assistance government
increased taxes on corporate profits and financial operationsby
executive decree. In early January 1999, a few Brazilian state
governors demanded betterpayment terms on their debt payments to
the federal government, and one declared a moratorium on these
payments (24 of Brazil's 27 stategovernors have agreements with
the federal government whereby, in exchange for fiscal adjustment,
the federal government has assumed theirdebt, rescheduled it over
the long term, and agreed to charge preferential interest rates).
This action precipitated the most recent crisis and putpressure
once again on Brazil's exchange rate, with major outflows of
international reserves. In early January 1999, the president of
the central bank resigned. OnJanuary 13, his successor then
widened the real's trading band. This action effectively devalued
the currency by 8 percent. Massive currency outflowsfollowed, and
2 days later Brazil gave up defending its currency and let the
real float. This action, in turn, resulted in an immediate
devaluation ofanother 12 percent.
Progress continued on implementation of the fiscal program in
January.After the real was allowed to float and new negotiations
began with the IMF, Brazil's Congress passed a law increasing the
pension contribution ofcivil servants, which had been rejected
previously. Brazil also approved a bill to increase the financial
transactions tax, which had been delayedbefore. Both of these
measures were requirements of the November IMF program. The BCB
raised interest rates even further to try to encourageinvestors to
keep their money in Brazil.
Under Brazil's arrangement with the IMF, completion of the first
andsecond review was scheduled to take place no later than the end
of February 1999; however, due to the change in the exchange rate
regimethat was pegged to the U.S. dollar and the currency
devaluation, Brazil and the IMF delayed the review completion
until March. As a result, Brazil didnot receive an additional
disbursement as scheduled in February.
In addition to negotiating revisions to the economic program with
the IMF,Brazilian officials also negotiated voluntary support
commitments with their creditor banks. According to the IMF's
Managing Director, this effortwas integral to the success of the
program and was seen as a key factor in the IMF Executive Board's
consideration of the program in late March.Brazilian officials
reached the necessary agreement in mid-March. In the
Completion of the FirstReview Was Delayed Slightly
Appendix III The IMF's Financial Arrangement with Brazil
Page 81 GAO/GGD/NSIAD-99-168 IMF Financial Assistance voluntary
agreement, banks agreed to keep trade and interbank credit linesat
end of February levels until the end of August. On March 8, 1999,
the IMF's Managing Director announced his intention torecommend to
the IMF's Executive Board the approval of the revised economic
program for 1999-2001 proposed by the Brazilian government.The
amount of support to be provided by the IMF portion and the total
package, including that provided by multilateral banks and
bilateralfinancing, remained the same. The key elements of the
revised program are strengthened fiscal adjustment and, in light
of the floating exchange rate,the adoption of a new nominal anchor
for monetary policy. The additional fiscal improvement and a firm
monetary policy are expected to limit theimpact of the currency
depreciation on prices in the first half of 1999 and to facilitate
a decline in the annualized monthly inflation rate to singledigits
by the end of the year. Brazil's balance of payments is expected
to improve as capital inflows recover and Brazil capitalizes on
its improvedcompetitiveness.
The IMF's Executive Board approved the revised program on March
30,1999, thereby opening the way for Brazil's next disbursement.
Brazil requested and was granted a waiver of nonobservance of one
performancecriterion--the ceiling on net domestic assets in the
BCB. According to IMF officials, the nonobservance of the
performance criterion was the result ofa premature easing of
monetary policy.
Like the initial program, the revised program contains fiscal,
externalsector, and monetary targets, some of which are the same
as previous criteria or indicative targets and others of which are
different. Accordingto the IMF, the changes were the result of two
factors: (1) understandings that were formulated in an informal
way under the original program weremade into performance criteria,
and (2) the reformulation of the program required different
performance criteria on technical grounds. The two fiscal targets
are different from the initial program. They consistof:
* a performance criterion that set a floor on the cumulative
primary balanceof the consolidated public sector
11 and
11 The public sector is defined to comprise the central
government, state and municipal governments,
and the public sector enterprises (including federal, state, and
municipal enterprises). The centralgovernment includes the federal
government, the social security system, and the BCB. The
cumulative
primary balance of the public sector is defined as the sum of the
cumulative primary balances of theentities that make up the public
sector.
Revised ProgramAnnounced in March Fiscal and Monetary Elements
ofthe Revised Program
Appendix III The IMF's Financial Arrangement with Brazil
Page 82 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
* an indicative target that set a ceiling on the total net debt
outstanding ofthe consolidated public sector.
12
The government intends to steadily reduce the ratio of public debt
to GDPto below 50 percent by end-1999, and to below the value
initially projected in the November 1998 program for the end of
2001 (46.5 percent). Thegovernment expects to accomplish this
through higher than originally targeted primary surpluses of the
consolidated public sector in the next 3years. The government
intends to increase the targeted primary surplus to at least 3.1
percent of GDP in 1999, 3.25 percent of GDP in the year 2000,and
3.35 percent of GDP in 2001. According to the IMF, the need for
higher primary surpluses comes from the higher interest bill that
resulted fromthe currency being devalued. Hence, to achieve the
same debt-GDP ratio, primary surpluses needed to be higher. As in
the initial program, the additional fiscal adjustment is to be
achievedthrough a range of revenue-raising measures and
expenditure cuts. This effort will be concentrated at the federal
level, but the state and localgovernments are expected to
contribute through the implementation of their debt restructuring
agreements with the federal government and bycomplying with the
requirements of the administrative reform laws.
The first two external sector targets were the same as in the
initialprogram, while four more performance criteria were added:
* a performance criterion that set a ceiling on the total
external debt of thenonfinancial public sector,
* a performance criterion that set a ceiling on new publicly
guaranteedexternal debt,
* a performance criterion that set a ceiling on total short-term
external debtof the nonfinancial public sector,
13
* a performance criterion that set a limit on net sales of
foreign exchange bythe BCB,
14
12 The total net debt outstanding of the consolidated public
sector equals the public sector's gross debt
net of its financial assets. 13 This criterion applies to all
external debt (disbursed and outstanding) of the nonfinancial
public sector with original maturities of strictly less than 1
year. According to the IMF, this performancecriterion replaced an
indicative target under the original program that covered all
public debt. This
more narrow definition allowed it to be a performance criterion.
14 According to the IMF, this performance criterion is similar in
purpose to the net international reserves floor of the original
program.
Appendix III The IMF's Financial Arrangement with Brazil
Page 83 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
* a performance criterion on the BCB's exposure in foreign
exchangefutures markets,
15 and
* a performance criterion on the BCB's exposure in foreign
exchangeforward markets.
16
The monetary target is the same--a performance criterion that sets
aceiling on net domestic assets in the BCB;
17 however, in the view of Brazil's
government, monetary policy became a more important component in
therevised program. The overriding objective of monetary policy is
securing
low inflation. The BCB intends to put in place as quickly as
feasible aformal inflation-targeting framework. This is expected
to take some time and in the meantime, it intends to rely on a
quantity-based frameworkunder which it will target its net
domestic assets.
According to IMF documents, the Brazilian government has
reaffirmed itscommitment to the wide-ranging program of structural
reforms included in the November program in such areas as social
security, taxation, fiscaltransparency, and the financial sector.
In most of these areas the government believes it has already made
significant progress. Acceleratingand broadening the scope of the
privatization program is also a goal of the revised program. In
addition, the government remains committed to thepolicy of trade
liberalization (summarized in the November 1998 program) adopted
by Brazil's President. Table III.3 shows the structural
benchmarkscontained in the revised program.
15 This performance criterion says the BCB will refrain from
entering into any new operations in the
foreign exchange markets. 16 This performance criterion says that
the BCB will refrain from entering into any foreign exchange
futures contracts. According to the IMF, Brazil never had any
exposure in foreign exchange forwardmarkets. This performance
criterion was added to clarify this issue.
17 A number of adjusters apply to this performance criterion. The
first is an adjuster for net international reserves being below
the baseline, up to a certain amount According to the IMF, this is
toallow for a limited amount of sterilized intervention in the
event of unforeseen capital outflows.
Sterilized intervention in foreign exchange markets does not
affect a nation's money supply; rather, itoffsets any monetary
expansion or contraction from the intervention through domestic
monetary policy tools. The two other adjusters are for changes in
the required reserve ratio on demand deposits,and for changes in
the reservable base of demand deposits.
Structural Benchmarks andReforms in the Revised Program
Appendix III The IMF's Financial Arrangement with Brazil
Page 84 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
Completion date Structural benchmark By end-May 1999 Submission to
the Brazilian Congress of alaw on the complementary private
pension
system.Submission to the Brazilian Congress of an ordinary law on
the pension system forprivate sector workers. Presentation to the
Brazilian Congress ofthe Fiscal Responsibility Law. By end-August
1999 Issuance of new regulation on the foreignexchange exposure of
banks, in conformity
with international standards in this area.Acceptance of the
obligations under Article VIII, sections 2, 3, and 4 of the IMF's
Articlesof Agreement, with a definite timetable for removing any
remaining restrictions (if any).Proposal of an action plan for
statistical improvements that will permit Brazil'ssubscription to
the Special Data Dissemination Standards.aSubmission to the
Brazilian Congress of the multi-year plan that
incorporatesimprovements in the budgetary process along the lines
described in the November1998 program. Implementation of the
remainingadministrative improvements in the social security
system, as described in theNovember 1998 program. By end-November
1999 Submission to the Brazilian Congress of anordinary law on the
pension system for
public sector workers.Privatization of a number of state-owned
banks.Implementation of a regulation for the institution of a
capital charge related tomarket risks, based on the Basle
Committee (in line with technical assistance from theWorld Bank).
Implementation of a forward-looking loanclassification system that
takes into account the capacity of borrowers to repay (and
inaccordance with technical assistance from the World Bank). aThe
Special Data Dissemination Standards have been developed by the
IMF to guide members in
the provision of macroeconomic and financial data to the public.
Source: IMF documents.
Table III.3: Structural Benchmarks inBrazil's March 1999 Revised
IMF Program
Appendix IVThe IMF's Financial Arrangement with Indonesia
Page 85 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Indonesia1
negotiated a $10.1 billion2 (special drawing rights (SDR)
7,338million),
3 36-month Stand-by Arrangement (SBA) with the IMF in the fall of
1997.4 At the time, Indonesia faced the loss of confidence of
financial markets demonstrated by a sharp currency depreciation, a
fall in equityprices, a decline in foreign currency reserves, and
a substantial fall in its
capital account. Although Indonesia had had real GDP growth
averaging 7percent annually since 1970, investors concerned about
the 1997 currency devaluation in Thailand also became concerned
about structuralconditions in Indonesia. These concerns included
long-standing weaknesses in the financial system; restrictive
domestic trade regulations;import monopolies; and substantial,
short-term, foreign-currencydenominated, private sector debt in
need of refinancing, along withconcerns about political
transition, drought, and the resulting need to import food. The
deep-seated nature of the balance of payments andstructural
problems facing the economy had become increasingly apparent to
IMF officials, who believed a thorough restructuring of the
banking andcorporate sectors was needed for the economy to recover
from the crisis.
The IMF's initial package of conditions in November 1997 called
forvarious monetary, fiscal, structural, and other reforms.
Monetary policy was to be tight to stabilize the exchange rate and
foreign currencyreserves. Once this was achieved, interest rates
could be eased. Fiscal policy started off with a budget surplus,
but became increasingly deficitoriented as the economic situation
worsened. More so than in previous IMF programs with other
countries, structural reforms took a central role.The initial IMF
program and subsequent modifications attempted to restructure
insolvent financial institutions, promote competition in
thedomestic economy, strengthen social safety nets, and address
deficiencies in governance in financial, corporate, and government
sectors. At one
1 Indonesia had a population of 202 million in 1997, had a nominal
gross domestic product (GDP) of
about $211 billion in 1997, and had a per capita income of about
$1,047 in 1997, according to IMF. 2 This amount was augmented
twice in July 1998 and March 1999 for a total amount available to
Indonesia of $12.2 billion as of April 13, 1999. 3 U.S. dollar
amounts are computed from SDR amounts based upon annual averages
for the SDR/dollar exchange rate. For example, in 1997 one SDR
was equivalent to $1.3760. For 1998 the rate was $1.3655and
$1.3807 for the first part of 1999.
4 The announced amount of assistance for Indonesia was $23 billion
of which $10 billion was from IMF, $4.5 billion from the World
Bank, $3.5 billion from the Asian Development Bank, and $5 billion
incentral bank use of reserves. In addition, some countries--the
United States, Australia, Brunei
Darussalam, China, the Hong Kong Special Administrative Region,
Japan, Malaysia, and Singapore--indicated that if necessary they
would make available supplemental financing. Bilateral commitments
amounted to over $18 billion. The tentative supplemental
commitment from the United States was for$3 billion from the
exchange stabilization fund (ESF).
Summary
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 86 GAO/GGD/NSIAD-99-168 IMF Financial Assistance point,
structural policy commitments in Indonesia's program with the
IMFcomprised 117 distinct items.
5
Between November 1, 1997, and April 30, 1999, the IMF's
financialarrangements with Indonesia went through nine letters of
intent
6 and six
reviews and evolved from an SBA to an Extended Fund Facility
(EFF),which allows Indonesia more time to repay the IMF. IMF
officials told us
that in most cases new letters of intent reflect further
development andelaboration of the reform program rather than
substantial revisions of the program. Economic, social, and
political developments followingIndonesia's initial letter of
necessitated program revisions--these adjusted conditions were
documented in new Indonesian letters of intent. Althoughparts of
the structural program have evolved over time, the structure of
the financial sector program was revised twice. Continued access
to IMF funds was contingent on meeting quantitativeperformance
criteria dealing with levels of currency reserves, the stock of
short-term debt contracted by the government of Indonesia or
guaranteedby Indonesia's public sector, and other criteria.
Accessibility of funds was also contingent on an evolving set of
structural performance criteriadealing with the financial sector,
domestic economic regulation and monopolies, and food prices.
These performance criteria changed aseconomic and social
conditions evolved, specific criteria were met or not met, and new
criteria were added. In four of the six program reviews, the IMF
Executive Board grantedwaivers for nonobservance of performance
criteria. In each of these four cases, waivers on structural
measures were requested and received. In onecase a waiver was
granted for nonobservance of financial targets.
At least twice, scheduled disbursements were rephased to reduce
theamounts of funds available and spread the disbursements out
over a longer period of time. The completion of four of the IMF
reviews was delayed,and access to funds was temporarily withheld
until Indonesia made additional progress in implementing
conditions. IMF officials told us thatonly two reviews were
significantly delayed--the first and second reviews under the SBA.
Reviews completed under the EFF, although concluded
5 Structural policy commitments, terms used in the Indonesian
letters of intent, are policy actions that
the government of Indonesia agrees to take within a certain
timeframe. Structural performance criteriaand benchmarks are a
subset of the larger group of structural policy commitments.
6 Letters of intent are prepared by the member country. They
describe the policies that a country intends to implement in the
context of its request for financial support from the IMF.
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 87 GAO/GGD/NSIAD-99-168 IMF Financial Assistance shortly
after their scheduled completion, were broadly on schedule.
Theseshort delays in completion of reviews under the EFF, reflect
provision of extra time to implement key actions or scheduling
constraints given thefrequency of reviews. As of March 25, 1999, a
total of $9.38 billion (SDR 6.793 billion) had been disbursed from
the $12.2 billion of potentiallyavailable IMF funds. Disbursements
were made at 8 points in time--2 on approval of the SBA and EFF
and 6 disbursements were subject toreviews. (See table IV.1 for a
chronology of events related to IMF conditionality in Indonesia.)
Year Month Day Events 1997 July
August October
November
December
2 14 8 31 1
5
30 31
Thailand ceases to maintain the exchange rate peg for the baht
Bank Indonesia allows its currency, the rupiah, to float Indonesia
seeks IMF aid to alleviate its financial difficulties Indonesia
requests IMF assistance and announces the first letter of intent
under the SBA Indonesia closes 16 insolvent banks and places
marginal banks under conservatorship or intensifiedsupervision
IMF Executive Board approves a 3-year SBA equivalent to $10.1
billion (SDR 7.338 billion). Supplementalfinancing commitments
included $18 billion as a second line of defense if the IMF money
was not sufficient. Indonesia receives a $3.0 billion (SDR 2.201
billion) disbursement Two-thirds of the banks, representing over
one-half of the banking system assets, experience runs on
theirdeposits
Government announces plans to restructure the state-banking sector
through mergers and privatization
Table IV.1: Chronology of Selected Events in Indonesia's Current
IMF Arrangement
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 88 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Year Month
Day Events1998 January
March April May
June
12 15 26
1 6 15 10 4
21 4
15 24
Senior IMF officials visit Indonesia to consult with the President
on an acceleration of reforms Indonesia announces the second
letter of intent under the SBA Indonesia announces a comprehensive
program to rehabilitate the banking sector and put into place
aframework for creditors and debtors to deal, on a voluntary and
case-by-case basis, with the external debt problems of
corporations Sixth Cabinet is dissolved President reelected
Scheduled completion of first review under the SBA Indonesia
announces third letter of intent under the SBA The IMF Executive
Board approves completion of the first review under the SBA.
Indonesia receives a $995.7million (SDR 734 million) disbursement
President resigns after several days of rioting, with fatalities
reportedly numbering close to 1,000 Agreement reached with private
creditors in Frankfurt, Germany, covering restructuring of
interbank debt, atrade facility, and a framework for restructuring
corporate debt
Scheduled completion of second review of the SBA Indonesia
announces fourth letter of intent under the SBA
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 89 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Year Month
Day Events1998 July
August September
October November December
15 29 21
25
9 11 23 25
19 24
25 30 6 13
15
The IMF Executive Board completes the second review of the SBA,
disbursing $995.7 million (SDR 734million), and approves an
increase in IMF financing under the SBA by $1.37 billion (SDR 1
billion). IMF announces that additional multilateral and bilateral
financing for the program will be made available, in partthrough
an informal arrangement among bilateral creditors that involved
debt rescheduling or the provision of new money--for total
additional financing of more than $6 billion, including the
increase in IMF funding Indonesia requests SBA be replaced by an
EFF. Letter of Intent outlines first program under the EFF The
government of Indonesia announces a major bank restructuring
package that covers banks with almosthalf banking system assets
IMF Executive Board approves a request to replace the SBA with an
EFF. This program would last 26 monthsin the amount of $6.336
billion (SDR 4.67 billion) and would be 312 percent of quota.
Indonesia receives a $995.7 million (SDR 734 million) disbursement
Announcement of Jakarta Initiative--a framework designed to
promote voluntary restructuring of corporatedebt
Indonesia announces second letter of intent under the EFF
Agreement reached on the rescheduling or refinancing of
Indonesia's bilateral external debt to official creditors
Scheduled and actual completion of first review of EFF. Indonesia
receives a $928.26 million (SDR 684.3million) disbursement
Indonesia announces the third letter of intent under the EFF IMF
staff submits and IMF Executive Board approves completion of
second review under the EFF. Indonesiareceives $928.26 million
(SDR 684.3 million)
Scheduled completion of second review of the EFF IMF Executive
Board approves completion of second review of the EFF. Indonesian
receives a $928.26 million (SDR 684.3 million) disbursement
Indonesia issues fourth letter of intent and memorandum of
economic and financial policies
Scheduled and actual completion of third review of the EFF.
Indonesia receives a $879 million (SDR 648million) disbursement
1999 February
March March
June
15 16 25
7
Scheduled completion of fourth review under the EFF Indonesia
announces its fifth letter of intent under the EFF. Completion of
the fourth review under the EFF and approval of a request for
augmentation of $985.8 million(SDR 714 million). This was the
first bimonthly review. Indonesia receives $465.3 million (SDR 337
million).
Scheduled completion of the fifth review under the EFF $465.3
million (SDR 337 million) available atdisbursement.
Source: GAO analysis of IMF documents.
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 90 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Until its
recent financial crisis--starting in mid-1997--Indonesia had
30years of real economic growth, averaging 7 percent annually,
with annual inflation held continuously below 10 percent in the
previous 2 decades.Over the past 2 decades, the incidence of
poverty was greatly reduced, assisted by improvements in primary
education, effective health care, andfamily planning. Poverty
rates declined from 70 million people in 1970 to 22.5 million in
1996. Universal primary school education was achieved inthe 1980s.
Indonesia's economic performance over the past several decades
rankedamong the best in the developing world. GDP per capita
income was rising toward the level of middle-income countries. The
economic structure hadbecome diversified, as dependency on the oil
sector had declined. An export-oriented manufacturing sector had
emerged led by a dynamicprivate sector and fueled by high domestic
savings and large inflows of foreign direct investment. Prior to
the regional market turbulence in 1997,Indonesia's macroeconomic
situation appeared by many measures reasonably sound: the budget
was in balance, inflation had been containedto single-digit
levels, current account deficits were low, and international
currency reserves were at a comfortable level. This strong
economicperformance helped attract large capital inflows.
These achievements masked persistent underlying structural
weaknessesin the economy, however, that made Indonesia vulnerable
to adverse developments. Extensive domestic trade regulations and
importmonopolies impeded economic efficiency and competitiveness.
Indonesia had many commodities with restrictive marketing
arrangements and manystate enterprises. A government agency--the
State Logistics Agency--had a monopoly over the importation of
essential food items, a domesticmarket monopoly, and the ability
to restrict prices on these food items. A lack of transparency in
decisions affecting the business environment anddata deficiencies
increased uncertainty and adversely affected investor confidence.
Indonesia had a banking system that had expanded too rapidly and
wasnot prepared to withstand the financial turmoil that affected
Southeast Asia in the latter half of 1997. Too many weak banks had
larger thannormal levels of nonperforming loans, foreign exchange
risk, concentrated bank ownership, large exposures to risks in the
property sector, andconnected lending--lending to related
companies. Furthermore, Indonesia had a large, unhedged, private,
short-term foreign currency debt promptedby large differentials
between domestic and foreign interest rates. Indonesian
corporations were heavily exposed to such debt and thus were
Condition of IndonesiaPrior to Its Financial Crisis--Years
ofGrowth and Low Inflation
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 91 GAO/GGD/NSIAD-99-168 IMF Financial Assistance vulnerable
to the adverse effects of a currency depreciation. Growth inshort-
term foreign liabilities outpaced growth in available
international currency reserves. Also, a severe drought in 1997,
the year leading up tothe crisis, created a need for large food
imports.
Following the widening of the intervention band7 on July 11, 1997,
therupiah was allowed to float on August 14. By October 1997, the
rupiah had depreciated significantly as the regional financial
crisis deepened. Thesudden rise in the rupiah value of the
foreign-currency-denominated loans and increased interest rates
that ensued placed the banking and corporatesectors under enormous
stress. At the time, Indonesia faced the loss of confidence of
financial markets demonstrated by a sharp currencydepreciation, a
decline in foreign currency reserves, and a substantial fall in
its capital account. On October 31, 1997, Indonesian authorities
requested and on November 1,1997, the IMF granted a 3-year SBA
equivalent to $10.1 billion (SDR 7,338 million).8 The typical SBA
is designed to provide short-term, balance-of-payments assistance
for deficits of a temporary or cyclical nature. The IMF granted
Indonesia the right to draw the funds provided Indonesia met
theconditions of the program. Drawings were scheduled in 13
disbursements but were to be substantially front-loaded with $3.0
billion (SDR 2,201million) disbursement on November 5, 1997, and
an equivalent amount to be released on March 15, 1998. Interest
charges were levied on a quarterlybasis--at a rate slightly above
the SDR interest rate. Repayments of principal under this
arrangement were to be in eight quarterly installmentsbeginning 39
months after disbursement and ending 60 months after disbursement.
The principal justification for such large access was that
theavailability of sizable external financing would catalyze a
speedy return to confidence and the resumption of normal capital
market financing.Subsequent releases of $785.4 million (SDR 579
million) were to be available on June 15, September 15, and
December 15, 1998. Amounts of$206.8 million (SDR 149.8 million)
were to be released at eight times during 1999 and the year 2000,
according to the IMF.
7 Bank Indonesia set a central rate for the Indonesian currency,
the rupiah, based on a basket of foreign
currencies and intervened in the foreign exchange market to buy or
sell rupiah at an intervention bandaround the central rate. The
intervention band was gradually depreciated to offset the
inflation
differential between Indonesia and its main trading partner
countries. The intervention band waswidened three times in 1996.
8As of April 30, 1999, Indonesia has an IMF quota of $2.9 billion
(SDR 2,079.3 million). IMF holdings of rupiah are $12 billion (SDR
8,726.7 million) or 419.7 percent of quota. The reserve position
in the IMF is$200.9 million (SDR 145.5 million).
Initial SBA--Monetary,Fiscal, and Structural Conditions
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 92 GAO/GGD/NSIAD-99-168 IMF Financial Assistance On October
31, 1997, the Treasury Secretary indicated that the UnitedStates
was prepared to provide contingent additional financial support
that could be made available for a temporary period, if necessary,
tosupplement the resources made available by the IMF. This support
was to be conditioned on the implementation of an appropriate set
ofmacroeconomic and structural policies supported by the IMF, the
World Bank, and the Asian Development Bank. The Treasury Secretary
said thatthe United States was prepared to provide up to $3
billion in assistance from the ESF.9 No negotiations on a possible
ESF arrangement were everconcluded. No legal agreement was reached
concerning such financing. In the event an agreement had been
reached, provision of funds could occuronly upon a determination
by the U.S. Treasury that conditions for a drawing had been met.
No money from ESF was ever disbursed toIndonesia, according to the
U.S. Treasury.
According to the IMF and documents we reviewed, the
overarchingobjective of the IMF financial arrangement was to
restore market confidence and reverse the decline in external
financing. The rupiahdepreciation and loss of confidence in
Indonesia following the Thai crisis was far more severe than IMF
staff expected. The assistance package wasformulated in the
context of an urgent need to deal with the sharp depreciation of
the currency and avert a prolonged deterioration in theeconomic
situation. The crisis exposed and intensified underlying
weaknesses in the financial sector and structural impediments in
theeconomy. There was concern about the large private sector
external debt and whether a significant portion of this maturing
debt would be renewedin the short term. Thus, the package was
designed to stabilize exchange market conditions, ensure an
orderly adjustment of the external currentaccount in response to
lower capital inflows, and lay the groundwork for a resumption of
sustained, rapid growth. The program sought to reduce thecurrent
account deficit to 2 percent of GDP and maintain gross official
reserves at about 5 months of imports. The IMF's initial package
ofconditions in November 1997 called for various monetary, fiscal,
structural, and other changes. Monetary policy was designed to
strengthen the rupiah-dollar exchangerate and limit increases in
inflation. High interest rates were intended to make rupiah-
denominated investments more attractive to domestic andforeign
investors, leading to a greater demand for the rupiah and an
increase in its value. In the period immediately following the
9 The U.S. Treasury can use ESF to provide loans, credits,
guarantees, and reciprocal currency
arrangements.
Tentative Financing From theU.S. Exchange Stabilization Fund
IMF Objective and ProgramDesign
Monetary and Exchange RatePolicy Included High Interest Rates
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 93 GAO/GGD/NSIAD-99-168 IMF Financial Assistance announcement
of the program, Indonesian authorities were to tightenliquidity.
If the rupiah appreciated, then interest rates could be eased.
Authorities were allowed to intervene in the foreign exchange
market toresist downward pressure on the exchange rate. However,
it was not seen as appropriate to deplete reserves in an effort to
resist pressure on therupiah, however, so there were limits on
foreign exchange intervention.
The aim of fiscal policy was to preserve a budget surplus, despite
aslowing of the economy, by reducing low-priority expenditures and
implementing new revenue measures. The program targeted a
budgetsurplus of about 1 percent of GDP in 1997/1998 and 1 percent
in 1998/1999 to facilitate external adjustment and provide
resources to pay for financialrestructuring. The fiscal measures
involved cutting what were seen as lowpriority expenditures,
including postponing or rescheduling major stateenterprise
infrastructure projects; reducing government subsidies;
eliminating value added tax exemptions; and adjusting
administeredprices, including the prices of electricity and
petroleum products.
A key component of the Indonesian authorities' reform and
stabilizationprogram was financial sector restructuring that would
address the financial system weaknesses that underlay the crisis.
