Foreign Relations of the United States, 1981–1988, Volume XXXVIII, International Economic Development; International Debt; Foreign Assistance

226. Memorandum From the Assistant Secretary of the Treasury for International Affairs (Mulford) to Secretary of the Treasury Baker¹

Washington, August 26, 1987

SUBJECT

• Enlarging the SAF—Issues for September Meetings

In discussions since the Venice Summit on the Camdessus proposal to enlarge the Structural Adjustment Facility (SAF), potential contributors have been strongly supportive of enlargement, but have expressed divergent views over the form of contributions and burden sharing.

Enlargement of the SAF will be one of the main subjects for discussion at the September 27 Interim Committee meeting. I will have a preliminary exchange of views on the subject at the G–5 Deputies meeting on September 8. In preparation for these meetings, we need to focus on two basic issues:

— Should the enlargement be structured in the form of loans directly to the IMF (thereby placing on the IMF the risk of non-payment by the low-income borrowers), or as loans to a trust fund administered by the IMF (which would spread the risk of non-payment among the contributors)?

— What, if any, contribution could the U.S. make to the enlargement?

A. Direct Lending to the IMF

One possible approach is that contributors could make loans directly to the IMF. These loans would be highly-liquid claims on the Fund that they could treat as reserve assets. In order to reduce interest charges to the low-income borrowers to the level of the SAF (½ percent per annum), contributors would also have to provide grants to an interest subsidy fund. (Roughly one dollar of grants for every three dollars of loans.) While there are precedents for this approach, it is inconsistent with the twin objectives of a SAF enlargement, namely supporting adjustment in low-income countries and protecting the Fund’s financial strength.

This approach is opposed by Camdessus, and we have argued strongly against it in post-Venice discussions. The overwhelming drawback is that it would lead to an increase in the Fund’s exposure in low-income countries, thereby undermining the monetary character of the Fund and further threatening its financial integrity. In addition, it would be difficult to fashion a facility that would be available only to the poorest countries without infringing on the fundamental IMF tenet that all members are treated uniformly. Consequently, the criteria governing use of the facility would probably result in some borrowing by middle-income LDCs, thereby dissipating the resources available for those countries in greatest need. Moreover, this approach would encourage members unable to gain access to the enlarged SAF to seek concessions regarding their access to other IMF resources (e.g., higher access limits under the enlarged access policy, longer maturities, lower interest rates, rescheduling IMF obligations, etc.). If successful, these efforts would reduce IMF liquidity and hasten the need for a quota increase.

The Japanese strongly favor this approach, however, arguing that direct loans to the IMF are the only way in which their central bank could provide resources, and that alternative financing techniques would preclude them from counting the resulting claims as reserve assets, and would require budgetary expenditures. The Japanese are also pushing for a large U.S. share. Other countries are also attracted to direct loans to the IMF for similar reasons, but have not been as adamant as the Japanese.

Implications for Possible U.S. Participation

— Under this approach, a U.S. contribution to the enlarged SAF would have to have two components:

○ A direct loan to the IMF, authorized and appropriated by the Congress. Consistent with current practice, this loan would probably not produce a net budget outlay. (There is some risk however, that Congress would perceive the loan as tantamount to concessional foreign aid and would treat the loan as producing a budget outlay. This would set a precedent for changing the treatment of other IMF transactions so as to produce budget outlays.)

○ A grant to an interest subsidy account, authorized and appropriated by the Congress. This would produce a net outlay under the 150 account.

— If the U.S. can make a loan to the IMF that does not have an impact on net budget outlays, other contributors may view this as grounds for a larger U.S. share. On the other hand, to the extent that other contributors insist upon this approach, it could lessen the pressure on the U.S. to make a substantial contribution.

— Under this approach, a direct U.S. loan of $300–600 million might be sufficient to reach agreement on an SDR 6 billion enlargement, but it is too soon to be sure. (A loan of this size would have to be matched by a grant of $100–200 million to the interest subsidy account, although we could also spread the grants out over the next 13 years at $8–16 million per year.)

B. Lending to a Trust Fund

The original Camdessus proposal envisaged loans from contributors to a trust fund on concessional terms matching those of the SAF. This approach is the most consistent with the twin objectives of helping low-income countries and strengthening the financial position of the IMF. In contrast to the direct loan approach, the risk of lending to low-income countries from a trust fund would fall on contributing governments rather than on the IMF (and ultimately the U.S. and the IMF’s other creditor members). We supported this approach, although we stressed that efforts to seek contributions should focus on countries with balance of payments or budget surpluses.

Most potential contributors expressed reservations about this approach in its purest form because it would leave them bearing the risk of default, and because their claims would not be liquid. As a consequence, they would not be able to make their contributions in the form of off-budget central bank loans.

Responding to these concerns, the Fund staff have proposed a variety of measures to provide security and liquidity for loans to a SAF Trust. These include: (a) establishing a reserve with the estimated SDR 4 billion in SAF reflows to compensate contributors in the event of non-payment—leaving the SAF Trust with a claim on the delinquent borrower; (b) adding to the reserve the proceeds from a small surcharge on interest paid by low-income borrowers or a small discount on interest paid to the contributors—0.2 percent on both lenders and borrowers would yield SDR 200 million; (c) establishing a sinking fund at a rate of 2.5 percent of the loans made by the Trust; and (d) including transfer and encashment provisions to provide liquidity.

