Structural Conditionality

Two opposing views have been expressed on structural conditionality in the Asian programs. One view holds that some of the structural reform measures were unrelated to the immediate problem of crisis resolution and distracted attention from the core macroeconomic and financial issues; and they were felt to be an encroachment into domestic decision making, creating an unnecessary opposition, and may have damaged investor confidence by signaling to the markets that the situation was worse than they had feared (Feldstein 1998; Radelet and Sachs 1998). The other view argues that restoring market confidence requires the demonstration of a will to tackle the structural causes of crisis vulnerabilities in the economy (Summers 1999; Goldstein 2002). The issue will never be fully resolved, though the balance of opinion has shifted to the former view, especially within the IMF.

As noted, in March 2009, the IMF Executive Board discontinued the use of structural performance criteria (the observance of which was required to disburse the funds) in all IMF programs. In coming to this decision, “most” Executive Directors are said to have stated that “structural performance criteria are perceived as reducing national ownership of Fund-supported programs” (IMF 2009a). In what follows, however, I will interpret structural conditionality not in the narrow sense of structural performance criteria but in a broader sense of structural reforms envisioned in the program, including in the form of structural benchmarks (which are not linked to the disbursement of the funds). I am not so much interested in the legal aspects of conditionality as in understanding the IMF's perception of structural measures that are needed, within the context of a crisis management program, to address the underlying vulnerabilities and to restore market confidence.

In Asia, weaknesses in the financial sector were central to the crises, and tackling these was crucial not only to resolving the damage done by the crisis but also to regaining market confidence. Thus, they were correctly a major focus of the programs. In fact, structural conditionality in the Thai program included little else (the other measures were relatively minor).¹⁹ In Indonesia and the Republic of Korea, too, financial sector restructuring received major emphasis. In Indonesia, the government closed down 16 banks as a prior action for the IMF program (though, given implementation difficulties, the measure failed to calm the market). In the Republic of Korea, the government had suspended nine insolvent merchant banks on the day before the IMF program was approved; under the program, the authorities closed down or forced consolidation of institutions that failed to meet the minimum solvency requirements.

Structural conditionality in Indonesia and the Republic of Korea, however, went beyond addressing the critical problems of the financial sector (Table 6 [ PDF 22KB | 1 page ]). The Indonesian program was particularly extensive and included a large number of additional structural reforms related to cronyism and corruption (though most of them were benchmarks rather than performance criteria). In the Republic of Korea, too, the agenda of reform was broader than financial sector restructuring, covering also trade liberalization (especially, the termination of the so-called import diversification program), capital account liberalization (allowing greater foreign ownership of Republic of Korea firms), corporate governance, and labor market reform.

During the course of post-crisis debate, consensus emerged within the IMF on the need to “streamline” structural conditionality in a limited number of “macro-critical” areas. Following up on the interim initiative of 2000,²⁰ the IMF's new conditionality guidelines and associated documents (issued in 2002) stated: “conditions that are not of critical importance for achieving the macroeconomic goals of the program…are to be avoided” (IMF 2002). The IMF's internal review of conditionality, comparing structural conditionality in IMF programs between 1995–1997 and 2001–2003, noted that major shifts had occurred in the direction of “greater focus on criticality” (IMF 2005). Had such a policy been in place before 1997, structural conditionality in Asia would likely have only included measures to restructure and strengthen the financial sector. Although banking sector reforms were central to the program objectives, the focus was diluted, at least in Indonesia and the Republic of Korea, by measures imposed in a number of other areas.

In Europe, structural conditionality was essentially limited to reforms in the banking sector and the fiscal system. In all countries, bank restructuring met the requirement of macro-criticality, especially in Iceland, where three major banks holding about 85% of total deposits failed and were nationalized. In Hungary, where more than half of all outstanding housing loans were denominated in foreign currencies, international investors decided to pull out of the country's banking sector when they saw the large balance sheet mismatch. In Latvia, the drying up of liquidity associated with the global financial crisis caused the currency peg to be challenged and led to a precipitous run on the banking system. Details differ, but bank restructuring was closely connected with the eventual resolution of the crisis in all countries. Except for Ukraine, conditionality also included the introduction of a rule-based fiscal framework to ensure medium-term fiscal sustainability.

Structural conditionality was more extensive in Latvia, in view of its decision to maintain the peg. In addition to banking sector and fiscal system reforms, structural benchmarks were placed on the development of a comprehensive debt restructuring strategy, an amendment of the Insolvency Law, and the establishment of a framework of wage restraint in the form of a committee in the National Tri-Partite Council. The framework of wage restraint was designed to depreciate the real exchange rate when the nominal rate was fixed and thereby to restore international competitiveness. Although not part of formal conditionality, Latvia's letter of intent also included measures to “promote the development of new products and technologies, increase labor market flexibility,” and strengthen “the business environment.” These measures, because of the government's commitment to the peg, were considered to be macro-critical reforms.

The IMF Managing Director called the streamlined conditionality of the European programs as “targeted conditionality.”²¹ This refers not just to the structural conditionality that is largely limited to the banking sector, but also to the targeting of overall conditionality, including macroeconomic policy prescriptions, to a few critical areas deemed important for the program to be successful. The 2002 conditionality guidelines refer to this as the “principle of parsimony,” which requires “program-related conditions” to be “limited to the minimum necessary to achieve the goals of the Fund-supported program or to monitor its implementation” and “the choice of conditions” to be “clearly focused on those goals” (IMF 2002: 9). The March 2009 reform of conditionality was only a short step from such a concept.

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