The first step inrestructuring was to separate nonviable
institutions from the rest of the banking system. Insolvent banks
were to be closed and placed underreceivership. Special teams of
banking experts were to take over these institutions, liquidate
assets, and repay liabilities. State banks were to bemerged. A
timetable was to be developed for dealing with the remaining
weaknesses in the financial sector. The second step in
restructuring was to establish proper procedures andpolicies to
deal with weak but viable institutions. Banks were to develop
rehabilitation plans--outlining sources of new funding and changes
inownership and management--and the plans were to be evaluated by
Bank Indonesia, Indonesia's central bank. Banks without plans to
restoresolvency and bring them into conformity to prudential
regulation were to be closed and placed under receivership. The
third step in restructuring was to resolve specific problems of
stateand regional development banks. The goal was to make sure
that the banks were safe and sound and reduce the risks to the
government's budget ofensuring their capital adequacy. Some state
banks were to be merged, while others were to be privatized. A
rehabilitation plan for regionaldevelopment banks was to be
developed so that they could adopt
Fiscal Policy Aimed For aBudget Surplus Financial Sector
RestructuringInvolved Closing and Merging Banks
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 94 GAO/GGD/NSIAD-99-168 IMF Financial Assistance commercial
banking practices--institutions that could not be strengthenedin 1
year were to be closed. The final step in restructuring was to
improve the institutional, legal, andregulatory framework for
banking operations. Laws governing the central bank, bank
operations, bank liquidation, and bankruptcy were to berevised
according to best international practices. Loans by Bank Indonesia
to illiquid but solvent banks were to be fully collateralized.
Bank Indonesiawas to strengthen prudential regulations and
supervision to reduce connected lending. Another part of the
package concerned removing structural impedimentsto economic
activity and further deregulation of the domestic economy. Reform
measures included liberalizing of foreign trade and
investment,dismantling monopolies and price controls, allowing
greater private sector participation in the provision of
infrastructure, and expanding thegovernment's privatization
program.
10 Numerous barriers still stood in the
way of both imports and exports, significant sectors were not open
toforeign investment, and extensive regulation restrained domestic
competition. Tariffs on items already subject to tariffs were to
be furtherreduced. Nontariff barriers such as quantitative import
restrictions were to be diminished as well. Also, the scope of the
tariff program was to bebroadened by incorporating a number of
major items previously excluded. Export taxes were to be lowered.
Domestic competition was to beenhanced through deregulation and
privatization. In addition five agricultural commodities
controlled by the National Logistic Agency andsubject to price
controls, production controls, and distribution monopolies were to
be deregulated. Indonesia's implementation of the initial program
was to be measured byboth quantitative and structural performance
criteria. Quantitative performance criteria were
* a ceiling on the growth of the outstanding stock of base
money,11*
a cumulative floor on the overall central government balance,12*
a floor on net international reserves,13
10 For a more detailed description of trade conditions, see
International Monetary Fund: Trade Policies
of IMF Borrowers (GAO/NSIAD/GGD-99-174, June 22, 1999). 11 This is
the currency in circulation, bank deposits at Bank Indonesia,
private sector demand deposits at Bank Indonesia, aggregate debt
balances at Bank Indonesia, and the aggregate reserve deficiency.
12 This is the negative of the sum of (1) net foreign borrowing,
(2) change in net credit from the banking system, and (3) net
financing from all other sources to the government.
Other Structural ReformIncluded Dismantling Monopolies
Progress Was to Be Measured byQuantitative and Structural
Performance Criteria
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 95 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
* a ceiling on the contracting or guaranteeing by the public
sector of newnonconcessional external debt with an original
maturity of more than 1
year, and* a ceiling on the stock of short-term external debt
contracted or guaranteedby the public sector.
Targets on base money and international reserves were to
providemeasures of the effectiveness of monetary policy. Targets
on the central government balance, a limit on public sector
contracting or guaranteeingof new debt with a maturity of more
than 1 year, and a limit on the stock of short-term debt were to
provide a measure of the effectiveness of fiscalpolicy.
Structural performance criteria were
* the closure of banks placed under intensified supervision
orconservatorship that did not submit rehabilitation plans or
whose plans
were not approved by Bank Indonesia by end-December 1997,* the
establishment of quantitative performance criteria for state-
ownedbanks by end-December 1997,
* the issuance of implementation regulations on procurement
andcontracting procedures by end-December 1997,
* an increase in prices of petroleum products to eliminate
subsidies by end-March 1998, and
* a rise in electricity prices of 30 percent by end-March 1998.
Other structural measures were benchmarks by which program
progresswas measured but upon which the availability of IMF
funding was not contingent. Benchmarks included financial,
corporate, regulatory, andgovernment reforms. The first IMF review
of the IMF's arrangement with Indonesia was to be March 15, 1998.
Three billion dollars (SDR 2,201.5million) were to be available
from the IMF at that time. IMF staff recommended to the Executive
Board that the IMF should supportIndonesia's policy program
because, in part, Indonesia had a record of taking prompt
corrective actions in the face of adverse externaldevelopments and
had a sound capacity to repay the IMF.
13 This is the sum of (1) the dollar value of gross foreign assets
in foreign currencies minus gross
liabilities in foreign currencies, (2) the net forward position of
Bank Indonesia, and (3) reserves againstforeign currency deposits.
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 96 GAO/GGD/NSIAD-99-168 IMF Financial Assistance A series of
letters of intent issued by the government of Indonesia andprogram
reviews by the IMF of the SBA followed. The SBA had 4 distinct
letters of intent that documented program changes that took
account ofchanging economic and social factors in Indonesia. The
IMF reviewed the SBA twice during the November 1997-August 1998
time period. Funddisbursements were delayed twice over the course
of the SBA-- Indonesia's access to funds associated with the
completion of the first andsecond reviews was withheld. At the end
of the first review funding was rephased so that amounts available
for disbursement were reduced andreviews were changed from
quarterly to monthly. The initial Stand-by program was not
successful in restoring confidence in the economy. ByAugust 25,
1998, the SBA had been replaced by an EFF.
According to IMF documents, the first IMF Stand-by program
withIndonesia met with some initial success, as confidence
appeared to be boosted by the tightening of liquidity and exchange
market intervention.But financial market sentiment soon began to
sour. This deterioration of market sentiment reflected the
government's failure to follow throughquickly on the policy
measures. The closing of 16 banks while other weak banks continued
operation also contributed to a loss of confidence.Indonesia's
promise to carry out a tight monetary policy was derailed by a
strong liquidity expansion to deal with runs on banks. There was
alsopolitical uncertainty triggered by concerns about the health
of the President. Foreign creditors refused to roll over maturing
credit lines, andpressure on the exchange rate intensified. By
early January 1998, the rupiah had undergone a cumulative
depreciation of some 75 percent frompre-crisis levels. This
created severe tension in both the corporate sector and banking
sectors. On January 15, 1998, the Indonesian authorities released
a new letter ofintent which included major revisions to their
economic program and addressed new conditions. The new measures
were designed to reversethe decline of the rupiah before it
triggered a surge in inflation and a wave of corporate
bankruptcies. Key changes from the previous programincluded a
commitment to implement a tight monetary program, and to
accelerate deregulation and trade reform. In late January, the
program wasstrengthened with the introduction of a comprehensive
bank restructuring program--to be implemented by a new agency
called the Indonesian BankRestructuring Agency (IBRA) and the
announcement of a voluntary scheme to restructure private
corporate debt. Market reaction to the January 15 letter of intent
was swift and negative.Shortly after the announcement of the new
letter of intent, the rupiah was
Program Revisions andBoard Reviews of the SBA--Progress
andProblems
Second Stand-by Letter ofIntent--Implementation Commitment and
DetailedBanking and Corporate Conditions
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 97 GAO/GGD/NSIAD-99-168 IMF Financial Assistance depreciating
rapidly and had lost a cumulative 85 percent of its valuecompared
to 7 months earlier. Owing to difficulties in implementing
required policy changes following the announcement of the second
letterof intent under the SBA, continuing uncertainty about the
government's commitment to elements of the program, and other
developments, therupiah failed to stabilize, inflation picked up
sharply, and economic conditions deteriorated. Base money grew
rapidly, fueled by BankIndonesia's liquidity support for financial
institutions. Moreover, program implementation was sidetracked by
a February announcement that thegovernment was considering the
introduction of a currency board as a means of stabilizing the
rupiah. There was widespread internationalconcern that Indonesia's
financial and credibility crisis would make such a measure
extremely risky. IMF officials viewed a currency board
asinappropriate for Indonesia at this time because they were
concerned about the rupiah's credibility and sustainability--
especially at an exchangerate far above the prevailing market
rate--in light of ongoing capital outflows.14 Decisive policy
action was also inhibited by preparations forthe change in
government after a March presidential election. The economic
downturn deepened, while inflation accelerated sharply.
Againstthis background, as well as the need to await the
appointment of a new cabinet in the wake of the reelection of the
President, the first IMFquarterly review was delayed.
The first quarterly review was scheduled to be completed on March
15,1998, and was to be tied to targets for December 1997 according
to the IMF. However, the review was not completed--and hence
additional fundswere not available to Indonesia--until May 4,
1998. During February and March 1998, only limited progress was
made in implementing the revisedprogram. There had been a
precipitous depreciation of the exchange rate and a large-scale
outflow of capital. The banking sector and the privatecorporate
sector were basically insolvent. Consumer prices increased 39
percent in the first quarter of 1998. In addition, Indonesia's
overall externalpayments position deteriorated sharply, especially
the capital account, because of a decline in new inflows, the
reluctance of foreign creditors toroll over bank and corporate
external debt, and the repatriation of portfolio investment. IMF
officials were concerned that, without a strongadjustment effort,
Indonesia would encounter an even more severe crisis and a
deepening recession.
14 See Lane, Ghosh, Hamann, Phillips, Schulze-Ghattas, and
Tsikata. "IMF Supported Programs in
Indonesia, Korea and Thailand: A Preliminary Assessment."
Washington, D.C.: IMF, Jan. 1999.
First Review of SBA--Access toIMF Funds Temporarily Withheld
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 98 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Bank
Indonesia had lost control over monetary policy in the first
quarter of1998. Monetary policy was dominated by the crisis in the
banking system, with liquidity support provided to the banks
reflecting the drawdown inforeign currency deposits, the reduction
of credit lines by foreign banks, a shift into foreign currency
from rupiah deposits, losses on forwardcontracts, and higher
nonperforming loans. Moreover, Bank Indonesia had been hurt by the
complete turnover of staff in the most senior positions.To deal
with the crisis, foreign experts were appointed to a monetary
panel to help strengthen implementation of monetary policy. The
budget, too,was adversely affected by the deterioration in the
economic environment, experiencing substantial revenue losses and
increased outlays.Furthermore, government decrees designed to
dismantle cartels and open up markets were delayed and
circumvented in several sectors, whichraised concern about the
government's commitment to the IMF program.
None of the five quantitative performance criteria required for
completionof the first review were met, and only one of four
structural performance criteria was implemented. Quantitative
performance criteria were notobserved on base money and public
sector short-term debt outstanding at end-December 1997 and end-
March 1998. Quantitative performancecriteria were also not
observed on the government balance and net international reserves
at end-March 1998. One structural performance criterion was
completed on schedule--thatIndonesia issue implementation
regulations on procurement. Two structural performance criteria
were superseded by the creation of IBRA--the closure of banks
under intensified supervision and the establishment of performance
criteria for state-owned banks. Two performance criteriawere
pending and were expected to be implemented by end-June 1998--
increases in petroleum prices and increases in electricity prices.
The Indonesian government requested waivers for the nonobservance
ofthe performance criteria. IMF staff supported granting these
waivers in view of actions undertaken prior to the proposed
completion of the reviewand the proposed actions of Indonesian
authorities included in the revised program. Originally $3 billion
(SDR 2,201.5 million) was to be available forIndonesia, but this
amount was restructured so that equal amounts of $1 billion (SDR
733.8 million) were to be available each month over the next
3months. On May 4, 1998, the IMF Executive Board granted the
waivers and Indonesia received a $995.4 million (SDR 733.8
million) disbursement. Atthat point the IMF moved from scheduling
quarterly to monthly reviews of the arrangement.
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 99 GAO/GGD/NSIAD-99-168 IMF Financial Assistance On April 10,
1998, the IMF and the government of Indonesia issued a thirdletter
of intent to address the far-reaching changes that had occurred in
political, social, and external circumstances. The new
programcomplemented and modified the program outlined in the
previous letter of intent. According to IMF documents, the
economic situation haddeteriorated since the beginning of 1998:
prices had increased, the government's budget was under severe
pressure as a result of the declinein economic activity, subsidies
were needed to protect low-income groups from the rise in prices
of staples and essentials due to the depreciation ofthe rupiah,
restructuring the banking system was costly, and international oil
prices had declined. In addition, the financial position of the
domesticbanking system had dramatically deteriorated and Bank
Indonesia had granted very large-scale liquidity support.
Furthermore, foreign banks hadcut trade and other credit lines to
Indonesian banks.
The revised program built on the program specified in the previous
letterof intent but placed more emphasis on debt strategy, banking
system restructuring, privatization, and bankruptcy procedures.
The revisedprogram comprised 117 structural policy commitments
covering fiscal issues, monetary and banking issues, bank
restructuring, foreign trade,investment and deregulation, a social
safety net, the environment, and other issues. The program
required sharply raising interest rates to secure a
sustainedappreciation of the rupiah and strict control over the
net domestic assets of Bank Indonesia. Liquidity support to banks
was to be brought firmlyunder control. The program included an
accelerated strategy for restructuring the banking system--
including the takeover of seven banksthat accounted for most of
the liquidity support and raising the capital levels of healthier
banks. The cost of bank restructuring was estimated tobe 15
percent of GDP. The revised program also sought reform of
bankruptcy procedures. It required a revised budgetary framework,
withhigher subsidies for some food and other items to soften the
impact of the currency depreciation on the poor, as well as funds
to cover the costs ofbank restructuring. The revised program
outlined a framework for restructuring private corporate debt with
limited government support. This letter of intent shifted one
quantitative performance criterion--themonetary policy target--
from base money to net domestic assets because the net domestic
assets of Bank Indonesia had been the source ofmonetary
instability. The change was made because of the necessity of
bringing under control the rapid expansion of central bank credit
to bankswith liquidity problems, according to Indonesian
government
Third Stand-by Letter of Intent--117 Structural Policy Commitments
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 100 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
documentation. Other quantitative performance criteria remained,
withtargets changed. New structural performance criteria were to
* merge Bank Bumi Daya and Bank BAPINDO and transfer problem
loans tothe asset management unit of IBRA by end-June 1998;
* initiate sales of additional shares in listed state enterprises
including, at aminimum, the domestic and international
telecommunications
corporations by end-September 1998; and* reduce export taxes on
logs and sawn timber to 20 percent by end-December 1998.
New or strengthened structural policy commitments15 since January
15,1998, included
* raising profit transfers to the budget from state enterprises
includingPertamina--the state oil company,
* publishing key monetary data on a weekly basis,*
appointing high-level foreign advisors to Bank Indonesia to assist
in theconduct of monetary policy,
* setting minimum capital requirements for banks of rupiah 250
billion afterloan loss provisions,
* providing external guarantees to all depositors and creditors
of all locallyincorporated banks,
* establishing IBRA,*
transferring 54 weak banks to IBRA,* transferring claims
resulting from past liquidity support from BankIndonesia to IBRA,
* announcing 7 enterprises to be privatized,*
submitting to Parliament draft law on competition policy, and*
establishing a monitoring system for structural reforms.
The second review of the SBA was scheduled to be completed on June
15,1998, but the review and the subsequent disbursement of $995.4
(SDR 733.8 million) was delayed by about a month. The social
unrest that boiledover in mid-May and culminated in the
resignation of the president. There were runs on Indonesia's
largest private bank, and unemployment andinflation started to
rise dramatically. The country was seen as facing an extremely
severe and rapidly deepening systemic economic crisis. As aresult,
the review was completed on July 15, 1998. Indonesia did not have
access to additional IMF funds during the delay period.
15 Availability of IMF funds was contingent on satisfaction of
quantitative and structural performance
criteria but not on structural policy commitments.
Second Review of the SBA--Access to IMF Funds Temporarily Withheld
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 101 GAO/GGD/NSIAD-99-168 IMF Financial Assistance According
to IMF documents, the April 1998 program had gotten off to agood
start. Monetary performance was kept within program targets
specified in the April letter of intent, even though liquidity
support tobanks was higher than expected. Banks requiring most of
Bank Indonesia's liquidity support were put under the control of
IBRA. New bankruptcyprocedures were enacted, and restrictions on
foreign investment in wholesale trade were lifted. However, IMF
documentation shows that the social disturbances andpolitical
change in May 1998 derailed the April program despite generally
good policy implementation. Arson, rioting, and looting in
Indonesiaundermined business confidence and damaged the
distribution system. Business confidence was shaken, capital
flight resumed, and the rupiahdepreciated sharply pushing many
corporations and banks further into insolvency. GDP fell by 8.5
percent in the first quarter of 1998 and by 7 to 8percent in the
second quarter of 1998. The banking system was paralyzed--unable
or unwilling to lend to corporations--and the corporatesector was
deeply insolvent. According to MF documents, at this time, the
Indonesian economy faced the risk of falling into an even deeper
systemiccrisis, with normal financial market mechanisms breaking
down completely, banks unwilling to lend to insolvent
corporations, and accessto international markets denied.
Despite this situation, Indonesian officials reported that
Indonesia had metthree of the four IMF quantitative performance
criteria. For example, they judged the structural performance
criterion to increase petroleum pricesand eliminate subsidies to
have been met because petroleum prices had been raised on average
by 38 percent, although the increase in keroseneprices was
subsequently rescinded to assist poor households. Data on two
quantitative performance criteria were not available--the end-
Juneperformance criteria on the contracting or guaranteeing of new
external debt and the stock of public sector short-term debt
outstanding. Indonesia met the end-June 1998, structural
performance criteria to raisefuel and electricity prices according
to an agreed schedule. One of the structural performance criteria
was not met--the end-June 1998, mergingof two banks and the
transfer of problem assets to the asset management unit of IBRA
were delayed. The Indonesian government requested a waiverfor its
nonobservance. The IMF staff supported this request because the
preparatory work took longer than anticipated, and the merger
wasexpected to take place by end-July 1998. The IMF staff also
supported Indonesia's request to waive the applicability of the
other quantitative andstructural performance criteria that were
not met. On July 15, 1998, the
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 102 GAO/GGD/NSIAD-99-168 IMF Financial Assistance IMF
Executive Board granted the waivers and Indonesia received a
$995.4million (SDR 733.8 million) disbursement. At this time, the
government of Indonesia requested and the IMF's Board approved a
$1.4 billion (SDR 1billion) augmentation of the SBA.
On June 24, 1998, the government of Indonesia issued a fourth
letter ofintent to address the prevailing economic conditions.
Although the overall objectives and policy content of the revised
program remained the same asin previous letters of intent, the new
program was to be substantially revised to reflect the
deterioration in the economic situation, and theemphasis placed on
some IMF conditions changed to some extent. The economy faced a
serious crisis as a result of the social and politicalupheavals in
May. Tight monetary policy was thought necessary to prevent
hyperinflation. The new monetary program envisaged no increase in
basemoney or net domestic assets. The budget was the area where
major changes were made to the IMF program, including requirements
for asubstantially increased subsidy bill for basic foodstuffs,
petroleum products, and electricity; greater expenditures for
health and education;and expansion of employment-creating
projects. Deficit spending was expected to amount to more than 8
percent of GDP--with the recognitionthat this deficit was not
sustainable and would need to be reduced as the economy recovered.
The bank-restructuring strategy--focused on puttingin place as
quickly as possible a core functioning banking system-- envisioned
an increased role for foreign advisors. A revised strategy
wasadded to assist the resolution of the problems of the corporate
sector through the establishment of the Indonesian Debt
Restructuring Agency(INDRA), which was designed to provide
exchange rate protection for restructured debts. A strengthened
social safety net to cushion the escalating effects of thecrisis
on the poor was now required. As a result of the reduction in real
incomes, the number of households below the poverty line was
growingrapidly. The food distribution system was to be repaired to
ensure adequate supplies of food and other essential items to all
parts of thecountry. Nevertheless, it was thought that the revised
program was likely to encounter great risk from unsettled
political conditions and growingsocial strains.
Quantitative performance criteria were the same as in the prior
letters ofintent, but targets were changed. New structural
performance criteria were as follows:
Fourth Stand-by Letter ofIntent--Strengthening the Social Safety
Net
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 103 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
* Initiate sales of additional shares in listed state enterprises
including, at aminimum, the domestic and international
telecommunications corporation
by end-September 1998.* Submit to parliament a draft law to
institutionalize Bank Indonesia'sautonomy by end-September 1998.
* Reduce export taxes on logs and sawn timber to 20 percent by
end-December 1998.
* Complete audits of the State Oil Company, the State Logistics
Agency, theState Electric Company, and the Reforestation Fund by
end-December
1998. New or strengthened structural policy commitments included
thefollowing:
* Issue presidential decree to provide appropriate legal powers
to IBRA,including its asset management unit.
* Reduce the minimum capital requirements for existing banks.*
Take action to freeze, merge, recapitalize, or liquidate the six
banks forwhich audits have already been completed.
* Conduct portfolio, systems, and financial reviews of all other
banks byinternationally recognized audit firms.
* Introduce community-based work programs to sustain purchasing
powerof poor in both rural and urban areas.
* Increase subsidy for food and essential items.*
Introduce microcredit scheme to assist small businesses.
On July 29, 1998, Indonesia requested that the SBA be canceled and
theexisting policy program be supported instead by an EFF.
16 Several IMF
Board members had previously suggested that such an arrangement
mightbe more appropriate than a SBA due to the deep-seated nature
of
Indonesia's structural and balance-of-payments problems. The EFF
wasestablished to provide assistance to meet balance-of-payments
deficits over longer periods of time. By this time, Indonesia had
received $4.96billion (SDR 3.66 billion) in disbursements under
the SBA. The EFF was to cover the remaining period of the SBA--26
months--and access under thenew arrangement was to be the same as
the amount remaining to be drawn
16 The third review of the SBA was incorporated into the analysis
of the request for an EFF.
Quantitative performance criteria--for contracting or guaranteeing
new external debt and limits on thestock of public sector short-
term debt outstanding--were met. One structural performance
criterion
was completed on schedule--raising fuel and electricity prices
according to a schedule. One structuralperformance criterion was
delayed, and the IMF Board granted a waiver for its nonobservance
on July 15, 1998--merge Bank Bumi Daya and PABINDO and transfer
problem loans to the asset managementunit of IBRA. IMF officials
told us that if the August 1998 disbursement had not been made on
approval of the EFF, no waivers would have been needed for the
completion of the third review of the SBA.
Request for an EFF--Indonesia to Get More Time to Repay the IMF
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 104 GAO/GGD/NSIAD-99-168 IMF Financial Assistance under the
SBA--$6.33 billion (SDR 4.67 billion). An EFF allows a countrymore
time to repay the IMF, according to an IMF official. Repayment of
principal under an EFF was to be made in 12 semiannual
installmentsbeginning 4-1/2 years after disbursement and ending 10
years after the date of each disbursement whereas repayments under
an SBA are scheduled 3-1/4 to 5 years after each disbursement.
17
The deep-seated nature of the structural and balance-of-
paymentsproblems facing the economy had become increasingly
apparent. A thorough restructuring of the banking and corporate
sectors was neededfor the economy to recover from the crisis, even
if this restructuring would take some time to complete. IMF staff
supported the Indonesiangovernment's request that the SBA be
replaced by an EFF. On August 25, 1998, the IMF Board approved the
request for an EFF, and Indonesiareceived a $995.4 million (SDR
733.8 million) disbursement.
A series of five letters of intent and four reviews followed the
switch to anEFF. The five letters were an elaboration of the
elements of the reform program, according to the IMF. Monetary
policy requirements continued tobe tight and focused on getting
the exchange rate into an acceptable range. Fiscal policy
requirements pinpointed deficit spending. Structural
policiesfocused on reforming the financial sector, eliminating
anticompetitive structures in the Indonesian economy, and
providing social safetymeasures. Disbursements were on time twice
and delayed twice when IMF officials judged that Indonesian
officials were not satisfactorilyimplementing the set conditions.
On July 29, 1998, at the time the government of Indonesia
requested anEFF, Indonesia issued a new letter of intent to
address the prevailing conditions. Program modifications were
introduced in budgetarymanagement, corporate debt restructuring,
and bank restructuring. There was progress in implementing the
Frankfurt agreement18 with foreigncommercial banks and the
introduction of auctions for central bank instruments. Progress
was also being made on elaborating the details ofthe plan for bank
restructuring. IBRA and its asset management unit were fully
operational, and foreign investment banks and a leading foreign
17 See Financial Organization and Operations of the IMF
(Washington, D.C.: Treasurer's Department,
IMF, Sept. 1998). 18 The Frankfurt agreement was reached on June
4, 1998. It (1) restructured interbank debt falling due before
end-March 1999, (2) made available a trade facility under which
participating banks would usetheir best efforts to maintain their
aggregate trade credit to Indonesian banks to help restore normal
flows of trade financing, and (3) established a framework for
voluntary restructuring of corporate debt.
Program Revisions andBoard Reviews of the EFF--Progress
andProblems
First EFF Letter of Intent--NewSocial Safety Net and Banking
Measures
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 105 GAO/GGD/NSIAD-99-168 IMF Financial Assistance commercial
bank were assisting the bank restructuring process.
Thesedevelopments had a beneficial impact on market confidence. At
the time of the request for the EFF, the economic situation
remainedprecarious. Output had declined 10 percent and was likely
to decline as much as 15 percent for 1998/1999, according to the
IMF. Inflation wasprojected to be 80 percent for 1998. Food
security was a continuing concern--food prices had risen
dramatically since the beginning of May1998. Severe problems in
the banking system and corporate sector were still not adequately
addressed. Actions to resolve six private banks thatwere taken
over were needed. Actions were also needed on the recapitalization
of sounder banks and the restructuring of state banks.Progress on
corporate debt workouts was very slow, and IMF staff judged that
the Indonesian government needed to be involved in facilitating
suchworkouts. The outlook for the program was vulnerable to
changes in the political and social climate. The June program had
slippages in monetarypolicy--concerns about further bank closures
led to renewed withdrawals of deposits from troubled banks, and
the move by Bank Indonesia toreabsorb liquidity led to a rise in
interest rates. Strenuous efforts were necessary to bring base
money in line with program targets. New measures were added to
repair and strengthen the distributionsystem, to mitigate the
humanitarian effects of the crisis by expanding social safety net
programs and improving the targeting of subsidies, toremove
obstacles to corporate sector restructuring through the adoption
of regulatory and administrative reforms, and to restructure
insolventbanks. The distribution and subsidy systems were improved
to ensure that essential goods were available at affordable
prices. In addition, a newprogram was created to provide rice at
highly subsidized prices to the poorest families. Components of
this strategy were the following:
* The State Logistics Agency was to release large quantities of
rice of allqualities into the market.
* The rice was to be released into the market at less than the
market price.*
The State Logistics Agency was to increase direct deliveries of
medium-quality rice to retailers and cooperatives.
* To put further downward pressure on prices, the value-added tax
on ricewas to be suspended.
* The program for delivering rice at prices well below market
prices to poorfamilies was to be expanded as quickly as possible,
with the help of
provincial governors.* The State Logistics Agency was to
actively seek new imports for rice toensure that stocks remained
adequate.
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 106 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
* Private traders were to be freely allowed to import rice.
Quantitative performance criteria were the same as those in effect
in thefinal letter of intent of the SBA except for changes in
targets. Structural performance criteria were to:
* initiate sales of additional shares in listed state enterprises
including, at aminimum, the domestic and international
telecommunications
corporations by end-September 1998;* submit to parliament a
draft law to institutionalize Bank Indonesia'sautonomy by end-
September 1998;
* reduce export taxes on logs and sawn timber to 20 percent by
end-December 1998; and
* complete audits of the State Oil Company, the State Logistics
Agency, theState Electric Company, and the Reforestation Fund by
end-December
1998. New or strengthened structural policy commitments included
* an IMF review of public expenditure management,*
the transfer of assets of the seven frozen banks to the asset
managementunit,
* the transfer of the responsibility for six state banks from the
Ministry ofState Enterprises to the Ministry of Finance,
* the launch of the Indonesian Debt Restructuring Agency,*
the institution of tax neutrality for mergers,* the submission
to the Indonesian parliament of a new arbitration lawconsistent
with international standards,
* the completion of a review of accounting and auditing standards
to makethem consistent with international standards, and
* the establishment of a voluntary framework to facilitate
corporaterestructuring.
On September 17, 1998, IMF staff presented its first review of the
EFF tothe IMF's Executive Board. Completion of the review was to
be based on indicative fiscal and monetary targets, as well as
external targets for end-July and end-August 1998. IMF staff
recommended that the review be completed and that Indonesia
continue to have access to IMF assistance.The policy discussions
with the government of Indonesia were conducted in close
collaboration with the World Bank and the Asian DevelopmentBank.
