By Hugh Bredenkamp

In my previous postings this week, I have talked about the “double whammy” that low-income countries have faced over the past 2-3 years—the surge in food and fuel prices and global financial crisis—and how the IMF has stepped up its support to help them cope with these shocks. Without this support, and that of other agencies and rich-country donors, governments would have to slash spending as their tax revenues slumped. This, of course, is the exact opposite of what any government should be doing in a recession—it would add fuel to the fire.

But preserving or even increasing spending when revenues are declining means larger budget deficits, and more borrowing. Doesn’t the IMF always preach tight budgets? The answer is “not always.” Fiscal discipline and carefully-managed borrowing policies are essential for long-term economic health. But when economies are hit by temporary shocks—and the current recession, though severe, will surely be temporary—it makes sense for governments to use policy to limit the short-term damage.

Indeed, the IMF’s Managing Director, Dominique Strauss-Kahn, was among the first (as early as January 2008) to advocate a global fiscal stimulus as recession loomed. Some commentators suggested that this advice was really meant only for rich countries. Not so. What matters is whether the country could afford the stimulus, and those that can’t include some advanced countries as well as some low-income countries. But every country that can afford it should do it.

Farmers inspecting drought-affected corn in Kenya (photo: AFP)

Farmers inspecting drought-affected corn in Kenya (photo: AFP)

Fine, you might say, but has the IMF put its money where its mouth is? In low-income countries that have programs supported by the IMF (let’s call them “program countries” for short), have we actually adjusted the targets to allow more spending and higher deficits?

The experience to date suggests that we have (we plan to publish a paper on this later in September). Budget deficits in program countries should get bigger this year, on average 2 percent of GDP higher than before the crisis. Some countries are preserving spending, and borrowing more to cover the recession-driven drop in tax revenues. Others have been able to take more active fiscal stimulus measures—about two-thirds of program countries have been able to increase government spending despite declines in revenues. Inevitably, countries with more vulnerable debt positions had less room for maneuver, but this is consistent with our advice. And even for these countries, programs provide for some expansion in budget deficits in 2009.

When the recovery arrives, countries will need to reverse temporary stimulus measures, and bring budget deficits down to sustainable levels. But they should not be forced into doing this prematurely, before it is clear that the recovery is underway, simply because they can’t get affordable financing. This is a serious constraint. Low-income countries often have fewer borrowing options and their borrowing costs tend to be higher than in advanced and emerging economies. This is why scaled-up financial support from the IMF and donors is so important, especially this year and next, when the needs will be greatest.

In all of this, the welfare of the poor must top our agenda. Countercyclical fiscal policy can certainly help protect jobs. But for many of the most vulnerable, when food prices triple, or remittance lifelines are cut dramatically, public social benefits are the only answer. We have therefore encouraged governments to safeguard social protection and other core social spending, and in most instances programs were able to increase this spending, targeted toward the most vulnerable. This being said, both the food and fuel price shocks and the global recession have exposed weaknesses in the fabric of social protection systems in most low-income countries. They need better mechanisms to channel support to the most needy, quickly and efficiently. This is an area where more work is needed before the next crisis hits.

Conditions cut by one third

We have also been trying to streamline the policy conditions attached to programs, to make them more effective. Drawing on lessons from the Asian crisis, the IMF made a strategic decision that programs should focus only on structural reforms that are essential to support sustainable, growth-oriented macroeconomic policies.

Recent experience suggests we have made some progress in this direction. The number of conditions we use to monitor structural reforms in low-income country programs has fallen by a third compared with the early 2000s. Around 40 percent of these conditions are focused on measures to improve public resource management—better expenditure control systems, auditing and publication of government accounts, more efficient tax administration, and so on—that almost everyone agrees are critical to policy effectiveness. And it should be no surprise that, as we have streamlined, more reforms are being implemented now than in the past—ownership in action.

There’s one more step. Earlier this year, we redesigned the way that conditionality is applied to structural reforms in all IMF-supported programs. From now on, loans will no longer include conditions on specific, timebound measures. Instead, progress will be assessed as part of the regular program reviews—this will encourage more focus on the objectives of the envisaged reforms, and give governments more flexibility in attaining their goals.

In my final posting tomorrow, I will talk about another aspect of the IMF’s more flexible approach in low-income countries, which has to do with how IMF-backed programs monitor and control countries’ debt burdens.