238. Information Memorandum From the Acting Assistant Secretary of State for Economic and Business Affairs (Larson) to Secretary of State Shultz1
SUBJECT
- Problems Brewing on IMF Conditionality in Major and Strategic LDCs
Summary and Introduction. Over the next 6–9 months, pressures regarding IMF policies will intensify. A number of politically important, problem-debtor countries need good Fund programs to avoid a severe financial squeeze, but are unable or unwilling to undertake serious economic adjustment. These include Egypt, Yugoslavia, Argentina, Zaire, and probably Senegal and Brazil. At the same time, G–7 countries (and most OECD countries) are pressuring IMF Managing Director Camdessus to toughen up the Fund programs. They blame the US for the recent tendency toward weaker ones. End Summary and Introduction.
Industrial-country members of the IMF are beginning to resist “weak” standby programs. Fund standbys have supported a number of weak adjustment programs recently as a last resort to prevent important LDC debtors from abandoning managed adjustment altogether. Weak standby programs do little to correct entrenched balance of payments problems but do allow the Fund to supply credit to “refinance” payments to the IMF, and provide justification for Paris Club rescheduling. industrial countries conclude that weak programs cannot continue without compromising the integrity of the IMF and endangering the monetary nature of the organization. In addition, there is fear that the Fund is falling victim to the conditionality paradox which has plagued concerted commercial lending; viz. the worst financial/economic performers, which should pursue the most stringent adjustment, are rewarded with the softest lending terms and performance criteria.
This emerging consensus that the Fund must toughen up runs directly counter to the growing “adjustment fatigue” of the debtor/developing countries. Egypt is the most adamant, as you heard personally from Mubarak. At the same time, Egypt requires both enormous adjustment and enormous financing if it is to avoid severe economic crisis. Without a standby and the concomitant Paris Club, [Page 612] Egypt’s financing requirement this year would be about $2 billion. But Yugoslavia, Zaire, Argentina, and possibly Brazil and Senegal may also become big problems before mid-year. These governments, like Egypt, seem to be drawing a line in the sand, saying they will accept an IMF program only on their terms. Also like Egypt, they all need generous Paris Club and/or commercial bank reschedulings along with standbys.
To take the long view, we are at the conjuncture of two contradictory trends: “adjustment fatigue” in the LDCs/debtors vs “financing fatigue” in the creditors. Effective adjustment in most LDC’s requires deep structural change and a strong, prolonged political will to effect this change in the face of slow growth. This realization is one factor which increasingly influences both debtors and commercial lenders as they struggle to reach accommodation on rescheduling/new money packages.
Creditors have learned that the effectiveness of conditionality is questionable. Countries cannot be forced against their will into sound economic management. The IMF and IBRD, like the commercial banks, have found themselves protecting their investments in debtors, instead of pursuing effective adjustment. The result has been acceptance of weak programs for both middle income and the poorest countries.
The developing world has discovered that policy adjustment can be both delayed and piecemeal without immediate consequences, perhaps because of an overly tolerant international financial community. In other words, the incentives for LDC political leaders to pursue sound economic policies have been less than clear.
The US has not been consistent in its own approach. We have tended to acquiesce—if not encourage—accommodating IMF programs in the big debtors (except Yugoslavia), but have been tough on the programs in other countries. In addition, the US has insisted on conservative financial management by the IMF, in particular significant and continuous increases in IMF reserves against losses.
Other G–7 Finance Ministries and Central Banks are trying to close ranks on the need for better IMF programs. (There will, of course, be conflicts within the G–7 governments over these issues, between finance and foreign ministries.) The G–7 Deputies, we believe, are charged to monitor major IMF programs and report on them to Ministers. Treasury staff is sensitive to the perception that the US has been the leading culprit, and is no doubt sensitizing Baker. However, it is questionable whether Treasury can withstand the temptation to jump in on the side of a major debtor (e.g. Brazil) when problems with the Fund threaten the debt strategy.
Within the next few months, Egypt, Argentina, Yugoslavia, Zaire, Brazil and Senegal will all seek new or renewed IMF programs with minimal conditionality. They will expect our support in the IMF as part [Page 613] of the political and security relationship they have with us. Balancing our broad interests in these countries will be extremely difficult, and easily could create friction with Treasury, and possibly within the G–7, from time to time. In our view, we need to get Baker’s agreement to set up a system for early warning, discussion, and resolution of these issues. The primary interlocutors should probably be Allen Wallis and Peter McPherson; Alan Woods should be included when AID is involved in the debtor country—as in Egypt. Such a system would avoid much strain, and the need for last-minute, Cabinet-level decisions.
- Source: Department of State, Executive Secretariat, S/S Files, 1988–1989 Official Office Files for (E) Economic Affairs Allen Wallis, Lot 89D154: Through Memoranda March 1988. Confidential. Drafted by Seth Winnick (EB/IFD/OMA) on March 11; cleared by Milam. Sent through Wallis. Wallis wrote on the memorandum: “worth reading.” “3.16 JB” is written at the top of the memorandum.↩