First Review of the EFF--GoodPolicy Implementation
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 107 GAO/GGD/NSIAD-99-168 IMF Financial Assistance According
to IMF documents, Program implementation was generally goodand the
program was broadly on track. Market sentiment had improved as a
result of good implementation and increased financing for the
program.Steps were being taken in key areas where problems had
occurred, especially in regard to food security, or where progress
needed to beaccelerated, such as corporate restructuring. A
cautious easing of monetary policy was seen as possible once
inflation had been broughtdown from its high levels. The challenge
for policy at that time was to proceed with structural reforms--
chiefly banking system and corporaterestructuring. Improving the
food situation was crucial for ensuring social stability. Real GDP
was estimated to have declined by 12 percent in the first half
of1998, while cumulative inflation for the first 8 months of the
year was 69 percent. Although the political situation had
stabilized to some degree bySeptember, it remained fragile, as
indicated by street protests. The privatization program was behind
schedule, and a shortfall from the targetfor privatization
revenues was believed to be likely. The budget was running far
within program targets in part because of delays in
increasingspending on social programs. Because the government had
adopted a strategy for addressing the urgent problems created by
the recent rapidincrease in rice prices, IMF staff believed it
helped limit risks to the program from social unrest. On the other
hand, bank restructuring had been subject to delays. Thetransfer
of assets to the asset management unit was being delayed pending
passage of amendments to the banking law. In addition, little
progress hadbeen made in corporate restructuring. To address some
of these issues, a package of measures to address bank
restructuring was announced onAugust 21, 1998. The package
included the recapitalization of core banks, the closure of six
large private banks, the merger of four state banks, andother
items. An important development with respect to corporate
restructuring was the announcement of the Jakarta Initiative--a
voluntaryframework to guide and streamline out-of-court
restructuring of corporate debt. This initiative was announced in
early September 1998 and usedapproaches that were proven
successful in other countries. The approach covered all foreign
and domestic debt and applied equally to all creditors.To promote
financing to distressed companies, the principles encouraged
creditors to subordinate their existing claims to lenders that
were willingto provide interim financing.
Several benchmarks were implemented during the course of this
review.The end-June 1998 measure to allow transferability of
forest concessions
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 108 GAO/GGD/NSIAD-99-168 IMF Financial Assistance and to de-
link their ownership from processing of new concessions wasdone by
end-August. The end-July measure to issue a presidential decree to
provide appropriate legal powers to IBRA, including its
assetmanagement unit, was done on schedule. The end-August measure
to submit to parliament a draft amendment to the banking law,
incorporatingprocedures for the privatization of state banks, and
the removal of the limits on private ownership of banks was done
on August 24, 1998. OnSeptember 25, 1998, the IMF Board completed
the review and Indonesia received a $928.3 million (SDR 684.3
million) disbursement. On September 11, 1998, at about the time of
the first IMF review of theEFF, the government of Indonesia
announced a revised program to address the new conditions. The
letter of intent established indicativetargets for monetary and
fiscal variables and for international reserves. The letter of
intent indicated that the program intended to continue toimplement
a firm monetary policy. As inflation declined, the government of
Indonesia expected interest rates to decline, easing pressure on
thecorporate and banking sectors. Development expenditures,
particularly those for the social safety net, which were running
below the programmedlevels, were to be stepped up. Rice was to be
provided at highly subsidized levels to poor families. For the
first time in 30 years, the government wasto allow private traders
to import rice. This letter of intent included commitments related
to an August 21, 1998, announcement by thegovernment of Indonesia
of a major bank-restructuring package that covered banks with
almost half the assets of the banking system. The end-September
targets for net domestic assets, overall centralgovernment balance
and net international reserves, and net international reserves
were quantitative performance criteria. The letter of
intentcontained an updated matrix of structural policy commitments
with the following new or strengthened commitments:
* Eliminate subsidies on imports of sugar, wheat, wheat flower,
corn,soybeans, soybean meal, and fishmeal.
* Strengthen public expenditure management.*
Prepare a final plan for restructuring three banks.* Complete
the legal requirements for the merger of four state banks.*
Prepare a plan for the operational merger and restructuring of
four statebanks.
On October 23, 1998, IMF staff submitted a second IMF staff review
ofIndonesia's program. IMF staff reported that further progress
had been made with stabilization since the last review and that
policy
Second EFF Letter of Intent--New Strategy for Rice and Banks
Second Review of the EFF--Waivers Requested and Granted
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 109 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
implementation under the IMF program continued to be generally
good.The priority for policy at this juncture was to foster
recovery in output, consolidate gains in stabilization, and
strengthen programs to protect thepoor. IMF staff recommended that
waivers for nonobservance be granted for two missed structural
performance criteria provided that there was asatisfactory
arrangement for the repayment of liquidity support by private
banks. The situation remained fragile and the economy extremely
weak.Unemployment and poverty were on the rise. Although the
political situation had stabilized, the outlook remained uncertain
and, in the IMFstaff's view, further turbulence in coming months
was not ruled out. There had been slippages in some areas, notably
privatization. Privatization ofseveral mining companies and the
domestic telecommunications concern had been postponed until
market conditions improved. The inability ofmost corporations to
pay high rates on loans had resulted in a negative spread between
commercial bank deposit and lending rates, contributingto
continuing decapitalization of the banking system. At this time
there was no satisfactory agreement on the repayment of liquidity
support byprivate banks.
By the third week in October 1998, the rupiah had strengthened
beyondexpectations, inflation had moderated, and prices for many
staple food items had declined. Key elements of bank restructuring
were movingahead. Indonesia then announced a government-assisted
recapitalization program for viable banks. The merger of four
state banks had beeninitiated, and plans had been announced for
resolving the debt situation of six major private banks. Progress
was being made in establishing theappropriate legal and regulatory
framework for the Jakarta Initiative.
Completion of the second review under the EFF was to be based
onindicative and performance targets for end-August and end-
September 1998. The government of Indonesia had complied with
performancecriteria for end-September 1998 on net domestic assets
and net international reserves. However, Indonesia requested a
waiver for thefollowing end-September performance criteria due to
the lack of available data on
* the central government balance,*
the contracting or guaranteeing of new external debt, and* the
short-term external debt outstanding.
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 110 GAO/GGD/NSIAD-99-168 IMF Financial Assistance One
benchmark for the end of September 1998 was done on schedulewhile
the completion of another benchmark was delayed. The benchmark to
complete action plans for all 164 state enterprises was done
onschedule. The benchmark to complete divestiture of two state
enterprises that were unlisted was delayed because of weak market
conditions. The government also requested waivers for structural
performance criteriathat were not met. These criteria dealt with
share sales of domestic and international telecommunications
companies and submission toparliament of a draft law to
institutionalize Bank Indonesia's autonomy. Although share sales
of one company had been completed, other shareshad not been sold
due to weak market conditions. The draft law was nearing
completion, and submission to parliament was expected by mid-
November. On October 30, 1998, the IMF Board granted the requested
waivers. On November 6, 1998, Indonesia received a $928.3 million
(SDR684.3 million) disbursement.
On October 19, 1998, the government of Indonesia announced a new
letterof intent incorporating adjustments to prevailing
conditions. This was the third letter of intent to be announced
under the EFF. This revisioncontained several measures to further
strengthen the IMF program, especially in the areas of banking and
corporate debt restructuring. Theletter of intent called for
lowering interest rates as long as the rupiah remained strong and
inflation was falling. Development spending was to beaccelerated.
Monitoring of development spending was to be strengthened to
protect against leakage and corruption. The preparation of the
masterplan for privatization was completed--all but a few selected
enterprises were to be privatized within the next decade. The
program includedrequirements to streamline the food distribution
procedures and make adequate food supplies available to the most
vulnerable groups. On September 28, 1998, the government announced
the formal merger offour state banks into the newly established
Bank Mandiri. The next day, Bank Indonesia announced key elements
of a bank recapitalizationprogram for potentially viable private
banks--including higher capital adequacy ratios, injections of new
capital, lower levels of nonperformingloans in accordance with new
prudential requirements, and preparation of business plans
demonstrating achievement of medium-term viability andcompliance
with prudential regulations. Indonesia's parliament approved
amendments to the banking law on October 16, 1998, which
facilitated therestructuring process by strengthening the legal
powers of IBRA and its asset management unit.
Third EFF Letter of Intent--Additional Banking Reform and
Corporate Debt RestructuringCommitments
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 111 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The Jakarta
Initiative on corporate debt restructuring was expected to befully
operational by end-October. The decrees necessary to give effect
to the Initiative were signed and a chairman appointed. At this
time about adozen companies, with a combined debt exposure in
excess of $3 billion, were entering the process. On October 23,
1998, a draft governmentregulation was to be signed to provide for
tax neutrality for mergers and removal of other tax disincentives
for restructuring. Quantitative performance criteria were as
specified in the first EFF, withtargets changed. New and
strengthened structural policy commitments were to
* complete a review by Bank Indonesia of business plans of
relatively strongprivate banks,
* recapitalize banks whose business plans are accepted by
Indonesia,*
transfer to IBRA banks that are determined to be insolvent and
ineligiblefor the recapitalization plan,
* resolve 26 banks currently subject to IBRA control for which
audits wereexpected to be completed by mid-November,
* establish centralized control of lending decisions and
treasurymanagement in the four state banks that were being merged
into Bank
Mandiri,* reach final settlement with former owners of two
private banks forrepayment of Bank Indonesia liquidity support,
* encourage the initiation of negotiations between debtors and
creditorsunder the Jakarta Initiative, and
* expand the subsidized rice scheme to 17 million poor families.
On November 13, 1998, the government of Indonesia issued a letter
ofintent and supplementary memorandum of economic and financial
policies that detailed revised conditions under the EFF. The new
letter of intentundertook a number of additional steps to
implement the key areas of corporate and financial restructuring.
The letter of intent reaffirmed thegovernment's commitment to keep
base money under control so as to stabilize prices and accommodate
further appreciation of the rupiah.Progress continued to be made
on lengthening the maturity structure of monetary instruments.
Development expenditure was targeted to rise. Therevised program
sought collaboration at all levels in stepping up internal
government oversight mechanisms to help identify leakages and
ensureaccountability. The letter of intent had a commitment to
sell majority interests in the Jakarta container port and minority
interests in the Jakartaairport operations, the largest palm oil
plantation in Indonesia, and the international telecommunications
enterprise. The letter of intent contained
Fourth EFF Letter of Intent--Implementing Corporate and Financial
Restructuring
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 112 GAO/GGD/NSIAD-99-168 IMF Financial Assistance a
commitment to taking steps to release detailed financial
informationabout the state logistics agency, the state oil
company, and the state electric company. Banking sector reforms
included requirements forrecapitalization of private sector banks,
resolution of debt in certain frozen banks, and other actions.
There was to be a renewed effort to implement the Jakarta
Initiative. Aforeign exchange monitoring system was to be
developed to allow Bank Indonesia to oversee foreign currency
flows on a more timely basis. As ofApril 30, 1999, the system had
been approved by the government of Indonesia but had not begun
operations. The letter of intent only had one structural
performance criterion--reduceexport taxes on logs and sawn timber
to 20 percent by end-December 1998. New and strengthened
structural policy commitments included thefollowing:
* Raise aviation fuel prices to international levels.*
Complete terms and conditions of bank recapitalization bond.*
Reach agreement with former owners of six banks for repayment of
BankIndonesia liquidity support and connected lending.
* Issue three new prudential regulations on connected lending,
the capitaladequacy ratio, and the semi-annual publication of
financial statements.
* Establish a mechanism for the appointment of ad hoc judges to
theCommercial Court.
* Expand the subsidized rice scheme and increase monthly
allocations to 20kilograms per family.
* Eliminate exchange rate subsidies for rice imports by the
NationalLogistics Agency and replace them with explicit budgetary
subsidies.
On December 15, 1998, IMF staff presented their third review under
theEFF to the IMF Board. In its view, macroeconomic policies were
on track, financial sector reform was proceeding, progress was
being made oncorporate restructuring, and slippages and delays in
some areas were being addressed. The rupiah had strengthened,
allowing money marketrates to begin falling. Inflation had
abruptly slowed. Fiscal policy had been less stimulative than
envisaged but development spending wasaccelerating. Moreover, the
rice program was being broadened beyond the initial target of 7.5
million families. The privatization agenda was narrowedto 4 or 5
enterprises from the original list of 12 enterprises. Financial
sector and corporate restructuring was moving forward on several
frontswith the aim of restoring the soundness of the banking
system. On November 7, 1998, final agreement was reached with the
previous owners
Third Review Under the EFF--Completion of Review Delayed
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 113 GAO/GGD/NSIAD-99-168 IMF Financial Assistance of four
banks to repay the equivalent of 9 percent of GDP in
obligationsstemming from loans obtained by their enterprises from
these four banks. An increasing number of companies were seeking
assistance in initiatingnegotiations with creditors.
The review noted slippages in some areas of the program,
includingprivatization and some risk that political unrest could
again derail the program. Government authorities remained
reluctant to finance therestructuring costs because of the
political implications. There had only been limited progress in
corporate debt restructuring--further steps wereneeded in
expediting regulatory approvals for restructuring, establishing a
public registry to facilitate interim financing, and streamlining
theCommercial Court.
According to IMF documents, Indonesia met the indicative targets
on netdomestic assets and net international reserves. Data were
not available for the indicative target for the central government
balance, but the IMFbelieved that the target had been met. IMF
staff recommended completion of the third review and supported the
introduction of three bimonthlyreviews during the first half of
1999 before moving to quarterly reviews. On December 15, 1998, the
IMF Board approved completion of the review.Indonesia received a
$928.3 million (SDR 684.3 million) disbursement.
On March 25, 1999, the IMF completed its fourth review of the EFF
and therequest for augmentation of funds. The review was scheduled
to have been completed on February 15, 1999. This was the first
bi-monthly review.Although progress was reported in implementing
the IMF program, delays had occurred in implementing key banking
and corporate restructuringmeasures. Nevertheless, the IMF staff
was satisfied that policies and developments were continuing to
evolve as well as could be expectedunder difficult and unsettled
domestic conditions. Progress toward achieving macroeconomic
stability had been helped by a firmer and moreconsistent monetary
policy. The external current account kept its solid surplus of
almost 5 percent of GDP in 1998-1999, offsetting a weakercapital
account. A trade surplus of $17 billion accounted for the bulk of
the improvement in the current account. In mid-March 1999, net
internationalreserves of $15 billion remained above the program
targets. Opposition political parties supported the IMF program.
Indonesia continued to pose exceptional risks for the IMF,
particularlyuntil the political transition was further advanced,
according to IMF staff. The economy had not yet bottomed out.
Export volumes had declinedsharply, and domestic banks were
reluctant and unable to extend credit to
Fourth Review Under the EFF--Indonesia Requested Additional Funds
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 114 GAO/GGD/NSIAD-99-168 IMF Financial Assistance exporters.
Although the judiciary had not implemented the bankruptcy lawin a
manner consistent with international practice, Indonesian
authorities were believed to be cooperating fully in carrying out
a corrective strategy.This corrective strategy included proposed
legislation aimed at improving governance of the judiciary and
expectations that state banks and IBRAwere aggressively to pursue
their largest borrowers. Corporate debt restructuring under the
Jakarta Initiative had yet to spread rapidly--only15 companies,
involving about $2 billion in foreign currency debt, had concluded
debt restructurings with creditors. Several benchmarks were
completed on schedule. For example, themeasure to finalize a
decision on the resolution of all banks that fail the criteria for
eligibility to the recapitalization program was implemented inthat
all these banks were closed or intervened on March 13, 1999. The
IMF granted a waiver for nonobservance of the structural
performancecriterion--to reduce the export tax on logs and sawn
timber to 20 percent at end-December 1998. The measure was adopted
in February 1999. Theresult of the review was that on March 25,
1999, Indonesia received a $465.3 million (SDR 337 million)
disbursement, and the total amountavailable to Indonesia was
increased $985.8 million (SDR 714 million).
The government of Indonesia issued a fifth letter of intent under
the EFFon March 16, 1999. This letter of intent included a number
of new steps to strengthen the program--especially the banking
system and corporaterestructuring. Banking reforms requirements
included state bank resolution; private bank recapitalization;
resolution of debt in banks underIBRA control; and improvement of
the legal, regulatory, and supervisory framework. Steps to
strengthen the corporate restructuring framework included
thefollowing:
* A regulation became effective that removed company law
limitations ondebt-to-equity conversions.
* The Ministry of Finance passed a decree providing more
favorable taxtreatment of cancellation of indebtedness income in
restructurings.
* Legislation was to be submitted for the registration of
security intereststhat would give certainty concerning the
priority rights of lenders.
Actions related to the rice situation included
* elimination of the state trading agency's exchange rate subsidy
for importsof rice,
Fifth EFF Letter of Intent--Strengthening the Program for the
Banking System andCorporate Restructuring
Appendix IV The IMF's Financial Arrangement with Indonesia
Page 115 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
* a public procurement floor price policy that was aimed at
keepingdomestic rice prices broadly in line with world prices, and
* the unhindered import of rice by the private sector.
To supplement the People's Economy Initiative for development of
small-and medium-sized enterprises and cooperatives, Indonesia was
to
* review commercial lending practices to and the financing needs
of small-and medium-sized enterprises and cooperatives,
* transform the BRI state bank into a specialized bank with a
mandate tolend only on commercial terms, and
* simplify directed credit schemes to cooperatives and small- and
medium-sized enterprises and ensure that lending rates are
positive in real terms
and adjust them periodically to reflect market conditions. The
letter of intent set end-March and end-May quantitative
performancecriteria and indicative targets for the rest of 1999
and the year 2000 as well as structural performance criteria and
benchmarks through September1999. There were no new structural
performance criteria in this letter of intent. Policy actions were
to continue to be guided by the matrix from theNovember 1998
letter of intent.
Appendix VThe IMF's Financial Arrangement With South Korea
Page 116 GAO/GGD/NSIAD-99-168 IMF Financial Assistance South
Korea, officially named the Republic of Korea,1 experienced
anexternal financing crisis in late 1997, which stemmed from
underlying weaknesses in its corporate and financial sectors.
These sectors reliedheavily on short-term external borrowing. This
reliance stemmed in part from a government policy that allowed
flexibility in short-term capitalflows, while retaining controls
on long-term capital flows. A common belief that the government
would prevent major firms in certain sectorsfrom failing may also
have contributed to the heavy reliance on debt financing. In
November 1997, when Korea requested the IMF's assistance,Korea had
almost depleted its foreign reserves and its currency was
depreciating rapidly. In an effort to stabilize Korea's economy
andstimulate economic growth, the IMF negotiated a large financing
package for Korea, combining adjustments in macroeconomic policies
withaccelerated and strengthened structural reforms. Korea's IMF
program was intended to restore market confidence, limit private
capital outflows,and restore economic growth.
The macroeconomic and structural reforms were considered complex
andaggressive. The macroeconomic program initially focused on
stabilizing Korea's currency exchange rate and increasing Korea's
foreign currencyreserves by raising interest rates and limiting
government spending. Financial sector restructuring was a key
focus of the structural reforms. Asthe program progressed, the
program's reforms in the banking and corporate sectors became more
specific and detailed. As Korea's domesticeconomy began to
contract, the IMF encouraged Korea to lower interest rates and
increase government spending, bringing Korea's formerlybalanced
budget into a deficit position. For example, when Korea's IMF
program began, Korea's fiscal target was to have a surplus of 0.2
percent ofgross domestic product (GDP). The IMF adjusted its
growth projections in the first quarterly review to reflect
declining economic conditions inKorea. In Korea's March 10, 1999,
letter of intent signed with the IMF, Korea's fiscal target was
lowered to a deficit of 5 percent of GDP that wasbudgeted for in
1999.
After announcing Korea's program on December 4, 1997, the
IMFmonitored Korea's progress beginning in December 1997 with its
first biweekly review. In January 1998, the IMF conducted a second
biweeklyreview, followed by four quarterly reviews beginning in
February 1998. The IMF conducted its fifth quarterly review in
March 1999. All reviews werecompleted and disbursements made. The
IMF accelerated its disbursements to Korea at the end of 1997, and
the majority of the IMF's
1 We will refer to the Republic of Korea as "Korea" in this
appendix.
Summary
Appendix V The IMF's Financial Arrangement With South Korea
Page 117 GAO/GGD/NSIAD-99-168 IMF Financial Assistance funding
($19.3 billion out of $21 billion) was disbursed by April 30,
1999.Korea met all its performance criteria until its fourth
quarterly review. IMF staff recommended a waiver for meeting a
condition of the agreement atthe fourth quarterly review due to
delays in obtaining bids for the sale of two Korean banks. Korea
has subsequently obtained bids for these sales.In addition, the
IMF staff requested waivers at the fifth quarterly review for (1)
completing an audit of the Korea Asset Management Corporation
toreflect any losses identified in the external audit in the
Corporation's audited financial statement and (2) the delivery of
recommendations to theMinistry of Finance and Economy as to any
remedial action based on a financial supervisory review of the
Korea Development Bank. These twoactions have since been
completed.
Although Korea's IMF program began slowly due in part to its
presidentialelection, Korea has made substantial progress in
advancing its financial sector reforms and has begun repaying its
IMF borrowings. As of April 30,1999, Korea has repaid about $6.1
billion of its IMF borrowings. Some officials we spoke with noted
that Korea still faced difficult reforms in itscorporate sector
and emphasized that it would take time for Korea to complete the
reforms it has begun. Prior to Korea's 1997 financial crisis,
Korea had experienced about 30years of economic growth and was
considered to have had broadly favorable macroeconomic
performance. Korea had recorded real GDPgrowth of about 6 percent
in the first 3 quarters of 1997, and inflation was around 4
percent. Korea's external financing crisis stemmed fromfundamental
weaknesses in its corporate and financial sectors. Korea had
experienced a mild recession in 1993. In response, Korea's elected
officialspromised growth and encouraged Korea's conglomerates
(called "chaebols") to invest heavily in new factories. In turn,
Korean firms madesubstantial investments, leaving Korea with
excess production capacity and large debt burdens for Korean
firms. This overcapacity led to fallingprices for its main
exports--computer memory chips, cars, ships, steel, and
petrochemicals--and weakened profitability. The large amount of
short-term borrowing compounded these otherproblems. Most of the
corporate debt was either short-term borrowing from domestic
financial institutions or from the issuance of promissorynotes. At
the end of December 1997, the 30 largest conglomerates owed
approximately 111.3 trillion won2 (the Korean currency) in loans
and
2 Using the conversion rate of 1,900 won (approximate exchange
rate at the end of December 1997) to
the dollar this amount is about $58.6 billion.
History of the Crisis
Appendix V The IMF's Financial Arrangement With South Korea
Page 118 GAO/GGD/NSIAD-99-168 IMF Financial Assistance payments to
Korean banks, according to Korea's Office of BankSupervision. The
conglomerates' current liabilities (less than 1 year) accounted
for 60 percent of total liabilities and roughly half of nominalGDP
in 1996. These factors resulted in an increase in bankruptcies
beginning in 1997, including a large Korean steel company and
carmanufacturer.
These bankruptcies weakened the financial system, since bank loans
werenot being paid off, and non-performing loans rose sharply,
causing strains in the banking system. Korean government estimates
of nonperformingloans at the end of 1997 were 34.9 trillion won.
3 Weaknesses in the banking
system were thought to be based on a lack of commercial
orientation (thatis, a focus on increasing market share over
improving profitability) and
limited experience in managing risk, combined with lax
prudentialsupervision. These factors, as well as the large-scale,
external short-term borrowing of the Korean banks, made Korea
vulnerable to the contagioneffects of financial problems in
Southeast Asia.
The weak state of the banking sector led to successive downgrades
byinternational credit rating agencies and a sharp tightening in
the availability of external financing. External creditors began
to reduce theirdebt exposure to Korean banks in the latter part of
1997, causing a sharp decline in usable reserves. A large amount
of these reserves were beingused to finance the repayment of the
short-term debt of Korean commercial banks' offshore branches.
Historically, Korean authorities hada policy of not letting
private banks go into default. Consequently, the Bank of Korea was
providing foreign exchange support to commercialbanks as foreign
creditors reduced their exposure on short-term lines of credit.
The total amount of foreign currency reserves the Bank of
Korea,the central bank of Korea, held at the end of December 1997
was $20.4 billion, the usable portion of which was $8.9 billion.4
As of December 31,1997, the total amount of Korea's private and
governmental external liabilities was $154.4 billion, calculated
under IMF standards. The Koreangovernment estimated that at the
end of December 1997, approximately $27.3 billion was due by the
end of the first quarter in 1998. The ability of
3 Using the conversion rate of 1,900 won to the dollar
(approximate conversion rate at the end of 1997),
the amount would be $18.4 billion. 4 Under the IMF program, Korea
tightened its definition of "usable reserves" and has reported its
reserves under this stricter definition. Previously, Korea had
included its deposits with overseasbranches of Korean financial
institutions when reporting its foreign exchange reserves, thus
overstating its usable reserves. Usable foreign currency reserves
equal the total foreign currencyreserves less amounts on deposit
with overseas branches of Korean financial institutions and swap
positions between the Bank of Korea and other central banks.
Appendix V The IMF's Financial Arrangement With South Korea
Page 119 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Korea to
repay its short-term foreign debts was dependent on thewillingness
of foreign lenders to extend the terms of existing loans and/or to
offer new financing. Korea had made earlier attempts to reform the
financial sector and hadtaken steps to liberalize its capital
account. Korea permitted short-term foreign borrowing but had not
allowed domestic banks access to longer-term foreign borrowing,
which added to Korea's financing problems. Korea was faced with
depleted foreign reserves and a rapidly depreciatingcurrency when
it asked for IMF assistance in late November 1997. It had been 10
years since Korea had had an IMF program, and Korea did nothave
any outstanding IMF credit. Korea had made its last repayment of
prior borrowings to the IMF in 1988. Table V.1 presents a history
of Korea'srecent financial problems.
Year Month Day Action 1997 January Hanbo Steel, a large Korean
conglomerate, collapses under $6 billion in debts, first
bankruptcy of a Koreanconglomerate in a decade.April President's
Committee on Financial Sector Reform recommends short-term reform
measures.
July 2 Thailand devalues its currency, the baht.Kia, Korea's third
largest carmaker, requests emergency loans.
August 25
Korean government announces plan for providing special financing
for certain commercial and merchantbanks. Announced government
guarantee for overseas foreign currency borrowings by Korean
commercial banks.October IMF mission goes to Seoul for an Article
IV consultation.
a
Credit rating agencies begin to downgrade the ratings of Korea and
Korean companies to below investmentgrade.
22 Kia Motors Corp. announces bankruptcy. November 6 Bank of Korea
intervenes to attempt to halt the decreasing value of the won. IMF
announces it is ready toprovide assistance if needed.19 Bank of
Korea loosens band on currency, won begins to drop sharply.
b
21 Korean government requests IMF assistance.
24 Korea bank asset workout program announced. Korea Asset
Management Corporation reorganized to acquireand dispose of
nonperforming loans.December 4 $21 billion IMF package announced,
which was part of a larger financing package totaling about $58
billion. 16 Korea eliminated its daily currency exchange rate
band.
a Under Article IV of the IMF's Articles of Agreement, the IMF
holds bilateral discussions with
members, usually every year. A staff visits the country, collects
economic and financial information,and discusses with officials
the country's economic developments and policies.
b As discussed later, in 1997 Korea had operated with a currency
exchange rate system that permitted exchange rates to float freely
within a daily range of plus or minus 2.25 percent. On November
19, 1997,the Korean government announced that the range of daily
exchange rate fluctuations would be
expanded from plus or minus 2.25 percent to plus or minus 10
percent. The daily exchange rate bandwas eliminated as of December
16, 1997 and, as a result, the exchange rate for the won now
floats according to market forces.
Table V.1: Chronology of Selected Events Concerning Korea's
Financial Problems, 1997-May 1999
Appendix V The IMF's Financial Arrangement With South Korea
Page 120 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Year Month
Day Action17 IMF staff conduct first biweekly review of Korea's
program.
18 South Korea elected opposition party Kim Dae-jung to serve a 5-
year presidential term.22 Moody's rating service announces that it
lowered Korea's foreign currency ratings.
23 Won drops to its low of 1,963 won to the dollar. Standard &
Poor's announces that it lowered Korea's long-termforeign currency
credit ratings. 24 IMF funding accelerated, debt restructuring
talks begin. IMF and 12 country lenders agree to advance Korea$10
billion to prevent default. Korea issues second letter of intent
with accelerated and strengthened reforms. 29 Korea's National
Assembly passes 13 financial reform bills designed to facilitate
financial sector restructuring,accelerate capital market
liberalization, and improve prudential regulation.1998 January 8
IMF conducts second biweekly review of Korea's program. 28 $22
billion in Korean foreign debt restructured. February 6 Tripartite
accord (among labor, management, and the government) reached on
Korea's restructuring programand sharing the burden of reform.17
IMF conducts first quarterly review of Korea's program.