The staff also looked into the possibility of pledging a portion of the Fund’s gold as collateral for loans to the SAF Trust, although it does not yet have approval from Camdessus to advance this means of enhancing security and liquidity. While use of IMF gold would make loans to the Trust more attractive, it could also prompt other LDCs to seek use of a portion of the Fund’s gold for their balance of payments financing needs (as occurred with the 1975–80 gold sales for the initial Trust Fund).

Since the U.S., as the Fund’s largest creditor, bears most of the risk of the Fund’s current exposure in low-income countries, we benefit the most from a Trust Fund approach in which other contributors provide the bulk of the financing and assume a larger share of the risk. Similarly, the U.S. has a strong incentive to minimize the use of IMF gold to back the Trust as this gold provides the ultimate security for the much larger U.S. claims on the IMF.

Implications for Possible U.S. Participation

— Better than the direct lending approach because it is easier to target on low-income countries, and because it would shift a portion of the risk to other contributors.

— Even with various embellishments to provide liquidity and some risk protection, we probably would not be able to avoid treating a U.S. loan to a SAF Trust as producing a net budget outlay. With IMF gold as collateral, we could discuss with Congress the possibility that this loan be treated like other transactions with the IMF (i.e., no net outlay), but it is doubtful they would agree.

— Use of IMF gold as collateral, however, would require prior Congressional approval. Furthermore, depending on the amount of collateral and possible pressure to use additional IMF gold for the benefit of other LDCs, this approach to reducing risk could weaken the IMF’s financial position and the security of U.S. claims on the Fund.

C. Other Approaches

There are two other approaches that have been discussed but do not appear to have enough support to warrant serious consideration:

— First, the SAF could be enlarged by means of selling IMF gold. While this would allow the U.S. (and others) to escape any budget impact, we would still need Congressional approval, and gold sales would undermine the security of our claims on the Fund. Furthermore, Camdessus has said he is adamantly opposed to this approach due to the weakness of the Fund’s financial position as a result of growing arrears.

— Second, enlargement could be accomplished by an SDR allocation of SDR 10 billion, of which SDR 6 billion would be “donated” by industrial countries to a SAF Trust. This is contrary to our position on SDR allocations in general, and to our position on an SDR-aid link. Moreover, U.S. loans or grants of SDRs could require Congressional approval. No other contributors are pushing this approach.

Conclusion

From the perspective of short-term budget implications, the direct lending approach has the advantage of minimizing outlays, although the total amount of authorizations and appropriations would be higher. This advantage is more than outweighed by the disadvantages, especially from increasing the Fund’s exposure in uncreditworthy countries and exacerbating repayment difficulties. From the broader perspective of U.S. interests in strengthening the IMF and promoting adjustment in low-income countries, the SAF Trust approach is clearly the most desirable, and also avoids the need to request congressional support for both a loan and a grant. Our support for the SAF Trust lends weight to the arguments of the Managing Director, and would lead to the smallest overall commitment of funds (assuming the same level for a U.S. loan in either case).

In advocating the SAF Trust approach, we can expect to meet some continuing resistance, although some countries may be more attracted to a SAF Trust approach when combined with various provisions for greater liquidity and risk protection. If other contributors insist on direct loans to the IMF, we are in a better position to argue for a smaller share. Indeed, our view of the efficacy of the direct loan approach provides grounds for making no contribution at all.

Recommended Approach for September Meetings

1. We should continue to argue strongly for lending to a Trust Fund rather than directly to the IMF, emphasizing that we have major doubts about the efficacy of enlarging the SAF by means of direct lending.²

2. We should support the exploration of various features to enhance the security and liquidity of loans to a Trust, possibly including a very modest use of IMF gold as collateral.³

3. We should indicate a willingness to contemplate a modest loan on concessional terms to the SAF Trust, but continue to stress that efforts to obtain contributions should focus on surplus countries.⁴ We should emphasize that we will not be in a position until later in 1987 to indicate whether the U.S. would contribute, and what the size of any possible contribution might be.⁵

4. We should stress to the Fund and other contributors that it would be counterproductive to draw public attention to the issue of a U.S. contribution during the September meetings because of pending Congressional action on the IDA VIII replenishment.⁶

5. We should point out that we are still not satisfied that some of the underlying problems associated with the operation of the SAF (conditionality, monitoring, IBRD participation) have been solved, and continue to press for improvements.⁷

RECOMMENDATION: That you approve the approach recommended above.⁸

1. Source: Washington National Records Center, RG 56, Executive Secretariat, Congressional Files, 1987, 56–90–29, Box 44, [no folder title]. Confidential.
2. Baker wrote “yes” in the left-hand margin next to this point.
3. Baker underlined “possibly including a very modest use of IMF gold as collateral” and wrote “no” in the left-hand margin next to this point.
4. Baker underlined “We should indicate a willingness to contemplate a modest loan on concessional terms” and wrote “no” in the left-hand margin next to this point.
5. Baker wrote “in advance” in the right-hand margin next to this point and drew a box around it.
6. Baker wrote “yes” in the left-hand margin next to this point. He wrote under the point “Our priorities, IDA, GCI, SAF” and drew a box around those words. Next to these words he wrote: “I intend to confront them in that order. No obj. to surplus countries [illegible].”
7. Baker wrote “yes” in the left-hand margin next to this point.
8. Baker did not indicate his approval or disapproval of the recommendation. Under the recommendation he wrote: “Other—See above issue by issue. JAB III 9/5.”