25 President Kim and the new administration take office.April
Korea issues global bond offering of $4 billion to add to its
official reserves. 1 Financial Supervisory Commission formed.May
29 IMF conducts second quarterly review of Korea's program and
completes its Article IV consultation. July 23 Korea signs
memorandum of understanding with the World Bank for implementing
corporate sector reforms.August 28 IMF conducts third quarterly
review of Korea's program. Review completed and disbursement made.
December
IMF conducts fourth quarterly review of Korea's program. Korea
requests waiver for obtaining bids for the saleof Korea First Bank
and Seoul Bank. IMF Board approves waiver, review is completed,
and disbursement made.31 Korea First Bank signs Memorandum of
Understanding with Newbridge Capital for sale of Korea First Bank.
1999 February 22 Seoul Bank signs memorandum of understanding with
HSBC for sale of Seoul Bank.
April 7
IMF conducts fifth quarterly review of Korea's program. IMF
recommends waivers for completion of an audit ofKorea Asset
Management Corporation and delivery of recommendations based on a
financial supervisory review of Korea Development Bank. The
financial supervisory review was conducted within the
timetableunder the review, and the remaining actions were
subsequently completed. IMF completes review and disbursement was
made.
Source: GAO analysis of IMF, Korean, Treasury, Securities and
Exchange Commission, and StateDepartment documents.
On December 4, 1997, the IMF approved a 3-year stand-by
arrangement5with Korea for an amount equivalent to special drawing
right
6 (SDR) of
15.5 billion (amounting to about $21 billion). This program was
formulatedunder emergency procedures
7 and later drew on the IMF's newly
5 A Stand-by Arrangement is a decision of the IMF by which an IMF
member is assured that it will be
able to make purchases (drawings) from the General Resources
Account (GRA) up to a specifiedamount and during a specified
period of time, usually 1 to 2 years, provided that the member
observes
the terms set out in the supporting arrangement. 6 Special drawing
right is defined by the IMF as the international reserve asset
created by the IMF in 1969 as a supplement to existing reserve
assets. 7 According to IMF documents, under an emergency financing
mechanism, the IMF has developed "a set of exceptional procedures
to facilitate rapid Executive Board approval of IMF financial
support fora member while ensuring the conditionality necessary to
warrant such support. These emergency
measures are used only in circumstances representing, or
threatening to give rise to, a crisis in amember's external
accounts that requires an immediate IMF response."
IMF Agreement Announced
Appendix V The IMF's Financial Arrangement With South Korea
Page 121 GAO/GGD/NSIAD-99-168 IMF Financial Assistance established
Supplemental Reserve Facility. 8 The World Bank and the
AsianDevelopment Bank committed $14 billion to the Korean
government. In addition, interested countries pledged $22 billion
as a second line ofdefense
9 for a total package of $58.4 billion. At the time of the
announcement, the IMF staff team continued to work with Korean
officialsto develop more fully the policy measures for the
program. The full
program was to be reviewed by the IMF's Executive Board in
January1998. It was planned that the review would expand the scope
of the performance criteria and set performance measures and
benchmarks for1998. Customary clauses were also included as
conditions for Korea's IMF program.10 Each subsequent review
adjusted and expanded theperformance criteria for the next
reviews, that is, they were set as "rolling" performance criteria.
The IMF's monitoring of Korea's program startedwith two biweekly
reviews in 1997 and quarterly reviews for 1998 and the first
quarter of 1999. After the fifth quarterly review in March 1999,
the IMFplans to conduct reviews every 6 months, and Article IV
consultation discussions are planned for June or July 1999. The
IMF program for Korea included a combination of
macroeconomicpolicies--changes to monetary and fiscal policies--
and structural reforms. The IMF-directed response was to tighten
monetary policy, includingraising interest rates to stabilize the
currency
11 and reduce government
spending, along with an ambitious reform program for financial
sector andcorporate restructuring. Macroeconomic policies were an
essential part of
Korea's program. The large official financing package was
assembled tohelp break the cycle of capital outflows, exchange
rate depreciation, and financial sector weakness. However,
compared with other countries' IMFprograms, the structural reforms
in Korea, as well as Indonesia and
8 The Supplemental Reserve Facility is a facility (window)
established in December 1997. Its aim is to
provide financial assistance to IMF members experiencing
exceptional balance-of-payments difficultiesdue to short-term
financing needs resulting from a sudden and disruptive loss of
market confidence
reflected in pressure on the capital account and the members'
reserves. 9 The United States offered Korea a line of credit using
the Exchange Stabilization Fund in December 1997, as a bilateral
agreement. According to Treasury officials, this line of credit
was not used byKorea. According to IMF officials, Korea did not
use the second line of defense offered by other
countries. 10 For Korea, the customary clauses on overdue
financial obligations to the IMF, on no accumulation of external
payment arrears, on exchange restrictions, on multiple currency
practices, on bilateralpayments agreements inconsistent with
Article VIII, and on import restrictions for balance-of-payments
purposes apply as performance criteria. 11 Since Korea's currency,
the won, was losing its value in the foreign exchange markets
(Korea's exchange rate), raising interest rates was seen as a way
to encourage current and new investors to holdtheir won-
denominated investments or to invest in won-denominated
undertakings that would help to
stabilize or raise the country's overall reserves.
IMF ProgramComprised MacroeconomicPolicies and Structural Reforms
Appendix V The IMF's Financial Arrangement With South Korea
Page 122 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Thailand,
were central to dealing with the underlying causes of thefinancial
crisis, restoring market confidence, and setting the stage for
resuming and sustaining growth in Korea. According to Korea's
December 3, 1997, IMF letter of intent, Korea's IMFprogram was
"built around (1) a strong macroeconomic framework designed to
continue the orderly adjustment in the external currentaccount and
contain inflationary pressures, involving a tighter monetary
stance and substantial fiscal adjustment; (2) a comprehensive
strategy torestructure and recapitalize the financial sector, and
make it more transparent, market-oriented, better supervised and
free from politicalinterference in business decisions; (3)
measures to improve corporate governance; (4) accelerated
liberalization of capital account transactions;(5) further
liberalization of trade; and (6) improvement in the transparency
and timely reporting of economic data." The broad policy goals of
restoring investor confidence and buildinginternational reserves
have remained throughout the program, although the emphasis has
changed and adjustments have been made in specifictargets as
Korea's reforms progressed.
Korea's macroeconomic program included monetary and fiscal
policymeasures. The initial letter of intent did not fully specify
Korea's reform program but did provide a framework of reforms that
Korea intended topursue. IMF staff continued to work with Korean
officials to develop more detailed policy measures to be taken. To
monitor Korea's progress underthe program, the initial agreement
detailed the following quarterly quantitative performance
criteria:
* a ceiling on net domestic assets of the Bank of Korea,12*
a floor on net international reserves of the Bank of Korea,13 and
12 In this agreement, the IMF provided precise definitions of the
quantitative variables monitored under the program. The IMF set
indicative targets for reserve money and broad money (M3) and
provideddefinitions to be used. In addition, it was agreed that
the ceiling on net domestic assets and the
indicative limit on reserve money would be increased (or
decreased) for any increase (or decrease) inrequired reserve
ratios.
13 The net floor on net international reserves of the Bank of
Korea was defined as the sum of (1) the U.S. dollar value of gross
foreign assets in foreign currencies minus gross liabilities in
foreigncurrencies and (2) reserves against foreign currency
deposits. The floor of the net international
reserves was to be adjusted (1) downward by the U.S. dollar
equivalent (converted at the programexchange rate) of the increase
in foreign liabilities of the Bank of Korea associated with the
emergency financing package, (2) upward by the amount of financing
under the emergency financing package inexcess of the program
baseline (and downward by any shortfall), (3) upward by the amount
by which deposits of the Bank of Korea at overseas branches and
subsidiaries of domestic financial institutionsare below the
baseline specified in the program, and (4) upward for any increase
in the net forward position over the end-November position of US
$6.2 billion.
Quantitative PerformanceCriteria Outlined in Initial Agreement
Appendix V The IMF's Financial Arrangement With South Korea
Page 123 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
* the interest rate charged by the Bank of Korea on foreign
exchangeinjections to Korean commercial banks or their overseas
branches was not
to be below 400 basis points above LIBOR. These quantitative
macroeconomic performance criteria, in addition toother indicative
targets, structural performance criteria, and structural measures,
were used to monitor Korea's progress. The IMF and Korea
alsoagreed to indicative targets to monitor Korea's economic
progress, including
* a floor on the consolidated central government balance,14*
reserve money,15and* broad money (M3).16
The principal macroeconomic objectives of Korea's IMF program,
asdetailed in the initial December 3, 1997, letter of intent,
include
* building the conditions for an early return of confidence so as
to limit thedeceleration of real GDP to about 3 percent in 1998,
17 followed by a
potential recovery in 1999;
* containing inflation at or below 5 percent; and
* building international reserves to more than 2 months of
imports by end-1998.
14 The "consolidated central government balance" is defined as the
consolidated balance of the central
government (comprising the general accounts and the special
budgetary funds) and the publicenterprises special accounts. The
balance is the difference between the total revenues and the sum
of
total expenditures and net lending. Expenditures include all
interest costs associated with therestructuring of the financial
sector borne by the public sector (including monetary authorities
and public banks). 15 "Reserve" money is defined as the bank notes
and coins issued plus reserve deposits of domestic money banks. 16
Korea's IMF agreement defines "M3" as "M2" plus deposits of other
financial institutions, debentures issued, commercial bills sold,
"deposits of credit unions," mutual credits of the National
Federation ofFisheries, "Community Credit Cooperatives," Mutual
Savings and Finance Cooperatives situated in
local and reserve life insurance companies, certificates of
deposit, repurchase agreements, and coverbills. "M2" is defined as
currency in circulation plus deposit money (demand deposits at
monetary institutions, time and savings deposits, and residents'
foreign currency deposits at monetaryinstitutions).
17 In Korea's initial program, the IMF had not yet projected
Korea's declining GDP for 1998. The IMF's projections were revised
in the first quarter of 1998.
Appendix V The IMF's Financial Arrangement With South Korea
Page 124 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The main
objective of the monetary policy was to contain inflation to
5percent in 1998 and limit depreciation of the won.
18 To demonstrate to
markets the government's resolve to confront the crisis, monetary
policywas tightened immediately--interest rates were raised--to
restore and
sustain calm in the markets and contain the inflationary impact of
the wondepreciation.
19 The government of Korea reversed its policy of providing
liquidity to Korean banks and allowed money market rates to rise
to a levelsufficient to stabilize markets.
20 The day-to-day conduct of monetary policy
was guided by movements in the exchange rate and short-term
interestrates, which were used as indicators of how tight monetary
conditions
were. A flexible exchange rate policy was maintained, with
monetary andexchange rate policy being implemented in close
coordination with IMF staff.21 Fiscal policy in Korea had
traditionally been formulated prudently,according to the IMF. In
recent years, the Korean government's budget was in broad balance,
with government savings of around 8 percent of GDP anda low level
of public debt. Unlike economic problems in Latin America (large
public debts), the Korean crisis was centered in the private
sector.For 1998, Korea was to maintain a tight fiscal policy--by
cutting government spending and raising certain taxes--to limit
upward pressureon interest rates and to provide for the still
uncertain costs of restructuring the financial sector.
18 Foreign investors will often hold foreign currencies, in this
case the won, to earn profits and interest.
For the profits to be valued, foreign investors must exchange
their earnings in won into their owncurrency. If the value of the
won falls in value, foreigners' earnings on the won-denominated
asset will
also fall. To encourage foreign investors to invest in Korean won-
denominated assets, Korea must paya higher interest rate to
attract investors.
19 As the won depreciates, exports may increase as Korean goods
become cheaper when paying for them in other currencies. If
exports expand too quickly, excess demand could lead to inflation.
Pricesof imports increase with won depreciation.
20 The quantitative performance criteria limiting Korea's net
domestic assets and the understandings on the call rate were used
to guide monetary policy. 21 Historically, the Bank of Korea set
daily exchange rates--the Bank of Korea concentration base rate--
for the won based on a trade-weighted, multicurrency basket
system. Starting in 1989, theKorean government followed a plan
intended to progress gradually to a free-floating exchange rate.
By
1997, the government was operating with an exchange rate system
that permitted exchange rates tofloat freely within a daily range
of plus or minus 2.25 percent. In response to the substantial
downward pressures on the won caused by Korea's economic
difficulties in late 1997, on November 19, 1997, theKorean
government announced that the range of daily exchange rate
fluctuations would be expanded from plus or minus 2.25 percent to
plus or minus 10 percent. The daily currency exchange rate bandwas
eliminated as of December 16, 1997, and, as a result, the exchange
rate for the won now floats according to market forces.
Monetary Policy Fiscal Policy
Appendix V The IMF's Financial Arrangement With South Korea
Page 125 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The
quantitative performance criteria were adjusted at subsequent
reviewsto reflect changes in economic assumptions, discussed more
fully below. The first quarterly review of the full program was
completed in February1998, which expanded the scope of performance
criteria and set performance criteria and benchmarks for 1998. Two
biweekly reviewswere conducted in the interim period after
announcement of the Korea program and before the first quarterly
review in February 1998. The IMF used numerous structural
performance criteria to monitorKorea's progress in making
structural reforms. Korea's structural reforms focused on
financial sector reforms, capital account
liberalization,strengthening corporate governance and corporate
structure, labor market reforms, trade liberalization, and
information provisions and programmonitoring. After the first IMF
quarterly review, measures to increase spending for Korea's social
safety net, including unemployment insurance,were added to the
program. The third quarterly review added a World Bank component
on corporate sector reforms. For monitoring Korea's reforms, the
IMF set benchmarks in the initialletter of intent for the first
and second biweekly reviews. As Korea implemented its reforms, the
structural performance criteria used tomonitor progress changed to
reflect the reforms undertaken (see table V.2 and discussion that
follows). The IMF set Korea's benchmark for the firstbiweekly
review "to comply with the understandings between the Korean
government and the Fund staff regarding the implementation of
interestrate policy." For the second biweekly review, to be
completed on January 8, 1998, Korea was "to call a special session
of its National Assembly,shortly following its presidential
elections in December 1997 to pass reform bills on financial
sector reforms, capital account liberalization, andtrade
liberalization." Korea was also "to publicize its foreign reserve
data." Also, "the Bank of Korea was not to increase its deposits
with nonresidentbranches and affiliates of domestic financial
institutions after December 1997." At the first quarterly review,
and at each quarterly review throughout 1998,the IMF and Korea
agreed to additional specific structural performance criteria to
monitor Korea's reform efforts. For example, at the thirdquarterly
review, Korea was to obtain bids for the sale of Korea First Bank
and Seoul Bank by November 15, 1998. Korea was monitored against
thisperformance criterion at its fourth quarterly review in
December 1998. Table V.2 details Korea's reported progress and
changes in its structuralperformance criteria from the initial IMF
program in December 1997 through the fifth IMF quarterly review in
March 1999.
Structural PerformanceCriteria
Appendix V The IMF's Financial Arrangement With South Korea
Page 126 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Date
ofreview Structural benchmarks and performance criteria to be met
Disposition Firstbiweekly review,12/17/1997
Structural benchmark set:Compliance with understandings between
the Korean authorities and the IMF regarding the implementation of
interestrate policy.
Call rate rose to about 30 percent on Dec. 24, 1997.Increase in
interest rate cap from 25 percent to 40 percent was approved by
cabinet on Dec. 16 and becameeffective Dec. 22, 1997. Structural
benchmarks set: Call a special session of the National Assembly
after electionsto pass reform bills that (1) revise Bank of Korea
Act to provide
central bank independence; (2) consolidate bank supervision;and
(3) require corporate financial statements to be prepared on a
consolidated basis and certified by external auditors.
Passed the three financial reform bills by the NationalAssembly on
Dec. 29, 1997. The Financial Supervision Board will be under the
Prime Minister's office.
Submit legislation to harmonize the Korean regime on
equitypurchases with the Organization for Economic Cooperation and
Development's practices.
Raised ceiling on aggregate foreign ownership of listedKorean
shares from 26 to 50 percent and the individual ceiling from 7 to
50 percent on Dec. 11, 1997. Raised theaggregate ceiling on
foreign investment in Korean equities to 55 percent on Dec. 30,
1997. Under Korea's foreigndirect investment law, Korea already
allowed foreign investors to buy equity in the stock market (as
well asover the counter) for the purpose of friendly mergers and
acquisitions, without limits.Submit legislation concerning hostile
takeovers to harmonize Korean legislation on abuse of dominant
positions in line withindustrial countries' standards. Legislation
submitted to allow greater foreign ownershipof banks. It was
announced that foreign participation inmerchant banks would be
allowed without limit. Publication of foreign reserve data.
Publishing data on Korea's foreign reserves began Dec.17, 1997.
Data on usable reserves of the BOK is
published twice monthly (for 15th and the last day of eachmonth)
within 5 business days. Data on net forward position of the Bank
of Korea is being published monthly.All of these data were placed
on the Bank of Korea's web site, starting May 15, 1998.
Secondbiweekly review,1/8/1998
The Bank of Korea's deposits with nonresident branches
andaffiliates of domestic institutions will not be increased after
endDec. 1997.
Began Dec. 24, 1997. The Bank of Korea was to limit itsfunding of
financial institutions to short-term liquidity support, which the
BOK offered to commercial banksthrough its liquidity support
program. Eliminate interest rate ceiling. Korea was to submit
legislation toNational Assembly to remove interest rate ceiling as
soon as necessary procedures are completed, but not later than
Feb.28, 1998.
Increase in interest rate cap from 25 percent to 40 percentwas
approved by cabinet on Dec. 16, 1997, and became effective on Dec.
22, 1997. Firstquarterly review,Feb. 1998
Assume government control of Korea First Bank and SeoulBank and
request the management of these banks to write down the equity of
existing shareholders.
These banks came under intensive supervision beginningDec. 24,
1997. The equity capital was written down, and the government
recapitalized these banks and tookeffective control of the banks
by Jan. 31, 1998. By March 31, 1998Complete second round
evaluation of the remaining 20 merchant banks and suspend
operations of those banks that failto pass the evaluation.
Completed Feb. 26, 1998. Secondquarterly review,May 1998
Allow foreign banks and brokerage houses to establishsubsidiaries.
Came into effect on Mar. 31, 1998
Table V.2: Structural Performance Criteria for Korea's IMF Program
Appendix V The IMF's Financial Arrangement With South Korea
Page 127 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Date
ofreview Structural benchmarks and performance criteria to be met
Disposition
By June 30, 1998Complete an assessment of the recapitalization
plans of commercial banks. Completed June 29, 1998 Introduce
legislation to allow a full writedown of existingshareholder
equity, eliminating the current minimum bank
capital floor for this purpose.
Legislation was enacted to allow the writedown of
existingshareholders' equity in insolvent financial institutions.
Establish a unit for bank restructuring under the
FinancialSupervisory Board with adequate powers and resources to
coordinate and monitor bank restructuring and provision ofpublic
funds.
Unit established on Apr. 1, 1998.
In addition to the end-June performance criteria, IMF added
thefollowing for end Sept. 1998: Submit legislation to allow for
the creation of mutual funds (byAug. 31, 1998) Legislation
submitted to the National Assembly on Aug. 8,1998; related
legislation put into effect in Sept. 1998. Require listed
companies to publish half-yearly financialstatements prepared and
reviewed by external auditors in accordance with international
standards (by Aug.31, 1998)
Completed.
For end-Dec. 1998: Obtain bids for Korea First Bank and Seoul Bank
(by Nov. 15,1998) At the fourth quarterly review, the IMF staff
recommendeda waiver to extend the date for obtaining bids for
Korea
First Bank and Seoul Bank from Nov. 15, 1998, to end-Jan. 1999.
Korea First Bank: memorandum of understanding signed with
Newbridge Capital, Dec. 31,1998; Seoul Bank: memorandum of
understanding signed with HSBC on Feb. 22, 1999.
Thirdquarterly review,Aug. 1998
Introduce consolidated foreign currency exposure limits forbanks,
including their offshore branches (by Nov. 15, 1988). Completed
July 1998. In addition to end-Dec. 1998 performance criteria,
additionalcriteria were set for end-March 1999: To complete an
audit of Korea Asset Management Corporationto international
standards by a firm with international experience in auditing this
type of agency and to reflect any lossesidentified in the Korea
Asset Management Corporation's financial statement
IMF staff recommended a waiver for this action at the
fifthquarterly review but it has since been completed. External
audit report completed March 12, 1999. Losses identifiedin
external audit report were reflected in the Korea Asset Management
Corporation's financial statement as of April30, 1999.
Fourthquarterly review,Dec. 1998
The Financial Supervisory Commission to complete
supervisoryexamination of the Korea Development Bank and make
recommendations to Ministry of Finance and Economy, asneeded, as
to any remedial actions required.
IMF staff recommended a waiver for this action at the
fifthquarterly review but it has since been completed. Financial
Supervisory Commission completed itsexamination of the Korea
Development Bank March 20, 1999. Recommendations coming from the
examinationwere submitted to the Ministry on April 26, 1999.
Appendix V The IMF's Financial Arrangement With South Korea
Page 128 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Date
ofreview Structural benchmarks and performance criteria to be met
Disposition Fifthquarterly review,March 1999
Period of April 1-August 31, 1999(1) Issue regulation by April 1,
1999, requiring insurance companies that fail to meet the
mandatory solvency marginthresholds (specified in the Memorandum
of Economic Policies for the fifth review of the stand-by
arrangement) to submitrecapitalization plans by July 31, 1999. (2)
By June 1, 1999, begin publishing data on revenue,expenditure, and
financing of the consolidated central government on a monthly
basis with no more than a 4-week lag.(3) By June 30, 1999, issue
new loan classification guidelines that fully reflect capacity to
repay. These guidelines would alsocover the treatment of
restructured loans and the valuation of equity and convertible
debt acquired as part of corporaterestructuring. (4) For merchant
banks, implement prudential rules for foreignexchange liquidity
and exposures based on a maturity ladder approach by July 1,
1999.(5) Issue instructions, effective July 1, 1999, that at least
20 percent of the new guarantees issued by Korea CreditGuarantee
Fund and Korea Technology Guarantee Fund will cover only 80-90
percent of the value of guaranteed obligationsdepending on the
credit rating of the firm.
Ongoing. (1) Regulation was issued on March 26, 1999.
Sources: GAO analysis of Korea's letters of intent, and IMF and
Korean documents, in addition todiscussions with Korean and IMF
officials. The centerpiece of Korea's structural reform package
was financial sectorrestructuring. Korea's goals were to have a
sound, transparent (improved Korea's financial reporting,
according to international accountingstandards), and more
efficient financial system. Korea had already begun efforts to
reform its financial sector prior to seeking IMF assistance buthad
not been successful in passing reform legislation. Korea's initial
IMF letter of intent detailed the government's plans for
addressing the financialrestructuring of the banks. The Korean
government, in consultation with the IMF, prepared a comprehensive
action program to strengthensupervision and regulation in
accordance with international best practices. The IMF agreement
built upon the framework for financial sector reformsthat the
Korean government had published in November 1997.
In its original letter of intent, Korea specified the need for a
credible andclearly defined method for closing troubled banking
institutions. The strategy required that troubled institutions
present viable rehabilitationplans and close those insolvent
financial institutions that failed to carry out their
rehabilitation plans within specified periods. Korea also
plannedto set a timetable for all banks to meet or exceed Basle
capital standards.
22
22 Bank regulators from industrialized countries adopted common
risk-based standards for bank capital
for internationally active banks in 1988 under the auspices of the
Bank for International Settlements.Known as the Basle Accord, the
standards were fully implemented in 1992 by member countries. The
Financial Sector Restructuring
Appendix V The IMF's Financial Arrangement With South Korea
Page 129 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The
disposal of nonperforming loans was to be accelerated. All forms
ofassistance to banks, including financing from the Korean Asset
Management Corporation and the deposit insurance funds, would
beprovided only as part of viable rehabilitation plans. All
support to financial institutions, other than Bank of Korea
liquidity credits, were to berecorded transparently in the fiscal
accounts. In addition, blanket guarantees were to be phased out
and replaced by a limited depositinsurance scheme.
In its first IMF agreement, Korea stated its intentions to
restructure andrecapitalize troubled financial institutions.
Timeframes and rules for doing this were detailed in later
agreements that accelerated and strengthenedKorea's plans for
addressing these problems. For example, the Koreans were
successful in passing financial reform legislation and established
ahigh-level team to negotiate with foreign creditors by the end of
December 1997. The Korean government (1) appointed a high-level
task force todevelop and implement a strategy to address the
financial crisis, (2) assumed control of Korea First Bank and
Seoul Bank and hired outsideexperts to develop a privatization
plan, and (3) hired experts to conduct due diligence with respect
to the balance sheets of merchant banks and toassess the
rehabilitation plans.
Other measures included in Korea's initial IMF agreement were
reforms in
* trade liberalization,
* capital account liberalization,
* corporate governance and corporate structure,
* labor market reforms, and
* information provisions and program monitoring.
The reforms for trade liberalization were part of changes
alreadyunderway in line with Korea's World Trade Organization
commitments and were accelerated during Korea's IMF program.23 The
changes in Korea's
standards are formula-based and apply risk-weights to reflect
different gradations of risk. Since 1992,the rules have been
amended. One of the most notable change is the establishment of
risk-based
capital requirements to cover market risk in bank securities and
derivatives trading portfolios. 23 For more specifics on Korea's
efforts to liberalize its trade policies, see International
Monetary Fund: Trade Policies of IMF Borrowers (GAO/NSIAD/GGD-99-
174, June 22, 1999).
Other Structural Measures
Appendix V The IMF's Financial Arrangement With South Korea
Page 130 GAO/GGD/NSIAD-99-168 IMF Financial Assistance capital
account were aimed at increasing competition and efficiency in
thefinancial system. The schedule for allowing foreign entry into
the domestic financial sector was to be accelerated. The United
States supported thesereforms and sought to move them forward
quickly. Treasury officials told us that these were conditions
they considered necessary to addressunderlying structural
problems. More details were added in later agreements about the
other structural reforms. For example, details aboutsupport for
Korea's social safety net were added after the first quarterly
review in February 1998. As part of monitoring Korea's progress in
meeting IMF conditions, the IMFconducted quarterly reviews. After
these quarterly reviews, monetary and fiscal targets were revised
for the conditions outlined in the original IMFagreement. From the
initial review to Korea's present program, the IMF added details
and conditions to structural reforms that address
underlyingproblems in the financial and corporate sector.
According to IMF, Treasury, and State Department officials,
changes in conditions for Korea'sprogram reflected the progress
made under the IMF's program.
Korea's initial program was intended to restore market confidence
andlimit private capital outflows through the large financing
package, which was heavily front loaded, together with sound
economic policies.However, according to program documents and our
discussions with IMF officials, the program was not initially
successful in restoring investorconfidence, and private capital
outflows far exceeded program projections. According to IMF
officials, the changes made to Korea'smacroeconomic targets
reflected worsening conditions in the external environment (for
example, the weakening of the Japanese yen, affectingKorea's
export competitiveness) and were adjusted to match actual economic
data. Nevertheless, the IMF was criticized for the fact that
thepolicies taken in Korea to stabilize the economy caused
monetary conditions to become too tight. IMF and Treasury
officials told us the IMFprojections were overly optimistic at the
beginning of the program, based on Korea's past positive growth,
and emphasized that the IMF did notaccurately project the "rolling
financial crisis" throughout Asia.
According to IMF officials and program documents, Korea's response
tothe program was slow at first because of its national
presidential election on December 18, 1997. The positive impact of
the announcement of theIMF program on exchange and stock markets
was small and short-lived. In the 2 weeks from the announcement
until the first biweekly review, thewon dropped to its low of 1963
won per dollar on December 23, 1997. Before the crisis, the value
of the won was 915 to the dollar on September
The IMF MadeAdjustments in Performance CriteriaAfter Each Review
Within First 2 Weeks, theIMF Modified Korea's Program to
AccelerateFunding Disbursements
Appendix V The IMF's Financial Arrangement With South Korea
Page 131 GAO/GGD/NSIAD-99-168 IMF Financial Assistance 30, 1997.
Investor confidence was further undermined by doubts aboutKorea's
commitment to the IMF program, as the leading candidates for the
presidential election hesitated to endorse it publicly. Moreover,
newinformation became available about the state of Korea's
financial institutions, the level of its usable reserves, and
short-term obligationsfalling due, raising concerns among
investors about Korea's widening financing gap.24 Part of Korea's
agreement was to improve transparency inits financial reporting
because the levels of usable international reserves, corporate
debt, or banks' nonperforming loans had not been readilyapparent
from published data.
A temporary agreement was reached with the private, foreign
bankcreditors on December 24, 1997, to continue lending to Korean
borrowers (to roll over short-term loans), and discussions on
voluntary reschedulingof short-term debt were initiated. At the
same time, Korea issued another letter of intent requesting the
IMF to accelerate its funding, which the IMFagreed to do.
Specifically, on December 24, 1997, Korea asked the IMF to modify
the disbursement date under the stand-by agreement to December30
from the original date of January 8, 1998, to permit an
advancement of its IMF drawings. In negotiating the advancement of
funds, Korea agreedto strengthen its structural reform agenda to
accelerate financial sector restructuring and facilitate capital
inflows into the domestic economy andbond market. Interest rates
were raised significantly to about 30 percent at end-December 1997
from rates of about 12 percent in September 1997.Conditions for
the Bank of Korea to provide foreign currency liquidity support to
banks were tightened. One condition (quantitative
performancecriterion) of the IMF agreement was to raise the
interest rate on Bank of Korea foreign exchange loans to
commercial banks.25 These actions wereconsidered a signal of a
clear commitment by the incoming administration to support reforms
under the IMF program. According to IMF documents, signs that
Korea's economy was stabilizingemerged by the time of the second
biweekly review on January 8, 1998. Korea met the end-December
1997 quantitative performance criteria forthe net domestic assets
and net international reserves. The other conditions for the
review were met, and efforts to liberalize Korea's capitalaccount
were accelerated substantially. For example, Korea lifted the
24 According to Treasury officials and IMF documents, a leak of
IMF documents to the press released
specific information on two Korean banks and the low levels of
usable international reserves that hadnot been readily apparent
from public sources. IMF documents showed the actual adjusted net
international reserves as a negative $3 billion at the end of
December 1997. 25 The rate was gradually increased from 400 basis
points above LIBOR on December 2 to 1,000 basis points by December
23, 1997, and would be raised further, if necessary.
Appendix V The IMF's Financial Arrangement With South Korea
Page 132 GAO/GGD/NSIAD-99-168 IMF Financial Assistance restriction
on foreign borrowing of over 3-year maturity on December 16,1997.
To address Korea's vulnerability to its short-term debt and
improve itsrollover rates,
26 on January 28, 1998, Korea reached an agreement-in
principle with private bank creditors. IMF and Treasury documents
notethat this agreement was a voluntary rescheduling of Korean
banks' short
term debt into loans with longer-term maturities. The agreement
coveredinterbank deposits and short-term loans maturing during
1998, equivalent to about $22 billion. The IMF completed its first
full quarterly review of Korea's program inFebruary 1998.
According to IMF documents, Korea's exchange market situation was
improving, but there were growing signs of a decline ineconomic
activity. According to IMF, Treasury, and Korean officials, the
agreement with bank creditors had helped to improve Korea's
financingconditions. Korea's usable reserves had increased, and
the won had appreciated by nearly 20 percent from the low in late
December 1997. In terms of fiscal policy, the IMF said it had
proved difficult to adjustgovernment spending rapidly. With the
large currency depreciation occurring and domestic demand
contracting, the IMF made adjustments inKorea's program. The
revised program was based on lower (but still marginally positive)
growth projections. The fiscal target for 1998 waslowered from a
surplus of 0.2 percent of GDP in the original program (including
bank restructuring costs) to a deficit of 0.8 percent of GDP.
TheIMF and Korea agreed that Korea would maintain a tight monetary
policy as long as the exchange market situation continued to be
fragile. While Korea had already taken a number of steps to
implement theprogram's comprehensive structural reform agenda, the
revised program specified additional commitments in financial
sector restructuring andcapital account and trade liberalization.
For example, Korea was to establish a unit for bank restructuring
under the Financial SupervisoryBoard with adequate powers and
resources to coordinate and monitor bank restructuring and the
provision of public funds. Korea establishedthis unit in April
1998.
26 The effective rollover rate is defined as the proportion of
short-term loans by foreign lenders to
domestic financial institutions that are either rolled over or are
matched by the opening of new lines ofcredit. This term is
considered the rate that investments are converted or "rolled
over" into another
investment. The term is often used by banks when they allow a
borrower to delay making a principalpayment on a loan. Also, a
country that has difficulty in making its debt payments may be
granted a rollover by its creditors. With governments themselves,
rollovers in the form of refundings orrefinancings are routine.
First Quarterly ReviewShowed Korea's Market Situation Improving
Appendix V The IMF's Financial Arrangement With South Korea
Page 133 GAO/GGD/NSIAD-99-168 IMF Financial Assistance After the
new government took office in late February 1998, business,labor,
and the government reached a tripartite accord. Based on this
accord, the reform agenda was broadened to include measures
tostrengthen the social safety net, increase labor market
flexibility, promote corporate restructuring, and enhance
corporate governance. According to IMF documents and
announcements, Korea's programremained on track, and market
confidence in the new government's commitment strengthened. Growth
projections were marked down furtherduring the second quarterly
review, which was completed May 29, 1998. Korea had successfully
launched a global sovereign bond issue, significantcapital inflows
into the domestic stock and bond market had been registered, and
usable reserves now exceeded $30 billion. According toIMF
documents, Korea's sharp decline in economic activity, however,
was weighing heavily on corporations, necessitating an
acceleration ofstructural reforms in the financial and corporate
sectors. Korea had lowered interest rates, but monetary policy
continued to focus onmaintaining exchange market stability. In
view of the weaker outlook for growth, the fiscal target was eased
further to permit automatic stabilizers(that is, adjustments in
tax and government spending) to take effect.
In Korea's July 1998 letter of intent, Korea reported that it had
madesubstantial progress in overcoming its external crisis.
However, market sentiment weakened somewhat in June in view of
growing concerns aboutthe domestic recession and the impact of
economic conditions in the region. Nevertheless, the won remained
broadly stable and appreciated vis-a`-vis the U.S. dollar in July,
permitting Korea to further lower interest rates to pre-crisis
levels. The Korean government prepared a supplementarybudget to
support economic activity and strengthen the social safety net.
Output was now projected to decline by 4 percent in 1998,
inflation haddecelerated and was expected to average 9 percent
during the year, and the current account surplus was expected to
reach nearly $35 billion (over10 percent of GDP).
The IMF's third quarterly review, completed on August 28, 1998,
focusedon a further easing Korea's macroeconomic policies to
mitigate the severity of the recession and on strengthening
Korea's structural reformagenda. For example, Korea broadened its
corporate restructuring efforts significantly, supported by the
World Bank. In a July 23, 1998,memorandum of understanding between
the government of Korea and the World Bank, Korea agreed to
develop a framework and capacity to dovoluntary corporate workouts
and to provide policy support for corporate restructuring, in
addition to taking other actions to reform the corporate
At Second QuarterlyReview, the IMF Reported that Korea's Reforms
Wereon Track
The IMF's Third QuarterlyReview Focused on Strengthening
StructuralReforms
Appendix V The IMF's Financial Arrangement With South Korea
Page 134 GAO/GGD/NSIAD-99-168 IMF Financial Assistance sector. By
the end of October 1998, Korea had drawn $27.2 billion of thetotal
financing package for Korea, including $18.2 billion from the IMF
and $9 billion from the World Bank and the Asian Development Bank.
Output was projected to contract by 5 percent in 1998, inflation
haddecelerated further and was expected to average 8.5 percent
during the year, and the current account surplus was still
expected to reach nearly$35 billion. Exchange market conditions
permitting, interest rates were to be lowered again. According to
Korean officials, they reluctantly agreedwith the IMF to raise
Korea's fiscal deficit target to 4 percent of GDP. Korea
introduced a supplementary budget to increase governmentspending,
including additional spending for social programs for those most
affected by Korea's recession. The IMF completed its fourth review
of Korea in December 1998. The IMFstaff recommended, and the
Executive Board granted, a waiver for the structural performance
criterion to obtain bids for the sale of two Koreanbanks.
According to IMF staff, Korea's implementation of policies had
been good, and all their quantitative criteria had been observed.
It wasapparent that Korea would not obtain bids for selling two
Korean banks by the November 15, 1998, deadline, although the
bidding process had begun.Since the World Bank was assisting Korea
with this process, according to IMF staff, completing this action
was a matter of timing, and it wasnecessary to allow a sufficient
period for Korea to complete these negotiations. This action has
since been completed. The IMF Executive Board met on April 7,
1999, for Korea's fifth quarterlyreview. According to IMF
documents, the Korean authorities met all their quantitative
performance criteria for end-December 1998 and fulfilled itspolicy
commitments under the program. However, the IMF staff recommended
waivers for (1) completing an audit of Korea's AssetManagement
Corporation to reflect any losses identified during the audit in
its financial statement and (2) delivery of recommendations based
on afinancial supervisory review of the Korea Development Bank.
According to IMF and Treasury officials, Korea has since completed
these actions.Korea completed its audit of Korea's Asset
Management Corporation on March 12, 1999, and the losses
identified during the audit were reflected inits financial
statement as of April 30, 1999. Also, Korea's Financial
Supervisory Commission finished its supervisory examinations of
theKorea Development Bank on March 20, 1999, (within the timetable
of the review) and made recommendations to the Ministry of Finance
andEconomy on April 26, 1999.
IMF Staff Recommended aWaiver in Fourth Quarterly Review
Fifth Quarterly ReviewCompleted
Appendix V The IMF's Financial Arrangement With South Korea
Page 135 GAO/GGD/NSIAD-99-168 IMF Financial Assistance IMF,
Korean, U.S. Treasury, and State Department officials we spoke
withwere consistent in their views that Korea's reform efforts
remain strong, but difficult reforms still need to be made in
Korea's corporate sector. Asnoted earlier, Korea's program began
slowly due in part to a presidential election. But to date, Korea
has made substantial progress in its financialsector reforms. The
U.S. Department of the Treasury reported to Congress27 that Korea
had complied with its IMF program. The Treasuryreported that
Korea's external financing crisis has been alleviated--the Bank of
Korea's usable foreign exchange reserves recently surpassed
$50billion, reflecting a current account surplus in 1998 of nearly
12 percent of GDP and strong net inflows of portfolio capital.
According to theTreasury's report, Korea's short-term external
liabilities declined by nearly half, from $63.2 billion at the end
of 1997 to an estimated $32.5 billion atthe end of 1998. The
Treasury also reported that Korea's continued adherence to the
restructuring program set forth by the IMF and WorldBank will be
crucial to Korea's sustained recovery. Korea has already begun to
repay its IMF borrowings for a total of about $6.1 billion, as
ofApril 30, 1999.
According to Korean government documents, Korea's domestic
economyremains weak, although stable. While Korea's economy still
is vulnerable to external shocks, the government is projecting
growth for 1999. IMFofficials have changed its growth projections
for 1999 from a negative 1 percent to a positive 2 percent GDP
growth rate. As of April 1999, otherprivate sector projections for
Korea were also more optimistic. Some officials we spoke with
noted that Korea still faced difficult reforms in itscorporate
sector and emphasized that it would take time for Korea to
complete the reforms they have begun.
27 This report was the Treasury's first semi-annual report, dated
March 15, 1999, to the U.S. Senate
Committees on Banking, Housing, and Urban Affairs and on Foreign
Relations, in addition to the U.S.House of Representatives'
Committees on Banking and Financial Services and on International
Relations. This report provided details on financial stabilization
programs in Brazil, Indonesia, andKorea.
Status of Program--Reform Efforts Remain Strong
Appendix VIThe IMF's Financial Arrangement with Russia
Page 136 GAO/GGD/NSIAD-99-168 IMF Financial Assistance When the
Soviet Union disintegrated in 1991, Russia suffered a
massiveoutput collapse, with real GDP estimated to have fallen by
35 percent during 1991-94. Since the dissolution of the Soviet
Union, Russia hasborrowed from multilateral, official bilateral,
and private creditors to meet its financing needs. Beginning in
1992, the IMF became the main vehiclefor assisting Russia and
promoting economic reform. The IMF faced the challenging task of
helping Russia achieve financial stabilization whilemaking rapid
progress in transforming the economy to a market-based system.
This was difficult from the start, as the reformers never had
fullcontrol over economic policy.
1 Nevertheless, Russia was then, and
remains, a focal point of U.S. national interests. Russia's
political andeconomic stability are critical for the rest of the
former Soviet Union,
Eastern and Central Europe, and bordering areas. Further, Russia
is anuclear superpower and has large supplies of some of the
world's key resources, including oil, natural gas, and strategic
metals. According to theIMF, the world's stake in Russian reform
has been too critical not to make the effort to help the economy.
Russia negotiated the now-terminated $10 billion, 3-year Extended
FundFacility arrangement
2 with the IMF in March 1996. Disbursements under
the EFF were to be largest in the 1st year (65 percent of the
quota in thefirst year and 55 percent in the second and third
years); they were to be
made monthly until early 1997 and quarterly thereafter.
Performance underthe program, to be monitored through its
quantitative targets, was also to occur on a monthly basis,
switching to a quarterly basis beginning in 1997.(It was the only
IMF program to be monitored monthly at the time.)
3
Monthly "indicative targets" were established to serve as early
warningsignals of slippages in the program and to trigger the
implementation of
revenue measures in the event of deviations from the program
revenuepath. The 1996 program also contained a number (20) of
structural benchmarks aimed at accelerating transition to a
market-based system.These structural measures were formulated
through intensive collaboration with the World Bank staff
beginning June 1995, and Bank
1 The current President, Boris Yeltsin, and the Duma, the lower
house of Russia's parliament dominated
by the Russian Communist Party, have frequently been in conflict.
According to an IMF official,President Yeltsin, the Duma, regional
governments, and portions of the federal executive all failed to
support measures that were unpopular, especially with powerful
interest groups. 2 The Extended Fund Facility (EFF) is designed to
support medium-term programs that generally run for 3 years. The
EFF aims to overcome balance-of-payments difficulties stemming
frommacroeconomic and structural problems. Repayments are made in
41/2 to 10 years.
3 The IMF Executive Director representing Russia attributed the
positive developments Russia achieved under adverse political
circumstances during 1996 to the IMF's stepped-up monitoring
ofRussia's economy.
Summary
Appendix VI The IMF's Financial Arrangement with Russia
Page 137 GAO/GGD/NSIAD-99-168 IMF Financial Assistance staff
participated in every mission that dealt with structural
policycontents of the program. During the IMF program, Russia
achieved some notable successesincluding sharply reduced
inflation, a freely traded and convertible ruble, the abolition of
central planning, a reduction in trade barriers, and thecontinued
spread of privatization initiatives throughout Russia. Then, as
now, the critical problems facing Russia were fiscal and
monetaryimbalances, combined with very slow progress toward a
functioning market-based economy. While external developments,
including the Asiancrisis and associated weakness of energy
prices, contributed to Russia's financial difficulties, the root
cause of the unsustainable and intractablefiscal situation was
Russia's inability to collect taxes. Building on the earlier
programs, the 1996 extended arrangement continued to press
forfurther reductions in the fiscal deficit and inflation, and for
implementation of the key structural reforms that underpin a
marketeconomy. Increased revenue collection and improved
government expenditures were the centerpiece of the program, given
Russia'ssignificant weaknesses in these areas, which persisted
during the entire program. Between March 1996 and July 1998, there
were 12 reviews of the program,most of which included program
modifications. Russia missed quantitative performance criteria
targets in more than half of these reviews, and theIMF delayed
disbursements and/or program approval numerous times. There are
several explanations as to why Russia missed its targets:elections
and political uncertainty, high interest rates and large interest
payments, spending pressure and rise in arrears, investor
uncertainty, andcapital outflow. However, the substantive reasons
for Russia's failure to achieve key goals, according to the IMF,
were a fundamental lack ofpolitical will to collect revenues and
the pervasive culture of nonpayment. The staff always noted the
uncertainties and risks the IMF assumed inproviding support to
Russia. However, based on the IMF's assessment that Russia's
efforts warranted continued IMF support, the IMF grantedwaivers
for Russia's nonobservance of quarterly performance criteria,
citing Russia's exemplary cooperation with the IMF and the
determinationof key senior officials to abide by the program.
Amidst the financial crisis of summer 1998, Russia requested and
receivedadditional IMF funds on the condition that Russia
undertake major tax and other structural reforms. However, this
was not enough to halt the crisis.Russia's persistently weak
fiscal position and delays in structural reform, in combination
with the adverse impact of the declining price of oil on
Appendix VI The IMF's Financial Arrangement with Russia
Page 138 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Russia's
external balance and heavy reliance on short-term foreign
capitalinflows led to a full-scale banking and currency crisis by
mid-August. Subsequently, Russia deviated so significantly from
the program that theIMF halted further disbursements. In March
1999, the program was officially terminated upon Russia's request.
Currently the IMF and Russiaare negotiating a new arrangement.
4 Key events are indicated in the
timeline in table VI.1.
Date EventMar. 26, 1996 IMF Executive Board approves $10billion,
3-year EFF
arrangement to RussiaMar. 29, 1996 Russia receives 1
st tranche (233.63 SDRs)
Apr. 29, 1996 1st Monthly ReviewModify deficit limit (strong
spending pressure and revenue shortfall
coming).Concern over presidential elections for the 1st half of
1996. May 3, 1996 Russia receives 2nd tranche (233.63 SDRs)Jun. 5,
1996 1
st Quarterly Review (2nd Monthly Review)
Modification of deficit target.Jun. 1996 Presidential election
Jun. 10, 1996 Russia receives 3rd tranche (233.63 SDRs)Jun. 24,
1996 3
rd Monthly Review
Missed May floor targets for international reserves for
externalreasons.
Jun. 28,1996 Russia receives 4th tranche (233.63 SDRs)Jul. 31,1996
4
th Monthly Review completion delayed - program too far off track.
Missed end-June targets: net domestic assets, monetary
authoritycredit, reserves.
Barely complied with deficit target.Lack of revenue collection
effort. Broad performance modifications.Waiver for nonobservance
of end-June targets. Postpone completion of 2nd Quarterly
Review.Delay in June disbursement. Concerns over weak health of
president in 2nd half of 1996.Aug. 24,1996 4
th Monthly Review complete based on July targets
Aug. 26,1996 Russia receives 5th tranche (233.63 SDRs)Sep. 13,1996
2
nd Quarterly Review (5th monthly review)
Focus on structural policies and found disappointing
slippages.Missed additional end-June performance criteria:
monetary
authority credit to government, deficit of enlarged
government.Waiver requested for nonobservance of additional end-
June criteria.Sep. 18,1996 Russia received 6
th tranche (233.63 SDRs)
4 The IMF's Managing Director announced on April 28, 1999, that
IMF staff and Russia had agreed on an
economic program involving Fund finance of approximately $4.6
billion over 18 months. As of June 16,1999, the IMF Board had not
approved the arrangement.
Table VI.1: Chronology of Key Events inRussia's IMF Arrangements
(SDRs in Millions)
Appendix VI The IMF's Financial Arrangement with Russia
Page 139 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
Date EventOct. 9,1996 6
th monthly review
Met all end-August targets.Continuing pressure against ruble.
Oct. 8,1996 Russia receives 7th tranche (233.63 SDRs) Dec. 13,1996
3rd Quarterly Review (7th monthly review) - completion
delayed.Missed 3 end-Sept. targets (deficits, reserves).
Missed 1 end-Oct. target.Waiver for nonobservance of end-September
performance criteria. Modification of performance criteria.Delay
in Sept. and Oct. disbursements. Dec. 13,1996 Russia receives 8th
disbursement (233.63 SDRs) Feb. 7, 1997 4th Quarterly Review (8th
monthly review).Complied with end-Dec. targets.
Feb. 12, 1997 Russia receives 9th tranche (467.25 SDRs to make up
for 1996delays).
No disbursements until 1997 program approved; dependent
onimplementation of prior actions; also purchase schedule revised.
May 16, 1997 Article IV Staff Report (9th monthly review) and
approval of 1997program. May 16, 1997 Russia receives 10th
disbursement (500 SDRs)Jun. 1997 Preliminary data show first signs
of growth in years Sep. 3, 1997 5th Quarterly Review (10th monthly
review)Missed end-June cash revenue floor.
Signs of recovery becoming apparent.Waiver for nonobservance of
revenue target. Sep. 3, 1997 Russia receives 11th disbursement
(500 SDRs)Oct. 1997 Financial crisis in world financial markets
affects Russia's financial
markets.Substantial foreign exchange outflows. Decline in world
oil prices. Jan. 8, 1998 6th Quarterly Review (11th monthly
review) Completion delayed dueto non-observance of Jan.-Sept. 1997
performance criteria on
federal government revenue.Program continues to face serious
risks. Persistent fiscal fragility relating to revenue collection
andexpenditure control, and continued financial turmoil. 1997
progress: revitalization of privatization on transparent
basis,continued progress in closing and restructuring smaller
banks, and further rationalization of natural monopolies.Missed
end-Sept. targets: cash revenue and international reserves.End-
Sept. performance criteria not operationally relevant. Deviations
from program path widened making achievement ofend-Dec.
performance criteria impossible. Modification requested for end-
Dec. performance criteria (cashrevenue, monetary aggregates, net
international reserves)though Dec. performance criteria not
available yet (being revised duringthe 6
th review).
Waiver of applicability of end-Dec. performance criteria.Delay in
Nov. disbursement.
Jan.13, 1998 Russia receives 12th disbursement (500 SDRs)
Appendix VI The IMF's Financial Arrangement with Russia
Page 140 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
Date EventMar. 23, 1998 Prime Minister Chernomyrdin dismissed.
Weakening of oil prices. Apr. 24, 1998 Duma approves Sergei
Kiriyenko as Prime MinisterMid-May 1998 Severe financial crisis in
Russia coinciding with renewed financial
instability in South East Asia; reversal in market confidence;
laborunrest in Russia - miners' strike. No disbursements until
1998 program approved. Delay in approvalof 1998 program.
Contingent on implementation prior actions.Fiscal targets revised
with staff visits in April and May; also purchase schedule
revised.Oil prices still weak. Staff supports request for
extension of EFF for a 4th year.Jun. 12, 1998 7
th Quarterly Review (12th review) and approval of 1998 program.
Missed end-March targets (federal cash revenue, deficit).Waiver
requested for noncompliance with end-Dec. (1997)
targets.Delay in disbursement of quarterly tranche until June due
to cabinet changes and difficulty in meeting revenue package;
fiscaltargets revised. Russia requested extension of EFF
arrangement for a 4th yearJun. 30, 1998 Russia receives 13
th disbursement (500 SDRs)
Jun. 23-Jul. 16, 1998 IMF mission in Moscow to negotiate augmented
package Jul. 17, 1998 Russia requests augmentation of extended
arrangement andrequests purchase under CCFF.
Jul. 20, 1998 IMF Board approves $11.2billion additional financial
support toRussia.
End-June data not available to assess compliance with Junetargets,
so requirement was waived. Jul. 20, 1998 Russia receives
disbursement, but amount reduced from $5.6 to$4.8 billion because
of delays in passing two key tax measures
(personal income tax and pension fund). No further paymentsmade.
Aug. 17, 1998 Russia government imposes unilateral restructuring
of its ruble-denominated sovereign debt and announces a 90 day
moratorium
on private external debt payments.Subsequently ruble depreciates
by more than 60 percent. Sep. 11, 1998 German government
acknowledges that Russia missed virtuallyall of a DM800 million
interest payment due on August 20 on
Soviet era sovereign debt.Sep. 11, 1998 Dissolution of the
Kiriyenko government; Duma approval of Yevgeny Primakov as Prime
Minister.Sep. 1998 Remaining $10.3 billion IMF commitment from the
July 1998 package is no longer available. Negotiations begun on
neweconomic program. Mar. 31, 1999 Program officially terminated
at Russia's request.Apr. 28, 1999 IMF Managing Director announces
that Russia and the IMF
agreed in principle on an approximately $4.6 million Stand-
byArrangement; not yet approved by IMF Executive Board. May 12,
1999 President Yeltsin dismisses Prime Minister Yevgeny Primakov
(4thprime minister dismissed in 14 months). Source: IMF and
Russian government documents.
Appendix VI The IMF's Financial Arrangement with Russia
Page 141 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The early
IMF programs in Russia faced unsettled conditions,
systemicproblems, and large macroeconomic imbalances. During 1992-
94, the initial period of market reform, Russia received financial
assistance from the IMFin the form of a first credit tranche
Stand-By Arrangement (SBA) and two purchases under the Systemic
Transformation Facility (STF).5 From theoutset, the Russian
economic programs focused on reducing macroeconomic imbalances and
moving toward a market-based economy.The IMF, along with the World
Bank and other bilateral and multilateral agencies, also began
providing a broad range of technical assistance thatwould develop
the supporting macroeconomic management capability. These early
programs were implemented under unsettled political
andconstitutional conditions that severely complicated the already
daunting task of stabilizing the economy while transforming its
basic features. Whilesignificantly reducing the fiscal deficit and
curtailing credit expansion aided a decline in consumer price
inflation from 2,500 percent at end-1992to around 200 percent at
end-1994, none of the programs was successfully carried through:
stabilization remained elusive, reforms fell short of thegoals,
and inflation remained excessive.
The 1995 SBA was negotiated over several months against the
backdrop ofpolicy failures and worsening economic performance. For
example, in January 1995--midway through program negotiations--the
monthlyinflation rate accelerated to 18 percent and there was a
further $1 billion reserve loss. The SBA was approved in April
1995, despite a large measureof uncertainty regarding the Russian
government's ability and determination to implement the program.
The program itself wascharacterized by what the IMF considered to
be a large reliance on expenditure restraint. The SBA program
focused on Russia's achieving asubstantial and sustained reduction
in inflation, seen as essential for economic recovery. This was to
be effected by imposing an even tightermonetary policy and a
reduction of the deficit from 5 percent of GDP in 1996 to 2
percent of GDP in 1998. Although inflation in Russia
declinedsignificantly in 1995 - the consumer price index was 134
percent at the end of 1995 - it nonetheless remained significantly
above the level targeted inthe SBA program.
The focus of the 1996 arrangement was on reducing fiscal and
monetaryimbalances while transitioning to a market-based economy.
The primary
5 The STF was a temporary facility in effect between 1993 and 1995
to assist transition economies. It's
purpose was to provide financing to member countries facing
balance-of-payments difficulties arisingfrom severe disruptions of
their international trade and payments arrangements owing to a
shift away
from significant reliance on state trading at nonmarket prices
toward multilateral, market-based trade.
Early Programs andthe Context of the 1996 IMF Russia Programs
Inflation Was a PrimaryFocus of 1995 Stand-by Arrangement
The 1996 ExtendedFund Facility Program
Appendix VI The IMF's Financial Arrangement with Russia
Page 142 GAO/GGD/NSIAD-99-168 IMF Financial Assistance problems
were the fiscal deficit, weak tax collection, and
excessivegovernment spending. The recently terminated $10-billion,
3-year EFF arrangement, approved bythe IMF in March 1996, was
negotiated on the heels of the 1995, 12-month, SBA arrangement,
under increasingly adverse political circumstances. Theprogram's
broad objectives were to achieve financial stabilization while
transitioning to a market-based economy and to lay the basis for
sustainedgrowth. This was to be accomplished by reducing the
budget deficit from around 5 percent in 1995 to 4 percent in 1996
and 2 percent in 1998,lowering the inflation rate from around a 7-
percent monthly average in 1995 to 1.9 percent per month in 1996,
and implementing key structuralreforms. In addition to improving
tax administration and limiting government expenditures, the
fiscal strategy was to reduce the deficit byimproving revenue
collections - raising the revenue-to-GDP-ratio from around 10
percent in 1995 to 11 percent in 1996 and to 15 percent by
1999.The monetary strategy was to continue to lower inflation and
strengthen the banking system by resolving the problem of weak and
insolvent banks. At the time the IMF and Russia were negotiating
the 1996 arrangement, thecritical problems facing Russia were -
and continue to be - fiscal and monetary imbalances, combined with
very slow progress toward afunctioning, market-based economy. At
the heart of the fiscal deficit problem lay weakness in tax
revenue collection and government spendingin excess of what was
affordable. To address the revenue problem, the program focused on
improved tax administration, collecting outstandingtax arrears -
especially from the energy sector - and eradicating the culture of
nonpayment. The Russian government also agreed to resiststrong
spending pressures and to make cuts in noninterest spending to
achieve the deficit reduction target. A restrained credit stance
wasintended to lower inflation further toward a single-digit
annual rate and to serve as the first line of defense against
depreciation pressures on theruble. The 3-year EFF program also
continued to press for implementation of the structural reforms
key to a market-based economic system,including improving the
structure of government spending and treasury functions,
strengthening the banking system, reaccelerating theprivatization
process, and completing the process of trade policy
liberalization. IMF funding in 1996 was also seen as critical for
Russia to establishmedium-term balance-of-payments viability. At
the time of the 1996 extended arrangement, the IMF described
Russia's trade balance as"robust": the trade balance had been in
surplus since 1993. However, the Need to Strengthen Balance
ofPayments
Appendix VI The IMF's Financial Arrangement with Russia
Page 143 GAO/GGD/NSIAD-99-168 IMF Financial Assistance current
account was expected to weaken over the next few years
asinvestment recovered, private savings declined, and imports
rose. Also, Russia was experiencing a basic weakness in its
external accounts, due inpart to net short-term capital outflows
and an inadequate level of reserves. Further, a bunching of debt
service obligations was expected to occurbetween 1996 and 2000.
IMF funding was viewed as critical in catalyzing both Paris and
London Club debt rescheduling and encouraging the inflowof capital
to the private sector. This would reduce the future burden on the
federal budget and strengthen Russia's balance of payments. Key to
evaluating Russia's progress in the program, and to the decision
torelease the next quarter's loan tranche, were the quarterly
performance criteria. These quantitative quarterly performance
criteria included thefollowing fiscal, monetary and international
reserve targets:
* federal and enlarged (including regional and extrabudgetary
funds)government deficit,
* federal government cash revenue floor,*
limit on the stock of net domestic assets of the monetary
authority (that is,currency in circulation and bank deposits at
the Central Bank of Russia,
[CBR]),* limit on the monetary authority's claims on the federal
and enlargedgovernment, and
* floors on both gross and net international reserves.
The 1996 plan was based on an ambitious structural reform program
aimedat improving the functioning of markets. The following are
some of the 20 structural benchmarks proposed under the 1996
program: By March 31, 1996, Russia was to complete an evaluation
of the financialcondition of the 10 largest banks.
By June 30, 1996, Russia was to
* establish procedures for gas prices to reflect variation in
transmissioncosts to launch audit of 5 major fully or majority-
owned state owned
enterprises and* submit legislation for move to an accruals-
based system for the profit andvalue added tax.
Progress Measured byQuantitative Performance Criteria and
StructuralPolicy Benchmarks
Appendix VI The IMF's Financial Arrangement with Russia
Page 144 GAO/GGD/NSIAD-99-168 IMF Financial Assistance By
September 30, 1996, Russia was to
* ensure that all remaining import duties rates above 30 percent
are replacedwith excise taxes,
* submit specific legislation to improve the fiscal relations
between thefederal and subnational governments, and
* conclude an evaluation of the financial situation of the 200
largest banks.
By December 31, 1996, Russia was to
* complete an annual audit of the Pension and Employment
Fundsaccording to international standards,
* prepare a list and launch an audit of an additional 5 major
enterprises inwhich the state has full of majority ownership, and
* initiate an implementation procedure to deal with problem
banks.
Russia also had to undertake certain prior macroeconomic actions
(forexample, introduce additional revenue measures) and structural
policy actions (for example, revoke import restrictions on
alcoholic beverages)before the IMF Executive Board would approve
the 1996 EFF program. Both structural performance benchmarks and
prior actions for IMF Boardreviews of the program were altered
frequently throughout the program to reflect changing conditions.
Overall, the IMF determined that Russia's efforts during 1996 fell
short ofthe targets. There were seven program reviews during the
program's first year. These seven reviews included four instances
of programmodification, three occurrences of waivers for
nonobservance of performance criteria, and three delays in
disbursements. While Russia hadsuccess in moderating inflation -
the monthly average inflation rate for 1996 was 1.7 percent -
there was less success in achieving fiscal goals. For1996, the
federal deficit registered 6.3 percent of GDP instead of the
planned 4 percent, and federal revenues fell from 10.5 percent of
GDP in1995 to only 9.5 in 1996, in contrast to the targeted
increase of nearly 1 percent in 1996. Moreover, exchange rate
stability was bought at theexpense of a significant loss of
reserves. Additionally, progress in pursuing structural reforms
was disappointing, according to the IMF. In the first halfof 1996,
uncertainties related to the election outcome influenced fiscal
performance and revealed the fragility of the 1996 fiscal
framework; in thesecond half of 1996, concerns about the health of
the Russian president contributed to heightened uncertainty. More
fundamentally, however,fiscal slippages were attributable to a
lack of sufficient political commitment to insist on the payment
of tax liabilities, especially by large
IMF Board Reviews
Appendix VI The IMF's Financial Arrangement with Russia
Page 145 GAO/GGD/NSIAD-99-168 IMF Financial Assistance taxpayers,
as well as the weak capacity of tax administration and
thedeficiencies in the tax system. Nonetheless, while they delayed
the completion of a number of reviews for failure to meet program
conditions,the IMF staff continued to recommend approval of the
program, despite uncertainties about the government's capacity to
implement it, because, asthe staff said, the new government
demonstrated strong leadership, which could lead to a successful
program if backed at the highest level. Russian presidential
election concerns dominated the first half of 1996.During this
period, the IMF reviewed the program four times (three monthly
reviews and one quarterly review), modifying the deficit limits
inthe first two reviews and making broad performance modifications
in the fourth month review. Inflation continued to decline as the
monetaryauthority adhered to a tight credit stance, and the
central bank was able to maintain a stable exchange rate corridor
despite the political uncertaintyand pressure toward ruble
depreciation. There were other positive developments: Russia had
(1) achieved some structural reforms in bankingand tax-related
fiscal measures;
6 and, (2) satisfied the quantitative targets
in the first two reviews, aided by modification of the deficit
limits toaccommodate the clearance of accumulated wage arrears and
the jump in
treasury bill rates. However, the fiscal situation remained quite
vulnerable,owing to both internal and external factors. The
continuing weakness in revenue collection reflected the lack of
will to enforce existing law,deficiencies in the tax system,
rising tax arrears, and strong spending pressures with the
approaching June presidential elections. The highertreasury bill
rates, which raised the interest payments to higher levels than
assumed under the program, was in large part due to the highly
chargedpolitical environment. On this basis, Russia and the IMF
agreed to an upward adjustment in the deficit ceiling, while
securing the government'scommitment to focus on collecting tax
arrears. Two other areas that were also a source of ongoing
concern were the sustained depreciationpressures on the ruble,
which put the international reserve targets at risk, and the
sluggish progress on structural reforms. The staff also
attributedthe pressure against the ruble, and the consequent loss
in reserves, to the market sensitivity generated by this historic,
election-dominated situation.
6 At the second monthly review, on May 29, 1996, Russia had
fulfilled 3 of the 20 structural benchmarks
and 19 of the 38 structural measures.
Program Adjustment andDisbursement Delays Marked the First
FourMonths of Program Reviews
Appendix VI The IMF's Financial Arrangement with Russia
Page 146 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Throughout
this period, the IMF staff commented on the determination ofkey
senior officials to abide by the program, noting their commitment
and determined efforts. However, the completion of the fourth
review and thedisbursement of the July tranche was postponed until
late-August because the program had gotten too far off track.
Russia had missed its monetarytargets and had barely complied with
the deficit target. The main concern was the progressive weakening
of the federal government's cash taxrevenues, reflecting an
environment in which paying taxes appeared to be more a matter of
choice than an obligation. The upcoming heavy interestpayment
schedule and accumulation of wage and pension arrears made the
deficit target virtually out of reach. Hence there was a
broadreassessment of policy requirements for the remainder of the
year to bring the program back on track. The completion of the
fourth review was madeconditional upon Russia's meeting end-July
targets as modified and significantly increasing tax revenues.
Russia also received a waiver fornonobservance of end-June
targets. In the end, the IMF staff's support for the program
reflected their assessment that immense pressures had led
toRussia's missing the targets, that the Russian authorities were
taking actions to bring the program back on track, and that the
Russians' efforts"deserve the benefit of doubt and warrant
continued Fund support."
Three reviews were completed from August through December
1996(following the completion of the fourth review). The first
review focused on progress in structural policies and found the
results disappointing,though structural reform efforts had been
recently stepped up. Fourty-four modifications were proposed for
the structural program, and the Russianauthorities agreed to a
revised set of 10 new structural benchmarks for the remainder of
the year. During this period, the IMF continued to encouragethe
government to open the treasury bill market to nonresidents so
that Russia could have better access to private capital markets.
The CBRofficials agreed in principle but expressed concerns
regarding the volatility of foreign capital inflows that could
easily be converted into dollars ratherthan rolled over into new
debt. Meanwhile, by September, the dominant concern was continuing
pressure on the ruble and international reserves,despite the
favorable inflation trend and the cautious macroeconomic policy.
The IMF staff believed that noneconomic, temporary, andreversible
factors such as concerns about President Yeltsin's health, the
postponement of the completion of the fourth review, changes in
the rulesgoverning nonresident access to the Treasury bill market,
and concern about the health of the banking system contributed to
the exchangemarket pressure. While continuing to note the major
risks and difficulties in the Russian situation, the IMF
maintained a cautious optimism that the
Officials Committed ToProgram, But Systemic Weakness in Tax
RevenueCollection Continue
Missed Targets, Waivers,Program Modifications, and Delays in
DisbursementCharacterized the Remainder of the 1996Program
Appendix VI The IMF's Financial Arrangement with Russia
Page 147 GAO/GGD/NSIAD-99-168 IMF Financial Assistance authorities
would address these problems and continue to achieveprogram
objectives. However, by the third quarterly review, originally
scheduled forcompletion in October 1996, Russia had gotten too far
off the program, and the review was delayed until December.
Consequently, both October andNovember disbursements to Russia
were delayed. Russia had missed the September international
reserve and deficit targets - the deficit of thefederal government
amounted to 6.7 percent of GDP. There was a marked deterioration
in revenue performance because of a tax code change thatgave
priority to wage payment over meeting tax payments: revenues had
declined to 9 percent of GDP at November 1996. The nonobservance
of thedeficit target was due, in part, to the need to make large
interest payments on treasury bills that had been issued at high
interest rates in the secondquarter. But more fundamentally, the
deficit continued to originate from a weakness in revenue
collection due to a lack of government resolve toenforce tax laws.
As a result of weaker-than-anticipated revenue and higher-than-
anticipated interest payments, the IMF and Russia agreed
tomodifications to the fiscal and monetary performance criteria
for endDecember 1996. These modifications were to serve as the
first step of the1997 program. Also, understandings were reached
on a comprehensive action plan that sought to improve revenue
collection by creating a tax-paying culture in Russia rather than
just proposing tax measures.
The IMF staff noted that, in hindsight, the structural work plan
might havebeen too ambitious for Russia to manage, given its
limited institutional capacity. Even though program revisions had
just been introduced inAugust/September to reflect the slower pace
of implementation of structural reforms in the first half of 1996,
progress in the structural policyagenda was still lagging at this
time. With the important exception of banking reform - where
actions were in line with the program - structuralreforms fell
short of the objectives in all areas in 1996. Only two of the
seven structural benchmarks that were the subject of this review
had beenmet, and immediate action was required before the staff
could recommend completion of the third quarter review. At the end
of 1996, the situation inRussia remained fragile, and the fiscal
situation was difficult. However, the staff determined that the
authorities continued to demonstrate their firmintention to
maintain a restrained credit stance to forestall inflation and to
reduce pressure on international reserves. The staff also
acknowledged theauthorities' good faith efforts and exemplary
cooperation with the IMF. In the end, the IMF granted Russia a
waiver for its nonobservance of end-September performance
criteria.
At Third Quarter Review,Program Off Track, and Review and
DisbursementDelayed-Weakness in Revenue Collection atSource
Progress in StructuralReform Lagging, Fiscal Situation Difficult-
WaiverGranted Based on Good Faith Efforts
Appendix VI The IMF's Financial Arrangement with Russia
Page 148 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The
completion of the May 1997 Article IV staff report also gave
theExecutive Board's approval of the 1997 EFF program. The report
followed the April negotiations and the setting of program
targets. The approvalcame after Russia implemented a series of
prior actions, including submission of the tax code and a new 1997
spending plan to the Duma, acrackdown on large tax debtors, and
announcement of transparent privatization procedures. The 1997
program included a revised schedule ofdisbursements for the 1997
program year (Russia had received no program disbursements since
the one following the completed eighth month reviewin mid-February
1997). As envisaged under the program, performance was to be
monitored quarterly on the basis of quarterly performance
criteria.However, because of the significant risks that Russia
still faced, the IMF continued to closely monitor developments
throughout the period of theextended arrangement.
A major focus of the fiscal program in 1997 was the reversal of
thedeclining trend in federal cash revenues in relation to GDP and
the elimination of the use of noncash revenue sources. Cash
revenues weretargeted to increase, on average, to 8.3 percent of
GDP in 1997, compared with 7 percent of GDP in 1996. To improve
revenue collection, the Russianauthorities agreed to major tax
reform and the full implementation of the comprehensive November
1996 action plan. The annual limit on the federaldeficit in 1997
was set at 5.5 percent of GDP, higher than the original EFF target
of 3 percent of GDP for 1997, but lower than the 6.3 percent
deficitat yearend 1996. A further reduction in inflation to a
monthly rate of 1 percent in 1997 was one of the program's main
economic goals. In additionto implementing the November 1996
action plan in full, the structural program for 1997 was designed
to accelerate the process of building theinstitutional and legal
framework to support a market economy. Table VI.2 shows Russia's
performance in some critical areas.
Approval of 1997 ProgramDelayed Pending Completion of Prior
Actions
Appendix VI The IMF's Financial Arrangement with Russia
Page 149 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
1993 1994 1995 1996 1997 IMFProgramRevenue of which: Cash
13.713.7 11.811.4 10.69.1 9.57.0 9.48.3 Expenditures Noninterest
Interest
20.218.2
2.0
23.221.2
2.0
15.412.5
2.9
15.811.3
4.5
15.010.8
4.2Fiscal deficit -6.5 -11.4 -4.8 -6.3 -5.5 Inflation(annual
percentchange)
874.5 307.4 197.4 47.6 14.2(actual 1997,
14.6) Source: Various IMF documents.
Preliminary data at this time were showing that the economy had
begun toturn around since the third quarter of 1996. Output
appeared to have stabilized in 1997 after years of decline;
inflation continued to decelerate -the monthly percent change for
the last quarter of 1996 had declined to 1.7 percent; and the
exchange rate was stable. Structural reforms had gainedmomentum in
the areas of natural monopolies and public utilities, and the
government had eased restrictions on access to capital markets
bynonresidents. While the authorities had used a sizable reserve
cushion to defend the ruble during 1996, there was a reversal of
exchange marketpressure in the first half of 1997 attended by
large capital inflows. The easier monetary conditions due to the
capital inflows and the clearing upof arrears brought with them
the associated risk of renewed inflation, and the IMF monetary
program was revised for the second half of 1997.Compared to the
severe difficulties experienced in 1996, the developments during
the first half of 1997 were encouraging. The IMF staff
noted,however, that there were still considerable uncertainties in
Russia, and that the IMF assumed a potentially large exposure to
risk7 in providingsupport to the country. Given Russia's
substantial reliance on energy exports, there was also a risk of
external shocks, for example, due to adecline in the price of oil
or gas. Amid uncertainties about the government's capacity to
implement the program, the IMF approved the1997 program based on
the strong leadership demonstrated by the new government as well
as the completion of the prior actions.
7 The risk that Russia would not be able to repay the loan.
Table VI.2: Russian Federation: FederalBudget Aggregates and
Inflation, 1993- 1997 (in Percent of GDP)
Positive Developments inFirst Half of 1997
Appendix VI The IMF's Financial Arrangement with Russia
Page 150 GAO/GGD/NSIAD-99-168 IMF Financial Assistance In mid-
1997, the economic crisis that started in Thailand quickly spread
toother Asian countries and to Russia, aborting the nascent
economic recovery that had just begun in Russia after 8 years of
deep output decline.From October 1997 on, Russia continued to
experienced recurrent financial crises. The government and the CBR
attempted to protect themain economic policy achievements of the
recent years--low inflation, a fixed ruble, and the living
standards of the people - through foreignexchange market
interventions and interest rate hikes, both seen as needed to
defend the ruble. The spillover from the Asian financial
turbulence in the fall of 1997 spreadto Russia's financial markets
and further undermined investor confidence, already adversely
impacted by Russia's ongoing fiscal problems. Federalcash revenue
collections were not improving, and the government was able to
achieve the deficit target only by holding down cash
expenditures,thus creating new expenditure arrears. Substantial
foreign exchange outflows accompanied the financial turbulence.
The CBR's response wasto sell foreign exchange and, later, to
raise interest rates. Consequently, Russia was unable to meet its
international reserve target. Originallyintended to be an
assessment of end-September performance, the IMF's sixth quarterly
review and the corresponding quarterly disbursement weredelayed
until January 1998. The delay was due to the serious underlying
weakness and slow progress in addressing the fiscal problems,
asindicated by the nonobservance of the government revenue
performance criterion from January to September 1997. The review
also indicated thatthe September performance criteria, which
Russia did not meet, were no longer operationally relevant. The
December criteria were being modified,as they were no longer
attainable either, and thus could not be applied against Russia's
performance yet. Thus, the review requested a waiver ofthe
applicability of December performance criteria.
8 During this period,
structural reforms proceeded generally as envisaged under the
1997program, particularly in the areas of natural monopolies (gas)
and
privatization, and there was continued progress in closing
andrestructuring smaller banks. Overall, however, the IMF staff
recognized that the program continued to face serious risks.
8 A "waiver of applicability" generally is used when a review
slips. If the IMF staff believes it cannot
certify the country's compliance with the performance criteria
during the relevant time period but isconfident that the program
is on track, this waiver will be recommended. However, the staff
is likely
to try to verify the country's compliance with the waived
performance criteria at a later time, generallythe next review.
Fall 1997: Ripple EffectsFrom the Asian Financial Crisis Spill
Over to Russia'sFinancial Markets, Compounding Russia'sFiscal
Problems
Waivers, Modifications, andProgram Delays Ensue
Appendix VI The IMF's Financial Arrangement with Russia
Page 151 GAO/GGD/NSIAD-99-168 IMF Financial Assistance In late
1997, the IMF and Russia created a credible fiscal action plan
anddeveloped monetary policy actions and targets to reestablish
monetary policy restraint, which had deviated considerably from
the program. Onthe fiscal side, the discussions emphasized the
difficulties in controlling budget expenditures, as well as
ineffective efforts to collect taxes fromlarge debtors, as the
source of fiscal problems. For example, the inability of the
government to pay its own bills, combined with extensive use
ofmonetary offsets and noncash mechanisms to settle budgetary
arrears against tax debtors' arrears, undermined incentives for
paying taxes incash. The Russian government agreed to take steps
(prior actions) based on the newly developed strategy to bring the
fiscal program back on track,including the abolition of all types
of noncash tax arrangements on January 1, 1998. The monetary
policy discussions were concerned with theCBR's response to
sizable foreign exchange outflows and how to ensure that these
outflows would not become a source of inflationary
pressure.Informal and flexible understandings
9 were reached on a revised monetary
program for end-December 1997 that permitted some room for
expansionof base money but also emphasized keeping inflation on a
downward trend
and protecting international reserves. To complete the review,
thegovernment had to undertake fiscal measures, agree upon targets
for the 1998 federal budget, revise monetary performance criteria
for end-December 1997, and complete actions on the structural
side.
The IMF staff conceded that little had been accomplished on the
fiscal sideby end-December 1997, particularly in the collection of
tax revenues, owing to a lack of "forceful and focused
implementation," along with slowprogress in improving tax
administration, and that the credibility of the Russian
authorities was at stake. However, they recommended thecompletion
of the sixth review based on the newly adopted fiscal action plan
that brought a new approach to tackling the fiscal problem and
theexpectation that the authorities would make a concerted effort
to follow through this time.
9 For example, the mission staff stressed that when faced with
sizable foreign exchange outflows, the
CBR should allow domestic money market conditions to tighten (that
is, let interest rates rise), or atleast refrain from intervening
to prop up the price of treasury bills. The CBR concurred.
New Fiscal Action PlanAddresses Budget Difficulties and
TaxCollection
Lack of Political WillBehind Lax Revenue Collection
Appendix VI The IMF's Financial Arrangement with Russia
Page 152 GAO/GGD/NSIAD-99-168 IMF Financial Assistance During
February 1998, amid the ongoing pressures on Russia's
financialmarkets, an IMF mission team visited Moscow to hold
discussions for the seventh quarterly review and to complete the
talks begun earlier on the1998 program. The subsequent dismissal
of Prime Minister Victor Chernomyrdin in March and the Duma's
approval of Yevgeny Kiriyenko inApril, together with weak oil
prices, delayed the review and implementation of the program, as
well as the disbursement of the $700million credit tranche.
Follow-up staff visits took place in April and May to revise the
fiscal targets and policies for 1998. In mid-May, following the
formulation of the 1998 program, a severefinancial crisis hit
Russia, coinciding with renewed financial instability in Asia
(Indonesia) and labor unrest in Russia. The CBR's interventions in
theforeign exchange market led to a large decline in reserves, and
sharp increases in interest rate and financial volatility
underscored Russia'svulnerability to changes in market sentiment.
The IMF staff again recognized that the program might have to be
revisited unless confidencereturned. The completion of the review
and approval of the 1998 program occurred in June 1998, following
Russia's completion or satisfactoryprogress in 27 fiscal,
financial, and structural measures (many were from the November
1997 Fiscal Action Plan) and observance of the Marchtargets. Some
measures included (1) collecting taxes from large tax debtors, (2)
taking steps to improve tax collection, (3) establishing
bettermonitoring and control over expenditure commitment, and (4)
identifying additional expenditure cuts. Although Russia missed
the deficit and cashrevenue targets for end-March, no waiver was
requested,
10 though a waiver
was granted for nonobservance of one December 1997
performancecriterion. The staff also supported Russia's request
for the extension of the
EFF arrangement for a fourth year in light of the delayed
purchases during1996-97 and the need to catch up with the original
program objectives.
The Russian government favored achieving the deficit target
throughspending cuts, as officials did not think that they could
collect the required amount of cash tax revenues or that the Duma
would agree to the requiredtax measures. However, the IMF staff's
opinion was that expenditure cuts often translated into new
expenditure arrears, hence they emphasizedstrengthening
collections from large, delinquent tax debtors. In the end, the
program relied on both approaches. For example, the Emergency
TaxCommission met in May and made a decision to collect arrears
from a
10 The IMF Board discussed the seventh quarterly review on June
25, 1998. The relevant performance
criteria were those that were established for end-December 1997.
There were no performance criteriafor end-March 1998 (only
indicative targets) and, as a result, the end-December 1997
performance
criteria remained in effect at the time of the IMF Board review.
Cabinet Changes Delayed1998 Program Approval and Disbursement of
FirstTranche-Low Oil Prices Led to Further ProgramModifications
1998 Program ApprovedAmid May Financial Crisis
The 1998 ProgramEmphasized Expenditure Cuts and Pursuit of
TaxDebtors With Large Arrears
Appendix VI The IMF's Financial Arrangement with Russia
Page 153 GAO/GGD/NSIAD-99-168 IMF Financial Assistance number of
large tax debtors, and the Expenditure Reduction plan wasadopted
by presidential decree that month as well
11. Eliminating mutual
offsets, which undermined the incentives to pay taxes in cash, was
alsocritical to resolving the fiscal problem. No new offset
operations had been
approved since January 1, 1998, and federal government abstention
fromany offset operations was to be a performance criterion under
the 1998 program.12 The 1998 structural reform program was front
loaded with a wide range ofmeasures taken as prior actions ahead
of the IMF Executive Board's consideration. Structural reforms
that would have importantmacroeconomic impact over the medium term
were designated benchmarks for each quarter. Some areas of focus
for the structuralreform agenda included making improvements in
corporate governance through ensuring a more transparent
accounting by public utility andtransport monopolies, engaging in
an open and competitive privatization process, liberalizing the
trade regime, and strengthening the prudential andsupervisory
framework of the banking sector. Some of the fiscal prior actions
Russia had to undertake for the completion of the seventyquarterly
review were based on elements from the November 1997 Fiscal Action
Plan, for example, collecting taxes from large tax
debtors,establishing better monitoring and control over
expenditure commitments, and identifying additional expenditure
cuts needed to observe the programtargets. Progress in structural
reforms continued to be based on an overall assessment, but with a
particular emphasis on the structural benchmarks. While the IMF's
projections for 1998 and beyond indicated a strengtheningof
Russia's balance of payments over the medium term that would
permit Russia to service its obligation to the IMF, the IMF staff
was cognizant ofsubstantial risks to the program, such as:
* a variability in capital flows and foreign exchange outflows,
magnified byRussia's dependence on nonresident's participation in
the treasury bill
market (as illustrated by May 1998 events);* a vulnerability to
external shocks, given Russia's reliance on energyexports;
* a sluggish pace in transitioning to a market economy; and
11 One item, for example, in the Expenditure Reduction Plan
included reducing the number of spending
units from 139 to 99. 12 According to the U.S. Treasury, the
Russian government did another round of offsets in February 1999.
Structural Reforms WereFront-Loaded; Transparency
andAccountability Were Emphasized
1998 Program HadSubstantial Risks
Appendix VI The IMF's Financial Arrangement with Russia
Page 154 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
* the upcoming elections that could undermine the government's
will andability to implement tough measures.
Nevertheless the IMF staff indicated that the program was
deserving ofcontinued IMF support because of the government's
strong commitment to the program and the important steps it took
to stabilize and reform theeconomy during the first 2 years of the
EFF. Further, the staff noted, the Russian authorities were taking
additional prior actions before the IMFBoard meeting, were
implementing many of the fiscal measures, and were committed to an
ambitious structural reform agenda. The Russian government had
financed its high, and ultimatelyunsustainable, budget deficits by
selling ruble-denominated, short-term debt to both foreign and
domestic investors. By May 1998, nonresidentinvestors were holding
about one-third ($20 billion) of domestic treasury securities. The
government borrowed in capital markets and issuedtreasury bills
and bonds at high yields to attract capital. This added a heavy
debt service burden to the Russian budget. Further, the short-
termmaturity of the debt meant that Russia constantly had to roll
over the debt. This made the economy highly vulnerable to changing
investor sentimentsin the capital market. As long as foreign and
domestic investors were willing to renew short-term debt, this
practice could continue, but Asia'sfinancial problems intensified
the instability in global financial markets. The combination of
high yields, deteriorating investor sentiment, and theshort-term
maturity of the treasury bills raised investor concerns that the
Russian government would not be able to meet around $1.5 billion
in debtservice that fell due each week in the remainder of 1998.
By June 1998, domestic borrowing to finance the federal budget
came to a virtual halt. The Russian government had been in a race
between its need to collectmore taxes and to pay the rising
interest bill on its growing debt - the government had to roll
over more than $1 billion per week of treasury bills.This became
impossible, as export revenues declined with falling oil and
commodity prices and interest rates sharply increased when capital
fledthe country. The persistent weaknesses in tax collection and
government spending in excess of what was affordable exacerbated
the situation.Russia was forced to request international
assistance
* to replenish international reserves,*
to overcome liquidity problems arising from foreign investors
redeemingtheir short-term ruble-denominated debt, and
Economy Vulnerable toVariable Capital Flows and Foreign Exchange
Outflows
June 1998: Russia RequestsAdditional Funds to Avert Financial
Crisis
Appendix VI The IMF's Financial Arrangement with Russia
Page 155 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
* to provide the government with reserves of dollars and other
foreigncurrencies to keep the ruble at its current value in
foreign exchange
markets. The government needed more dollars to attempt to prevent
the ruble fromlosing too much of its value against the dollar. A
depreciated ruble could create serious problems for the Russian
banks and industries that had tobuy dollars with rubles to repay
their loans from foreign banks. It could also reignite the ruinous
inflation that had plagued Russia in the early1990s by raising the
price of imports.
Recognizing that it was a calculated risk,13and to try to help
Russia avoiddevaluation, the IMF made a decision to provide $11.2
billion in extra funding on an augmented EFF arrangement on July
20, 1998. The financingconsisted of an increase in the EFF
arrangement of about $8.3 billion, and about $2.9 billion under
the Compensatory and Contingency FinancingFacility (CCFF)
14 to compensate for a shortfall in export earnings, mainly
due to lower oil prices. Of the augmented amount to be provided
under theextended arrangement, about $5.3b was to be made
available under the
Supplemental Reserve Facility15 (SRF), and the remainder was new
EFFfunding. The augmentation of the extended arrangement came from
borrowing the equivalent of about $8.3 billion under the IMF's
rarely usedGeneral Agreement on Borrowing.
As June 1998 data were not available to assess Russia's
performance underthe 1998 program, this requirement was waived in
the proposed decision, and the IMF approved the first disbursement
under the CCFF. Theremainder of the disbursements were to be in
three additional installments phased through February 1999.
Because of Russia's delays in implementingthe personal income tax
and pension measures, the amount being made available immediately
was reduced from $5.6 billion to $4.8 billion. Thedifference was
to be made available in September, assuming the measures were
satisfactorily implemented.
13The risk to the IMF was that in this deteriorating situation the
attempt to avert devaluation and its
adverse impacts would fail and Russia would not be able to deliver
on its policy commitments. 14 The CCFF provides financial
assistance to IMF members experiencing temporary export
shortfalls. Repayments are made over 31/4 to 5 years. A decline
in world oil prices had reduced Russia's foreignexchange earnings.
15 The Supplemental Reserve Facility provides financial assistance
for exceptional balance-of-payments difficulties due to a large,
short-term financing need resulting from a sudden and disruptive
loss ofmarket confidence. Repayments are to be made within 1 to
11/2 years.
IMF Approves Request -Exceptional Risk Noted
Appendix VI The IMF's Financial Arrangement with Russia
Page 156 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The new
package included fiscal measures to aimed at reducing the
fiscaldeficit. These included:
* tax reforms, measures to increase tax revenues, and spending
cuts;*
new structural reforms to address the arrears problem and
promoteprivate sector development; and
* steps to reduce the vulnerability of the government debt
position (forinstance, a voluntary restructuring of short-term
treasury bills).
The July 20, 1998 announcement of the IMF's additional policy
packagehad a positive, but very short-lived, effect on Russia's
financial markets. Ultimately, the Duma's lack of support for the
program in the areas ofpersonal income tax and pension fund
financing and the veto by the president of several measures led
the IMF to reduce the initial amount ofthe disbursement from $5.6
billion to $4.8 billion.
16 The program also faced
opposition in the key energy sector, and the collection of overdue
taxpayments from a number of oil companies proved difficult.
Finally, the
government-owned Sberbank's decision to not roll over its sizable
treasurybill holdings falling due in the last 2 weeks in July
culminated in cancelled bond auctions because of prohibitively
high borrowing rates. Withpressure growing against the ruble and
spreading to the banking sector, the CBR was forced to intervene
on a large scale. However, these actionswere not enough to avert a
serious crisis. Russia was facing a full-scale banking and
currency crisis by mid-August. Russia's persistently large fiscal
imbalances, heavy reliance on short-termforeign borrowing financed
at high interest rates, the impact of the declining price of oil
on Russia's external balance, and delays in structuralreform led
to Russia's replacing Asia in August 1998 as the center of the
financial crisis afflicting emerging markets, thus potentially
erasing manyof the gains of prior years.
In August 1998, the Russian government abandoned its defense of a
stableruble exchange rate - one of the major accomplishments of
the previous years - essentially devaluing the ruble, forced a
restructuring ofgovernment domestic debt, and placed a 90-day
moratorium on commercial external debt payments. The financial
crisis intensifiedfollowing the dissolution of the Kiriyenko
government and the approval of
16The IMF program required the passing into law, ahead of IMF
approval on July 20, a series of
measures needed for the achievement of revenue and expenditure
targets.
New Package Could NotHalt Crisis Russia Defaults on Debt andIMF
Suspends Program
Appendix VI The IMF's Financial Arrangement with Russia
Page 157 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Yvegeny
Primakov as Prime Minister on September 11, 1998.17 On that dayas
well, the German government acknowledged that Russia missed
virtually all of a DM800 million interest payment due on August 20
onsovereign debt dating from the Soviet era. Russia's decision to
unilaterally restructure its ruble-denominated sovereign debt and
impose amoratorium on private external debt payments had
significant repercussion in the financial markets, effectively
destroyed Russia'sexternal creditworthiness, and cut Russia off
from international capital markets. Currently, Russia's debt
service exceeds Russia's ability to pay.The IMF's second tranche
was scheduled to be delivered on September 15, 1998, but the IMF
has made no further payments following the initial $4.8billion
disbursement because of the Russian government's failure to meet
its loan conditions. According to the IMF, the immediate cause of
the Russian economic crisiswas the growing loss of financial
market confidence in the country's fiscal and international
payments situation, leading to a loss of reserves and aninability
to roll over treasury bills as they matured. However, fundamental
problems having to do with Russian economic policy and
economicstructure lay behind Russia's vulnerability.
According to the IMF and the Congressional Research Service,
deeperproblems involving the incomplete restructuring of Russia's
economy caused Russia's vulnerability. Russia's fiscal problem
originated in Russia'sfailure to reform its huge and inefficient
tax system, resulting in inadequate tax collection. Further, the
culture of nonpayment and thewidespread use of barter have made it
difficult to resolve the fiscal imbalances. According to one
estimate by Russia scholars, more than 50percent of payments are
conducted by barter and 40 percent of the tax revenues are paid in
a nonmonetary form. Public spending has not beenadequately
controlled, and the government has not been able to cover its
expenditures with revenues. Other structural problems include the
lack ofclarity in the administrative relationship between the
federal government in Moscow and the regional and local
governments. This situationproduces confusion and conflict over
control of assets and tax authority. The vagueness of
relationships is further complicated by problems indealing with
the oligarchs, a group of individuals who have amassed a great
deal of wealth and who control the major banks and
enterprises.There has also been slow progress in making key
structural reforms such
17 On August 23, 1998, President Yeltsin dismissed then-Prime
Minister Sergei Kiriyenko and his
government. According to the Congressional Research Service,
Primakov chose for his governmentindividuals largely considered to
be less inclined to pursue economic reforms than had the previous
government.
Russia's Problems AreDeeper Than the Deficit
Appendix VI The IMF's Financial Arrangement with Russia
Page 158 GAO/GGD/NSIAD-99-168 IMF Financial Assistance as
introducing accountability and transparency at all levels of
governmentoperations, establishing a federal treasury system, and
restructuring enterprises and the legal framework, which adversely
affects theeconomy's performance more broadly.
Appendix VIIThe IMF's Financial Arrangement with Uganda
Page 159 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Uganda has
had continuous IMF arrangements since 1987. In November1997, the
IMF approved a new 3-year arrangement of about $138 million under
its Enhanced Structural Adjustment Facility (ESAF). The
IMFarrangement was requested by the Ugandan government to support
its 1997-2000 economic program. The arrangement was approved by
the IMFExecutive Board on the basis of the government's balance-
of-payments needs.1 IMF and U.S. Treasury officials described the
Ugandan governmentas a good performer that had consistently met
IMF terms and conditions and attributed this performance to the
Ugandan president's commitment toeconomic reform. U.S. Treasury
officials said the IMF program is in line with U.S. objectives for
the country. However, an IMF official said thatUganda did not meet
some of the conditionality for completion of the February/March
1999 midterm review, and began undertaking promptremedial measures
to enable the review to be completed after a lag of a few months.
The IMF consequently, delayed the second disbursement ofthe
arrangement until the review is completed.
The IMF established the ESAF in 1987 to address macroeconomic
policyand structural reform measures in low-income countries
facing protracted balance-of-payments problems. ESAF loans have
lower interest rates andlonger terms than regular IMF
arrangements. ESAF loans carry a concessional interest rate of 0.5
percent a year and are to be repaid in 10equal semiannual
installments, beginning 5 1/2 years and ending 10 years after the
date of each disbursement. ESAF loans are disbursedsemiannually,
beginning with approval of the arrangement by the IMF Executive
Board and subsequently upon the ESAF borrower's adherenceto
performance criteria and following a midterm review by IMF staff.
In contrast, regular IMF arrangements have quarterly reviews
anddisbursements. ESAF borrowers must develop a 3-year policy
framework paper, which is updated annually, setting forth the
macroeconomic andstructural adjustment policy objectives and
measures to be undertaken, along with the external financing
needs. The purpose of the process is tocatalyze and coordinate
financial and technical assistance from assistance donors. The
Ugandan government outlined its principal objective for its
economicprogram, to be supported by an ESAF arrangement, as
sustaining high and broad-based economic growth in which the
poorest segment of the
1 Structural reforms are a key element of ESAF arrangements. The
IMF rationale for supporting
structural reforms is that they are critical elements in achieving
balance-of-payments viability and laythe basis for sustainable
economic growth by eliminating institutional rigidities, such as
market
segmentation and vested interests' resistance to change, which
channel resources away from efficientuse.
Summary
Appendix VII The IMF's Financial Arrangement with Uganda
Page 160 GAO/GGD/NSIAD-99-168 IMF Financial Assistance population
can participate. To accomplish this objective, the
governmentintended to (1) maintain macroeconomic stability; (2)
continue liberalization of the economy to promote diversified,
export-orientedgrowth; (3) undertake structural and institutional
reforms that will further reduce impediments to economic growth;
and (4) promote goodgovernance.
According to the IMF, key elements for the government's
achievement ofits objectives are completion of ongoing structural
reforms in the financial sector, public service, tax policy and
administration, external trade,privatization, and public
enterprise restructuring. IMF staff reported that the government
must also improve its technical capacity and statisticaldata
bases, especially those relating to balance of payments, monetary
statistics, and social indicators. IMF quantitative performance
criteria and benchmarks include ceilings onthe net domestic assets
of the banking system, net claims on the government by the banking
system, gross issuance of promissory notes bythe government, and
external borrowing and debt, as well as increases in the central
bank's international reserves, minimum revenues, andminimum
expenditures on priority (including social) areas in the
government's 1998/99 economic program. Structural performance
criteriafocus on government arrearages and bank examinations.
Structural performance benchmarks specify reforms in trade,
fiscal, and privatizationissues; and in the civil service and
financial sectors. There were also prior actions relating to trade
liberalization and privatization for completionprior to the
February/March 1999 midterm review.
In performing their first review in December 1997, IMF staff found
that thegovernment had met the quantitative and structural
performance criteria except for the ceiling on net claims by the
banking system. An IMF officialsaid the IMF Executive Board issued
a waiver after deciding the nonobservance of the criterion was due
to a reversible technical factor thathad not seriously jeopardized
government performance. According to this official, the government
has generally met IMF benchmarks, althoughobservance of some
elements was delayed by a short period due to technical reasons.
However, the government's nonobservance in meetingbenchmarks in
the area of privatization of state-owned enterprises was
characterized by IMF staff as "significantly set[ting] back the
privatizationprogram."
An external evaluation of ESAF done for the IMF in March 1998
concludedthat Uganda had been successful both in terms of
achieving stabilization
Appendix VII The IMF's Financial Arrangement with Uganda
Page 161 GAO/GGD/NSIAD-99-168 IMF Financial Assistance and growth
and stated that key decisions were taken by the government onits
own initiative.
2 IMF officials indicated that Uganda was one of the few
countries where there had been no major program interruptions over
anumber of years. They attributed this to the government's
commitment to
reform. Also, government officials were aware of IMF procedures
andgenerally were careful to avoid nonobservance of program
conditionality. In some instances, however, program performance
criteria or benchmarkswere not observed mainly due to unintended
technical factors, or the government was unable to deliver on
implementation. For example, thepace of privatization fell short
of what was envisioned for in the first half of 1998/99 and was a
major reason for the IMF delaying the completion ofthe
February/March 1999 midterm review. The midterm review mission
also found that some of the quantitative performance criteria were
notmet, although by modest amounts. The government was expected to
get back into program targets within a short period of time,
according to anIMF official. An IMF staff mission was in Uganda in
May 1999 to reassess the situation regarding completion of the
midterm review.
2 Report by a Group of Independent Experts, External Evaluation of
the ESAF (Washington D.C.: IMF,
1998).
Appendix VII The IMF's Financial Arrangement with Uganda
Page 162 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Table VII.1
shows the timeline for Uganda's current 3-year ESAFarrangement.
Year Month Activity1997 October
November
-- Uganda requested a new 3-year ESAF arrangement -- Ongoing ESAF
arrangement completed-- IMF approved a new 3-year ESAF arrangement
-- IMF made the first disbursement under the first
annualarrangement
1998 February
March April
October November
-- Article IV consultations and midterm review by IMF staffmission
assessed Ugandan observance of performance criteria -- Uganda did
not meet all criteria for December 1997 -- Uganda requested waiver
from IMF for nonobservance ofcriterion
-- IMF Executive Board granted waiver-- IMF made second
disbursement under the first annual arrangement -- Uganda
requested approval for second annual arrangement -- IMF staff
review completed-- IMF approved second annual arrangement -- IMF
made first disbursement under the second annualarrangement
1999 February
May
-- IMF Article IV and midterm review by IMF staff missionassessed
Ugandan observance of performance criteria -- Uganda did not meet
all December 1998 criteria-- Completion of IMF review delayed to
provide time for the government to take corrective actions--Second
disbursement under the second annual arrangement delayed until
completion of the review -- IMF staff mission in Uganda to
reassess progress on programimplementation prior to completion of
the midterm review and subsequent release of the second
disbursement Source: IMF data.
Years of war and civil strife in the 1970s-1980s destroyed
Uganda'sinfrastructure, public services, and agricultural
production and impoverished the population. Per capita GDP in 1986
was 60 percentbelow its level of 1970, annual inflation had risen
to 240 percent, and external debt service was more than 50 percent
of exports. Exports otherthan coffee had all but ceased by 1987.
The country had annual declines in terms of trade each year from
1986 to 1992. However, the country has beenundergoing successful
macroeconomic adjustment and structural reform
Table VII.1.: Timeline of Key Activitiesfor Uganda's Current
Arrangement History of the IMFArrangements With Uganda
Appendix VII The IMF's Financial Arrangement with Uganda
Page 163 GAO/GGD/NSIAD-99-168 IMF Financial Assistance with IMF
and other donor support since 1987. Economic growth hasaveraged
over 5 percent per annum since 1987, but a European Union
representative in Uganda told us in April 1998 that much of the
country'sgrowth has been "recovery growth" and that the country
was only reaching levels in 1998 that it was at in 1972. He also
said that, after 25 years of warand chaos, with the society
surviving largely at the subsistence level, the country was
vulnerable to corruption. Uganda has had 10 IMF arrangements since
1987. The current 3-year ESAFarrangement approved by the IMF
Executive Board in November 1997 totals about $138 million and is
to support the Ugandan government's1997/98-1999/2000 economic
plan. The first semiannual installment of $27.6 million of the
first annual arrangement was made in November 1997. InApril 1998,
Uganda was the first country to complete an international
initiative aimed at reducing the debt burden of some heavily
indebted poorcountries.
3 The IMF has had a resident representative in Uganda since July
1982. U.S. Treasury officials said that, over the past few years,
problemshave become apparent in (1) government privatization of
state-owned
enterprises, (2) corruption within government, and (3)
governmentmilitary spending. IMF and U.S. Treasury officials said
that, unlike many governments, the Ugandan government is committed
to addressing thecorruption problem. There appears to be increased
emphasis by the IMF and other donors on reducing corruption within
the government andholding down military expenditures to ensure
that funds are available for needed social spending. The IMF
resident representative also told us inApril 1998 that the rule of
law needs to be strengthened since laws, regulations, and
procedures are weak throughout the system. According to the
external (independent) experts' 1998 evaluation of ESAF,the
government's reform program benefited from intensive public
education and consensus-building initiatives. The external
evaluation also
3 In 1996, the World Bank and the IMF proposed the Debt Initiative
for the Heavily Indebted Poor
Countries (HIPC Initiative) in response to creditors' concern that
some poor countries face debtburdens too large relative to their
ability to pay, even after receiving debt relief through the then
existing mechanisms. The Initiative's stated goal is to reduce
countries' debts to levels that aresustainable, meaning that in
the future they can make debt payments on time and without
reschedulings. As a condition to receiving HIPC assistance,
countries must undertake economic andsocial reforms. As a result
of its adjustment record, Uganda was the first country to be
granted a Paris Club stock-of-debt operation on Naples terms in
February 1995 - the equivalent of restructuring 32percent of its
outstanding debt with Paris Club creditors. Uganda was the first
country to reach its completion point under the Initiative in
April 1998, resulting in receipt of $69 million in HIPC
debtrelief. Uganda's total external debt was US$3.7 billion as of
June 1998. In nominal terms, total debt relief over time under
the Initiative is estimated to amount to US$650 million. The
Ugandangovernment said it intends to spend the funds garnered from
debt relief in the health and education sectors. For more
information on the HIPC initiative see the GAO report Developing
Countries: Statusof the Heavily Indebted Poor Countries Debt
Relief Initiative (GAO/NSIAD-98-229, Sept. 30, 1998).
Appendix VII The IMF's Financial Arrangement with Uganda
Page 164 GAO/GGD/NSIAD-99-168 IMF Financial Assistance noted that
the Ugandan president defended government policies in theface of
public opposition and protests, rather than opting for political
expediency as is done by "most presidents." IMF officials said the
Ugandanparliament supports the ESAF program, although there are
some questions among legislators about the speed at which it is
implemented. While theMinistry of Finance is responsible for
specific monitoring of program performance criteria and
benchmarks, the parliament's EconomyCommittee monitors the program
in a general way. IMF missions to Uganda meet with the president,
the Ministry of Finance, and the CentralBank, and in recent years
have also met with noneconomic ministries, parliamentary
committees, nongovernmental organizations, and private-sector
organizations.
The IMF is providing technical assistance to the government to
* implement changes in customs management and administration,*
establish a large-taxpayer unit for the 100 largest taxpayers,*
improve budget management through improved expenditure control
andfinancial accounting,
* promote secondary markets in treasury bills, and*
improve the statistical base through enhanced collection and
reporting ofnational accounts, revenue, expenditures, balance-of-
payments and debt
statistics, and implementation of prior technical assistance
missions'recommendations.
The IMF reported that, during the annual arrangement in 1994/95-
1996/97,annual real GDP growth averaged 8 percent and inflation
was 5 percent. The fiscal deficit, excluding grants, was reduced
from 11.2 percent of GDPin 1993/94 to 6.5 percent in 1996/97. The
external current account deficit, excluding grants, declined to
6.1 percent in 1996/97, and improved balanceof payments increased
international reserves to 4.6 months of imports of goods and
nonfactor services. Government elimination of marketingboards,
price controls, export taxes, and foreign exchange restrictions
contributed to expansion and diversification of the export base.
Uganda'sdebt service ratio as measured by the annual payments on
debt outstanding as a ratio of export earnings fell from 53.7
percent in 1993/94to 18 percent in 1996/97 following Paris Club
debt reschedulings.
The external experts' 1998 evaluation reported that the 1994-97
ESAFarrangement did not need a stabilization component and
consequently focused on a development agenda of structural
reforms. The scope of IMF-government policy dialogue focused on
issues not traditionally within the
Uganda's PerformanceUnder the 1994/95- 1996/97 AnnualArrangement
Appendix VII The IMF's Financial Arrangement with Uganda
Page 165 GAO/GGD/NSIAD-99-168 IMF Financial Assistance IMF's area
of expertise. As part of Uganda's structural adjustment,
thefollowing reforms were undertaken.
* The civil service was reduced in size by 25 percent, noncash
benefits weremonetized and salaries increased, and army
demobilization was
completed.
* Within tax policy reforms, the tax identification number system
wasexpanded, a value-added tax (VAT) introduced, most
discriminatory tax
exemptions were eliminated, and a new income tax bill was
submitted toparliament.
* The Bank of Uganda was restructured and its recapitalization
begun, twocommercial banks were restructured, the Uganda
Commercial Bank was
recapitalized and steps to privatize it begun, and enforcement of
adequatecapital requirements in the banking sector was undertaken.
* Fifty-five public enterprises were privatized, actions were
initiated toprivatize telecommunications, and a communications act
and amendments
to remove the Uganda Electricity Board's monopoly and regulatory
powerswere submitted to parliament.
* Import tariffs and import duty exemptions were reduced, export
taxeswere eliminated, and an external debt-management and
borrowing strategy
that eliminates nonconcessional borrowing was implemented.
IMF disbursements for the 3 -year arrangement were $24.5 million
inSeptember 1994 and $26.3 million in April 1995; $29.8 million in
December 1995 and $29 million in May 1996; and $33.7 million in
December 1996 and$32.5 million in May 1997.
On October 22, 1997, the government requested a new 3-year
ESAFarrangement of about $138 million to support its economic plan
for 1997/98-1999/2000. Uganda's fragile external position left it
vulnerable toexternal shocks; and it faced deteriorating terms of
trade, uncertainty over the effectiveness of revenue measures, and
substantial expenditurepressures. The IMF approved the arrangement
on November 10, 1997. IMF officials said that other donors wanted
Uganda to have an IMF program as
Uganda's New 3-YearArrangement and the First AnnualArrangement
Appendix VII The IMF's Financial Arrangement with Uganda
Page 166 GAO/GGD/NSIAD-99-168 IMF Financial Assistance an anchor
for their assistance. They also said that some IMF
executivedirectors felt that Uganda needed assistance on
structural issues such as financial sector reform, privatization,
trade liberalization, and socialspending. IMF and U.S officials
emphasized the Ugandan government's commitment to reform. The IMF
made its first disbursement to Ugandaunder the new arrangement in
November 1997 for $27.6 million.
The quantitative performance criteria for Uganda focus chiefly
onbolstering Uganda's liquidity and creditworthiness by improving
its ability to reduce inflation, by garnering resources readily
usable for the purposeof financing deficits in the balance of
payments, and by stabilizing the foreign exchange value of the
currency (Ugandan shilling). The quantitative performance criteria
for the first annual arrangementcovered the following:
* Ceilings were set on net domestic assets of the banking system
as amonetary policy measure intended to control the rate of
inflation by
limiting the amount of money in circulation. Increases in the net
domesticassets of the banking system are, in effect, increases in
outstanding loans to the nonbanking sector that raise the amount
of money in circulation andrepresent a potential source of
inflation.
* Limits were set on the net claims of the banking system on
thegovernment, as a mechanism to restrict the growth rate of
government
borrowing. Net claims of the banking system on the government are
loansto the government by the banking system. Bank loans to the
government may either increase the amount of money in circulation
and possibly raisethe rate of inflation in the country or raise
the interest rate by fostering competition with the private sector
for loans. Moreover, by discouragingbanks from lending to the
government, limiting net claims may also serve as a fiscal
restraint on the government.
* A prohibition was set on the issuance of promissory notes by
thegovernment to curb the rate of growth of government spending
financed
through issuance of negotiable instruments, such as bonds. This
fiscalrestraint prohibits government borrowing from the public to
finance government expenditures.
* Arrears on outstanding external debt was forbidden. This
prohibitionenforces the Ugandan government's agreement with the
IMF and the
Quantitative PerformanceCriteria and Benchmarks
Appendix VII The IMF's Financial Arrangement with Uganda
Page 167 GAO/GGD/NSIAD-99-168 IMF Financial Assistance World Bank
to maintain an on-time payment history to remain eligible forpast
and future debt reduction benefits under the HIPC.
* The Bank of Uganda was prohibited from incurring debt with a
maturity ofless than 1 year. Short-term external debt of the Bank
is loans from
external sources contracted by the Bank when it is unable to
providesufficient foreign exchange to pay for expenses that are
incurred for routine international transactions. This prohibition,
therefore, ensures thatthe Bank maintains sufficient foreign
exchange on hand to pay for each year's imports of good and
services. Consequently, short-term creditextended to Uganda to
facilitate trade with international trading partners cannot be
converted to long-term international debt.
* Limits were established on new public- or publicly-
guaranteednonconcessional debt. This was intended to reduce total
external debt by
restricting government borrowing from international sources,
unless thedebt contains a grant element of at least 35 percent.
* A minimum net international reserve level for the Bank of
Uganda was set.Setting a minimum reserve level enhances the
availability of foreign
exchange for the purposes of stabilizing the value of the currency
andmaintaining adequate foreign exchange to pay for several months
of imports of goods and services.
Appendix VII The IMF's Financial Arrangement with Uganda
Page 168 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Table VII.2
shows the specific criteria and timetable, or benchmarks, forthe
first annual arrangement. Quantitative criteria
Performancecriteria for
December1997
Benchmarkfor March
1998
Benchmarkfor June
1998
Remarks
Ceiling on the increase in net domesticassets of the banking
system
a U sh 24.8 U sh 36.2 U sh 29.8b Adjustments to be made for
import support inexcess of cumulative projections.
Ceiling on the increase in net claims on thegovernment by the
banking system
a U sh -35.0 U sh -40.5 U sh -55.9
Adjustments to be made for debt servicepaid by the central
government in excess of
cumulative projections. Ceiling on issuance of promissory notes
bythe governmenta 0 0 0 Excludes notes issued to regularize
domesticpayment arrears not to exceed 24.1 billion.
Ceiling on the stock of external paymentarrears
c 0 0 0 This criterion must be continuouslyobserved.
Ceiling on new nonconcessional externalborrowing over one year
contracted or
guaranteed by the governmentc $10.0 $10.0 $10.0 Excludes debts
contracted in the context ofreschedulings. Ceiling on outstanding
short-term externaldebt of the Bank of Ugandac 0 0 0 External debt
with maturity of less than 1year excluding normal import related
credit.
Minimum increase in net internationalreserves of the Bank of
Ugandac $35.9 $64.2 $71.7 Concurrent adjustments to be made in
caseof adjustments in ceiling of net domesticassets and net claims
on government.
aCumulative change in billions of Ugandan shillings from end of
June 1998. bThis benchmark was originally set at 36.9 million
Ugandan shillings. cCumulative change in millions of U.S. dollars
from end of June 1997.
Source: IMF. The structural performance criterion for the first
annual arrangement wasto complete government auditing of at least
200 VAT payers, 50 of which
would be from the top 400 VAT-registered taxpayers, and the rest
of whichwould be based on revenue-risk criteria. Achievement of
the criterion was to be completed by December 31, 1997. Three
prior actions for the removalof import bans by March 31, 1998,
were also established. Table VI.3 shows the structural performance
benchmarks for the first annual arrangement.
Table VII.2: Quantitative Performance Criteria and Benchmarks for
the First Annual Arrangement Structural PerformanceCriterion and
Benchmarks
Appendix VII The IMF's Financial Arrangement with Uganda
Page 169 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Category
Performance benchmark Privatization *Relinquish government control
of 80 public enterprises by December 31, 1997.*
Relinquish government control of 89 public enterprises by March
31, 1998.*Relinquish government control of 95 public enterprises
by June 30, 1998.
*Divest 23 enterprises including 7 with asset values of 5 billion
Ugandan shillings or more by June 30, 1998; divestiture ofat least
3 of these 7 large enterprises by December 31, 1997.
*Offer Uganda Telecommunications Ltd. for sale following its
separation from the Uganda Posts and TelecommunicationsCorp. by
December 31, 1997.
Governmentrestructuring *Set the size of the number-limited civil
service on the payroll, excluding primary school teachers, at
57,100 by December31, 1997, and 55,600 by June 30, 1998.
*Gain Cabinet approval of agreed structures and establishments for
9 central ministries/departments by January 31, 1998.*Reduce
Uganda Electricity Board employment from 3,060 as of June 1997 to
2,800 by December 31, 1997, and 2,300 by June 30, 1998.*Ensure
minimum nonwage budgetary expenditures for the Priority Program
Areas of health and education at $24.6 million by December 31,
1997, and $45.5 million by June 30, 1998. Taxation *Audit 600
taxpayers based on revenue/risk criteria by June 30, 1998. Banking
*Conduct annual on-site inspections of at least 40 percent of
banks by June 30, 1998.
Source: IMF.
In its March 24, 1998, Article IV consultation and midterm review,
the IMFstaff reported that the government had met its quantitative
and structural performance criteria for December 31, 1997, with
the exception of thegovernment's net position vis-a`-vis the
banking system. This criterion was missed, according IMF staff,
because of the more rapid liquidation ofdomestic nonbank
liabilities than expected (government checks cleared the banking
system sooner than expected). The IMF Executive Boardgranted a
waiver because nonobservance was deemed to be technical in nature,
as opposed to a policy violation. Performance was reported
assatisfactory with respect to the structural benchmarks. However,
some of the benchmarks were categorized by IMF staff as "observed
with delay,"meaning that the benchmarks were met but not within
the timeline envisioned. In addition, the removal of three import
bans, a prior actionwith a completion date of March 31, 1998, was
met according to the IMF. In the October 28, 1998, IMF staff paper
to the IMF Executive Board onUganda's request for a second annual
arrangement, the staff stated that the government had met the
removal of bans on three imports on time. TheIMF disbursed $27
million in April 1998.
On October 28, 1998, the Ugandan government requested the
secondannual ESAF arrangement. The IMF staff had reported in its
October 28, 1998, ESAF policy framework paper that heavy rains in
1997/98 hadadversely affected Ugandan food and coffee production,
transportation,
Table VII.3: Structural Performance Benchmarks for the First
Annual Arrangement Uganda's Observance ofCriteria and Benchmarks
Uganda's SecondAnnual ESAF Arrangement
Appendix VII The IMF's Financial Arrangement with Uganda
Page 170 GAO/GGD/NSIAD-99-168 IMF Financial Assistance and
exports; real GDP growth was 5.5 percent and inflation 5.8
percent.The current account deficit excluding grants as a share of
GDP was 8.3 percent. Capital and official transfers financed the
current account deficitand generated a balance-of-payments surplus
so that gross international reserves rose to 4.9 months of imports
of goods and services. The IMFExecutive Board approved the
arrangement on November 11, 1998. The first disbursement of $23.1
million was made November 25, 1998. The quantitative performance
terms and conditions for Uganda`s secondannual arrangement added
two criteria to those of the first annual arrangement:
* a minimum amount of total revenue was to be collected in order
to reducefiscal deficits, and
* a minimum amount of nonwage expenditures to be made in the
priorityprogram areas of education and health so that the social
sector would not
be overlooked relative to other priorities, particularly
militaryexpenditures.
Table VII.4 shows the quantitative performance criteria and
benchmarksfor the second annual arrangement.
Quantitative PerformanceCriteria and Benchmarks
Appendix VII The IMF's Financial Arrangement with Uganda
Page 171 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
Quantitative criteria Performancecriteria for
December1998
Benchmarkfor March
1999
Benchmarkfor June
1999
Remarks
Ceiling on the increase in net domesticassets of the banking
systema U sh 50.1 U sh 36.9 U sh 29.3 Adjustments to be made for
import supportin excess of cumulative projections. Ceiling on the
increase in net claims on thegovernment by the banking systema U
sh -9.1 U sh -41.9 U sh -73.8 Adjustments to be made for debt
servicepaid by the central government in excess ofcumulative
projections. Minimum revenue collected by the UgandaRevenue
Authoritya U sh 440.0 U sh 671.0 U sh 924.0
Minimum nonwage expenditures on priorityprogram areasa U sh 75.6 U
sh 124.6 U sh 179.1
Minimum expenditure would be increasedby no less than 50 percent
of the first 8.6 billion of import support in excess ofcumulative
projections.
Ceiling on issuance of promissory notes bythe governmenta 0 0 0
Excludes notes issued to regularizedomestic payment arrears not to
exceed Ush 24.1 billion. Ceiling on the stock of external
paymentarrearsb 0 0 0 This criterion has to be
continuouslyobserved. Ceiling on new non concessional
externalborrowing over 1 year contracted or guaranteed by the
government $10.0 $10.0 $10.0 Excludes debts contracted in the
context ofrescheduling agreements.Ceiling on outstanding short
term external debt of the Bank of Uganda 0 0 0 External debt with
maturity of less than 1year excluding normal import related
credit. Minimum increase in net internationalreserves of the Bank
of Uganda $18.9 $50.2 $94.8 Concurrent adjustments to be made in
caseof adjustments in ceilings of net domesticassets and net
claims on government.
aCumulative change in billions of Ugandan shillings from end of
June 1997. bCumulative change in millions of U.S. dollars from end
of June 1997.
Source: IMF.
The following structural performance criteria for the second
annualarrangement (1998/99) were to be completed by December 31,
1998:
* verification by the Verification Subcommittee of the Ugandan
governmentline ministries' report on arrears outstanding at the
end-June 1998 and
submission of its findings to the Arrears Monitoring and Reporting
Unit,and
* completion of follow-up site examinations of the banks for
which the Bankof Uganda sent a timetable of corrective actions.
Table VII.4: Quantitative Performance Criteria and Benchmarks for
the Second Annual Arrangement Structural PerformanceCriteria and
Benchmarks
Appendix VII The IMF's Financial Arrangement with Uganda
Page 172 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Prior
actions that were to be completed by March 31, 1999, for the
midtermreview were
* the removal of the import ban on cigarettes, and*
approval of divestiture plans in 1998/99 by the Divestiture and
ReformImplementation Committee and commencement of investment
search
(defined as issuance of information memorandum, advertisement of
sale,or placement of shares on stock exchange) for 10 enterprises
by March 15, 1999, of which 5 were to be high-priority
enterprises.
Table VII.5 shows structural performance benchmarks for the
secondannual arrangement.
Category Performance benchmark Privatization *Approval of
divestiture plans in 1998/99 by the Divestiture and Reform
Implementation Committee andcommencement of investment search
(define as issuance of information memorandum, advertisement of
sale, or
placement of shares on stock exchange) for 16 enterprises by June
30, 1999.*Decision by the Cabinet on options for increasing
private sector involvement in the operations of the Uganda
Railways Corporation by December 31, 1998. Governmentrestructuring
*Finalization by the Arrears Monitoring and Reporting Unit of a
plan to clear verified outstanding arrears within 3 yearsby end-
February 1999.
*Reduction in the size of the number-limited civil service on the
payroll, excluding primary school teachers to 53,190 byDecember
31, 1998, and 512,640 by June 30, 1999, with a margin of error of
up to 99 for new pending cases.
*Limitation of the waiting period between the date of reporting to
work and that of being put on the payroll to no morethan 4 weeks
to be a continuous benchmark beginning October 1, 1998.
Taxation *Completion by the Large-Taxpayer Unit of 10
comprehensive on-site audits by December 31, 1998.*
Completion by the Large-Taxpayer Unit of an additional 40
comprehensive on-site audits by June 30, 1999.*Completion of on-
site audits of all retail and nonretail gasoline outlets by the
Uganda Revenue Authority by June 30,
1999.
Banking *Completion of on-site examination of four commercial
banks that have been identified as showing less-than-
fullcompliance with bank regulations or being in need of stronger
management practices, and issuance of relevant
examination reports by September 30, 1998.
Source: IMF.
In the IMF staff paper to the Executive Board on Uganda's request
for thesecond annual arrangement, the staff stated that the
government had met its macroeconomic objectives for 1997/98 and
that real growth wasreviving and inflation was low. The staff also
said the end-June 1998 quantitative and structural benchmarks were
largely met, with theexceptions of net claims on the government by
the domestic banking system (which was exceeded by a very small
margin) and the number of
Table VII.5: Structural Performance Benchmarks for the Second
Annual Arrangement
Appendix VII The IMF's Financial Arrangement with Uganda
Page 173 GAO/GGD/NSIAD-99-168 IMF Financial Assistance public
enterprises privatized (which set back significantly the
privatizationprogram). The 1998 external experts' evaluation of
ESAF noted that the IMF'straditional role is crisis management and
that this has generally been the context for the extension of ESAF
arrangements. The evaluation statedthat Uganda had fully achieved
stabilization and the major macroeconomic reforms had been
implemented, and consequently, the IMF has reachedthe point where
it had to decide whether to (1) maintain its exclusive focus on
crisis-management and so withdraw from Uganda, or (2) extend
itsmandate and remain in Uganda. It noted that the case for
withdrawal from Uganda is that the IMF's work is done. The case
for continued involvementwas that (1) investors and donors still
regard Uganda as high risk and want the reassurance that an IMF
presence brings, (2) the Ugandan governmentstill needs IMF
expertise, and (3) ESAF resources are most productive in an
already reformed policy environment such as Uganda's. The
evaluationfavored continued IMF involvement in Uganda. U.S.
Treasury officials felt that continued IMF involvement in Uganda
is warranted because thereform program is still in a fragile state
due to (1) serious weaknesses in human and institutional capacity
that the IMF is uniquely suited to helpremedy, and the recently-
identified problems with corruption that are in part related to
these capacity deficiencies, and (2) the threats to fiscal
andeconomic stability posed the military security problems in the
region.
IMF staff conducted their midterm review of Uganda's performance
underthe arrangement in February/March 1999 in conjunction with
their annual Article IV consultations. Staff found that the
government had missed theDecember 1998 quantitative performance
criteria on (1) net domestic assets, (2) net credit to the
government by the banking sector, (3) issuanceof promissory notes
for current expenditures, (4) minimum non-wage expenditures in the
social sectors of health and education, and (5)minimum net
reserves. The structural performance criterion on the verification
of arrears was also missed. The midterm review wasconsequently not
completed and the IMF delayed the second disbursement under the
arrangement. An IMF official said the non-observance was marginal
and the country'smacroeconomic picture had not changed, with
inflation remaining low and the real growth rate possibly
exceeding the government's target of 7percent. The official said
that Ugandan revenues were very good due to (1) improved controls
of corruption in customs, (2) improved taxadministration, and (3)
income tax reforms, such as a broadened tax net and elimination of
tax exemptions, which were paying off. However, the
Uganda'sNonobservance of Criteria Results in theIMF Delaying of
Disbursement
Appendix VII The IMF's Financial Arrangement with Uganda
Page 174 GAO/GGD/NSIAD-99-168 IMF Financial Assistance official
said the government had used the unexpected revenues to
increasemilitary spending from 1.9 percent of GDP to 2.5 percent.
Although the increased military spending does not violate IMF
criteria, the officialexpressed concern that government officials
not continually expect revenues to exceed expectations in order to
pay for increasing militaryexpenditures. The official said that
IMF staff's major concern was that Uganda's privatization effort
was completely off track due to politicalfactors and corruption.
The official said there is a loss in government credibility and
therefore buyers are reluctant to bid for enterprises in
theprivatization program. The parliament had suspended the program
while it conducts an investigation. The IMF staff set prior
actions relating to theprivatization program and the financial
sector, which the government must meet prior to the staff's
completion of the midterm review, which resumedin May 1999 and is
expected to be completed in June 1999. Despite these problems, the
IMF official said the Ugandan government has been quick toreact to
IMF findings, is making efforts to meet IMF conditions, has fired
corrupt officials, has promised to hold down military spending,
and shouldstill be classified as a good performer.
Appendix VIIICriticisms of the IMF
Page 175 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The
financial support that the IMF has provided to member
countries,along with the conditions attached to that support, has
long been a topic of debate. This issue recently received
considerable prominence when theU.S. Congress considered an
increased U.S. quota contribution to the IMF in 1998. While a full
discussion of these issues is outside the scope of thisreport,
several themes, including "moral hazard," the appropriateness of
IMF conditionality, and the effect of IMF programs on the poor,
have beenconsistently raised and illustrate the complexity of this
debate.
The issue of moral hazard has two components: (1) the willingness
andability of an international financial institution, such as the
IMF, to "rescue" a country from problems that may be of its own
doing; and (2) the concernthat the financing provided by these
institutions is shielding private sector participants from the
risks inherent in their investments. In the firstinstance, critics
argue that the incentives for a country to avoid financial
difficulties are diminished by its reliance on IMF assistance to
lessen theimpact of its policy mistakes. In response to this
criticism, the IMF stresses that crises inevitably bring painful
consequences, and that, inexchange for receiving its financial
assistance, countries have to agree to adopt a stringent
conditionality program that is designed to address eachcountry's
underlying problems. The adjustments required in implementing such
a program can be very costly and painful, and thus should
providesufficient disincentive to countries from pursuing
questionable policies. Furthermore, countries are obligated to
repay the IMF for the financialassistance provided.
Under the second moral hazard issue, critics of the IMF contend
that inproviding financial support to countries, the IMF also
"bails out" large international banks and other private lenders.
When a member countryreceives financial assistance from the IMF,
the funds can be used to pay off existing creditors including
those in the private sector. This activity hasraised concerns
about the efficiency of the international financial system by
shielding private sector participants from the risks inherent in
theirinvestments. If some creditors are not fully assuming
investment risk, and are lending under the assumption that the IMF
and other official supportwill be forthcoming if necessary,
distortions could be introduced into the international financial
system. The IMF and the Group of Seven (G-7),1 inrecent public
announcements, have acknowledged the existence of this threat to
the international financial system and are exploring strategies
forreducing it. However, it has been argued that the danger of
moral hazard
1 The G-7 consists of seven major industrialized countries
(Canada, France, Germany, Italy, Japan, the
United Kingdom, and the United States) that consult on general,
economic, and financial matters.
Appendix VIII Criticisms of the IMF
Page 176 GAO/GGD/NSIAD-99-168 IMF Financial Assistance should be
balanced against the danger of the further spread of
financialdifficulties, or "contagion." During a crisis, lenders
and investors may try to limit their exposure to all developing
countries, not just those in crisis.This can result in countries
with sound economic policies experiencing a financial crisis,
driven largely by external events out of their control.
Byproviding assistance to nations facing such a crisis, the IMF
may also slow or stop the exit of private-sector lending to other
developing countries andthus help minimize this potential threat
to the international financial system. The appropriateness of IMF
conditionality has also been subject to aconsiderable amount of
debate. First, some critics believe that the IMF has overstepped
its original mission by including conditions related toeconomic
and social development strategies ("mission-creep"). Second, some
critics have stressed that the imposition of an IMF
conditionalityprogram, under crisis conditions, that lacks a
political consensus is unlikely to be successful and could in fact
generate instability within thecountry. Third, during the Asian
financial crises, several critics questioned the IMF's underlying
economic assumptions for these countries, believingthe initial IMF
programs in Korea, Thailand, and Indonesia represented the IMF's
standard approach to crises (macroeconomic austerity) that
wasinappropriate for these countries' situations. According to
those critics, the IMF's "cookie-cutter approach" was doing those
countries more harm thangood. In response, the IMF has said that
the flexibility of its approach to countries has allowed it to
adapt to changing situations. In particular, itsincreasing
emphasis on structural issues has reflected a growing
understanding that balance-of-payments problems cannot be resolved
if aneconomy suffers from deep-seated structural weaknesses.
Moreover, the IMF has emphasized that its arrangements for
individual countriesconstantly evolve, depending on developments,
and that conditions are modified as necessary. The Thai,
Indonesian, and Korean programs, forinstance, were modified to
take account of these countries' unexpectedly severe recessions.
The IMF has also striven in recent years to coordinateits efforts
with other international financial institutions, including the
World Bank. The IMF has also been criticized because of the belief
that its programsimpose undue hardships on the poor. These critics
point out that IMF programs often require that governments cut
expenditures and reducebudget deficits in order to meet the IMF's
macroeconomic goals. They argue that such cuts often result in
reductions in spending on health,education, and other social
programs vital to the poor. The IMF has acknowledged that, in
certain cases in the past, programs for the poor
Appendix VIII Criticisms of the IMF
Page 177 GAO/GGD/NSIAD-99-168 IMF Financial Assistance have been
excessively reduced. To lessen this potential, the IMF says thatit
now pays considerable attention to social issues and to social
safety nets, to the point of sometimes now requiring that
countries maintainminimum spending levels for social programs,
despite the need for a general reduction in government spending.
Appendix IXComments from the Department of the Treasury
Page 178 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Now on p.
3. Now on p. 2.
Appendix IX Comments from the Department of the Treasury
Page 179 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Appendix
XGAO Contacts and Staff Acknowledgments
Page 180 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Susan S.
Westin (202) 512-8678Harold J. Johnson (202) 512-4128 James
McDermott, Thomas Melito, Barbara Keller, Cheryl Goodman,Gezu
Bekele, John DeForge, Patrick Dynes, Nima Patel Edwards, Debra
Johnson, Bruce Kutnick, Samantha Roberts, RG Steinman
GAO Contacts Acknowledgments
Glossary
Page 181 GAO/GGD/NSIAD-99-168 IMF Financial Assistance This
glossary is provided for reader convenience, not to
provideauthoritative or complete definitions for IMF funding
arrangements, programs, and facilities. A decision by the IMF that
gives a member the assurance that theinstitution stands ready to
provide foreign exchange or special drawing rights (SDRs) in
accordance with the terms of the decision during aspecified period
of time. An IMF arrangement--which is not a legal contract--is
approved by the IMF Executive Board in support of aneconomic
program under which the member undertakes a set of policy actions
to reduce economic imbalances and achieve sustainable
growth.Resources used under an arrangement carry with them the
obligation to repay the IMF in accordance with the applicable
schedule, and to paycharges on outstanding purchases (drawings).
(See "purchases and repurchases.") Under Article IV of the IMF's
Articles of Agreement, the IMF holds bilateraldiscussions with
members, usually every year. A staff team visits the country,
collects economic and financial information, and discusses
withofficials the country's economic developments and policies. On
return to headquarters, the staff prepares a report, which forms
the basis fordiscussion by the Executive Board. At the conclusion
of the discussion, the Managing Director, as Chairman of the
Board, summarizes the views ofdirectors, and this summary is
transmitted to the country's authorities.
An international treaty that sets out the purposes, principles,
and financialstructure of the IMF. The Articles, which entered
into force in December 1945, were drafted by representatives of 45
nations at a conference held inBretton Woods, New Hampshire. The
Articles have since been amended three times, in 1969, 1978, and
1992, as the IMF responded to changes intheworld economic and
financial structure.
A country's balance-of-payments accounts summarize its dealings
with theoutside world. Balance-of-payments accounts are usually
divided into two main parts, the current account and the capital
account. A country is saidto have a surplus in its balance-of-
payments if there is an increase in its net official assets
(official reserves minus its liabilities to foreign
officialinstitutions). It is said to have a deficit (or external
deficit) if there is a decrease in its net official assets. The
smallest unit in quoting yields on bonds, mortgages, and notes,
equalto one one-hundredth of one percentage point.
Arrangement Article IV Consultation Articles of Agreement Balance-
of-PaymentsAccounts
Basis Points
Glossary
Page 182 GAO/GGD/NSIAD-99-168 IMF Financial Assistance Bank
regulators from industrialized countries adopted standards for
creditrisk exposure for internationally active banks in 1988 under
the auspices of the Bank for International Settlements. Known as
the Basle Accord, thestandards were fully implemented in 1992 by
member countries. The standards are formula-based and apply risk-
weights to reflect differentgradations of risk to each asset
category. Since 1992, the standards have been amended. The most
notable amendment is the establishment of risk-based capital
requirements to cover market risk in bank securities and
derivatives trading portfolios. A set of standards for effective
bank supervision, issued by the BasleCommittee on Banking
Supervision in September 1997. The core principles were developed
in close collaboration with supervisors from around theworld, the
IMF, and World Bank. The standards are comprised of 25 core
principles that form a sound framework on which to build
supervisorystructures that meet the needs and conditions prevalent
in individual countries. In the context of IMF programs, a point
of reference against whichprogress may be monitored. Benchmarks
are not necessarily quantitative and frequently relate to
structural variables and policies. In EnhancedStructural
Adjustment Facility Arrangements, some benchmarks are designated
as semiannual performance criteria and are required to beobserved
in order to qualify for phased (semiannual) borrowings. In
addition, quantitative benchmarks are set for the quarters for
which thereare no performance criteria, and structural benchmarks
are set for any date agreed upon under the arrangement. The
capital account of the balance-of-payments shows all flows
thatdirectly affect the national balance sheet. It includes (1)
direct investment by foreign firms in domestic affiliates and by
domestic firms in theirforeign affiliates; (2) portfolio
investment, which include net purchases by foreigners of domestic
securities and net purchases by domestic residentsof foreign
securities; (3) net lending to domestic residents and net lending
by domestic residents to foreigners; and (4) changes in cash
balances,which include changes in cash balances held by banks and
other foreignexchange dealers, resulting from current and capital
transactions. A special IMF financing facility (window) that was
established in 1988 tocombine the long-standing Compensatory
Financing Facility (retaining its essential features) with
elements of contingency financing. Thecompensatory element
provides resources to members to cover shortfalls in export
earnings and services receipts, as well as excesses in cereal
Basle Capital Standards Basle Core Principles Benchmarks
Capital Account Compensatory andContingency Financing Facility
Glossary Page 183 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
import costs, that are temporary and arise from events beyond
themembers' control. The contingency element may help members with
IMF arrangements to maintain their economic programs when faced
with abroad range of unforeseen adverse external shocks.
As defined by the IMF, economic policies that members intend to
follow asa condition for the use of IMF resources. These are often
expressed as performance criteria (for example, monetary and
budgetary targets) orbenchmarks, and are intended to ensure that
the use of IMF credit is temporary and consistent with the
adjustment program designed to correcta member's external payments
imbalance.
This is the broadest measure of a country's international trade in
goodsand services. Its primary component is the balance of trade,
which is the difference between merchandise exports and imports.
The current accountshows all the flows that directly affect the
national-income accounts. It includes exports and imports of
merchandise and services, inflows andoutflows of investment
income, and grants, remittances, and other transfers. A set of
exceptional procedures established by the IMF to facilitate
rapidExecutive Board approval of IMF financial support for a
member while ensuring the conditionality necessary to warrant such
support. Theseemergency measures are to be used only in
circumstances representing, or threatening to give rise to, a
crisis in a member's external accounts thatrequires an immediate
IMF response.
An IMF facility established in December 1987 to provide assistance
onconcessional terms to low-income member countries facing
protracted balance of payments problems. The ESAF's operations are
financedthrough borrowing by a trust administered by the IMF as a
trustee.
A government's policies concerning at what price (or whether) it
will seekto stabilize or otherwise influence the rate of exchange
between domestic currency and other currencies. Currency reserve
fund of the U.S. government employed to stabilize thedollar and
foreign exchange markets. ESF is managed by the Treasury. The
Federal Reserve Bank of New York acts as fiscal agent for the
Treasury.ESF holds special drawing rights allocated to the United
States by the IMF.
A decision of the IMF under the Extended Fund Facility that gives
amember the assurance of being able to purchase (draw) resources
from
Conditionality Current Account
Emergency FinancingMechanism Enhanced StructuralAdjustment
Facility Exchange Rate Policy Exchange StabilizationFund
Extended Arrangement
Glossary Page 184 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
the General Resources Account, in accordance with the terms of
thedecision, during a specified period, usually three to four
years, and up to a particular amount. A financing facility
(window) under which the IMF supports economicprograms that
generally run for three years and are aimed at overcoming balance-
of-payments difficulties resulting from macroeconomic
andstructural problems. Typically, an economic program states the
general objectives for the 3-year period and the specific policies
for the first year.Policies for subsequent years are spelled out
in program reviews.
See "Balance of Payments Accounts." Taxation and government
spending policies designed to achievegovernment goals, such as
achieving full employment, price stability, or growth in the
economy. Foreign direct investment occurs when citizens of one
nation purchasenonfinancial assets in some other nation.
Distinguished from portfolio investment (below), foreign direct
investment generally involvesownership of assets used in
production (e.g., factories).
The purchase by one country's private citizens or their agents
ofmarketable noncontrolling positions in equity and debt
securities issued by another country's private citizens,
corporations, banks, and governments.Commonly, these marketable
noncontrolling positions can be easily reversed. Foreign exchange
is the money issued by a foreign country. The foreign exchange
market is an interbank or over-the-counter market inforeign
exchange that is a network of commercial banks, central banks,
brokers, and customers. The stock of liquid assets denominated in
foreign currencies held by themonetary authorities (finance
ministry or central bank). Reserves enable the monetary
authorities to intervene in foreign exchange markets toaffect the
exchange value of their domestic currency in the market. Reserves
are typically part of the balance sheet of the central
bank.Reserves are invested in low-risk and liquid assets--often in
foreign government securities.
Extended Fund Facility External Deficit Fiscal Policy
Foreign Direct Investment
Foreign PortfolioInvestment
Foreign Exchange Foreign Exchange Market
Foreign Exchange Reserves
Glossary
Page 185 GAO/GGD/NSIAD-99-168 IMF Financial Assistance In an IMF
arrangement, placing a more that proportional part of
thedisbursement of the financial resources available to a member
near the beginning of the arrangement. Long-standing arrangements
under which 11 industrial countries standready to lend to the IMF
to finance purchases (drawings) that aim at forestalling or coping
with a situation that could impair the internationalmonetary
system. Since the establishment in 1962, these arrangements have
been renewed every four to five years and been invoked 10
times,according to IMF documents. Additional funds are also
available to the IMF under an "associated agreement" with Saudi
Arabia. Assets, whether ordinary (owned) or borrowed, maintained
within theIMF's General Resources Account.
Key interest rates at which the major banks in the London
interbankmarket are willing to lend funds to each other at various
maturities and for different currencies. LIBOR has become the most
important floating ratepricing benchmark for loans and debt
instruments in the global financial markets. These rates are
published daily by the Bank of England and arebased on a sampling
from a group of reference banks that are active in the
Eurocurrency market, but agreements that use LIBOR do not
necessarilyrely on quotes published by the Bank of England.
Macroeconomic policy is governmental and central bank
policyconcerning a nation's economy as a whole including, among
other things, price levels, unemployment, inflation, and
industrial production. Themacroeconomic analysis of open economies
is concerned with the effects of international and domestic
transactions on output, employment, and theprice level and the
effects of these in turn on the balance of payments and exchange
rate. It is also concerned with the implications of openness andof
exchange-rate arrangements for the functioning of monetary and
fiscal policies. Monetary policy is the central bank's use of
control of the quantity ofmoney and interest rates to influence
the level of economic activity. The quantity of money can affect
price levels and, for a given real income, thelevel of nominal
income within a given system. The central bank often concentrates
its policy actions, such as the interest rates it charges banksto
borrow, to achieve a money stock target. In theory, the demand for
money changes with changes in income and interest rates, in
addition toother factors.
Front-loading General Arrangements toBorrow
General Resources London Interbank OfferRates (LIBOR)
Macroeconomic Policy
Monetary Policy
Glossary
Page 186 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
Arrangements under which 25 member countries or their
financialinstitutions would be ready to lend to the IMF under
circumstances similar to those covered by the General Arrangements
to Borrow (see GeneralArrangements to Borrow). The New
Arrangements to Borrow are not to replace the General Arrangements
to Borrow, and the total amount ofresources potentially available
under the New Arrangements to Borrow and the General Arrangement
to Borrow is about $46 billion. The NewArrangements to Borrow can
be activated when participants representing 85 percent of the
credit lines' resources determine that there is a threat tothe
international financial system. The New Arrangements to Borrow
became effective on November 17, 1998 and were activated in
December1998 in connection with the financing of an arrangement
for Brazil.
Measurable and observable indicators, such as monetary and
budgetarytargets, or structural (policy) adjustments, that must be
met, typically on a quarterly basis, for a member to qualify for
purchases under a country'sarrangement with the IMF. These
indicators measure a country's implementation of conditions agreed
to under the country's IMF program.Performance criteria are
generally categorized as quantitative or structural depending on
the conditions being measured. (See also "benchmarks.") The
practice of making the IMF's resources available to its members
ininstallments over the period of an arrangement.
When the IMF makes its general resources available to a member, it
doesso by allowing the member to purchase SDRs or other members'
currencies in exchange for its own (domestic) currency. The IMF's
generalresources are, by nature, revolving; purchases (or
drawings) have to be reversed by repurchases (or repayments) in
installments within the periodspecified for a particular policy or
facility.
See "performance criteria" and "benchmarks."
The capital subscription, expressed in SDRs, that each member must
payto the IMF on joining, up to 25 percent is payable in SDRs or
other acceptable reserve assets and the remainder in the member's
owncurrency. Quotas, which reflect members' relative size in the
world economy, are normally reviewed every five years.
New Arrangements toBorrow Performance Criteria Phasing Purchases
and Repurchases
Quantitative PerformanceCriteria Quota
Glossary
Page 187 GAO/GGD/NSIAD-99-168 IMF Financial Assistance The debt
instruments issued or guaranteed by the central government of
acountry. Debt instruments are typically bonds evidencing amounts
owed and payable on specified dates or on demand. International
reserve asset created by the IMF in 1969 as a supplement
toexisting reserve assets. Its value as a reserve asset is
derived, essentially, from the commitments of participants to hold
and accept SDRs and tohonor various obligations connected with its
proper functioning as a reserve asset. The IMF defines its value
in terms of a basket of majorinternational currencies that
fluctuates with market conditions.
A decision of the IMF by which a member is assured that it will be
able tomake purchases (drawings) from the General Resources
Account up to a specified amount and during a specified period of
time, usually one to twoyears, provided that the member observes
the terms set out in the supporting arrangement. See "performance
criteria" and benchmarks."
A facility (window) established in December 1997 to provide
financialassistance to members experiencing exceptional balance of
payments difficulties due to short-term financing needs resulting
from a sudden anddisruptive loss of market confidence reflected in
pressure on the capital account and the members' reserves.
Sovereign Debt Special Drawing Right
Stand-by Arrangement Structural PerformanceCriteria Supplemental
ReserveFacility
Page 188 GAO/GGD/NSIAD-99-168 IMF Financial Assistance
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