Understanding the IMF 'conditionalities'

The IMF has just approved a loan package of 3.5 billion SDRs (equivalent to 4.7 billion US dollars) to be disbursed from three IMF facilities, including a recently created facility to address climate change-induced challenges. 

The first tranche of $476 million is to be disbursed immediately. The rest will be disbursed in several tranches over the next three years, with the last tranche to be disbursed on May 1, 2026. These disbursements are not going to be automatic. These are contingent on the Bangladesh government taking several reform measures and fulfilling certain performance targets. 

The IMF calls these by various names, such as quantitative performance criteria, indicative targets, reform measures and structural benchmarks. The person on the street has a simple word to encompass all these - 'conditionalities'. An IMF loan inevitably triggers a lot of discussion in the recipient country, especially around the conditionalities. Bangladesh is no exception.

One key concern of many is whether these conditionalities are going to be harmful to the country. Quite a bit of the discussion is more speculative than analysis, based on misperception and not good understanding.

Before we go into these issues, it is useful to understand why the IMF has provided the loan, or at least what its professed objective is. The IMF Staff Report on the program, a 125-page document released on February 3, provides the rationale. 

It states up front: "Bangladesh's robust economic recovery from the pandemic has been interrupted by Russia's war in Ukraine, leading to a sharp widening of Bangladesh's current account deficit, depreciation of the Taka and a decline in foreign exchange reserves. The authorities have taken on a comprehensive set of measures to deal with these latest economic disruptions. The authorities recognize that in addition to tackling these immediate challenges, long-standing structural issues and vulnerabilities related to climate change will also need to be addressed to accelerate growth, attract private investment, enhance productivity, and build climate resilience."

In other words, Bangladesh is on a potentially good long-term growth trajectory and the robust recovery from the pandemic has helped keep it on this track. However, three sets of factors have generated uncertainty. These are the macroeconomic fall-out of the Russia-Ukraine war, long-standing structural and governance issues, and vulnerabilities related to climate change. The funds to be disbursed, along with the reforms, are expected to help address this threefold challenge.  

The government has responded to the recent economic challenges, such as the increase in global prices of major import commodities and the decline in foreign exchange reserves, through a set of measures intended to reduce demand, especially import demand. While this is helping to slow the decline in foreign exchange reserves, it is coming at a cost.

In an import-dependent economy, reduced imports will lead to reduced output in different sectors, especially the industrial sector, and possibly reduced employment. This, plus increased inflation, is likely to hit the poorer sections of the population harder. The IMF program will address this by helping to rebuild reserves and thus increase our capacity to fund imports. 

But this will only help address the first of the three challenges mentioned above. Addressing the deeper challenges will require a set of reforms to be implemented in phases. The IMF staff report states: "The program will prioritize the implementation of the most urgent and critical reforms, gradually increasing the pace of reforms during the program period". 

Are these reforms good or bad for the country? The best way to answer this question is to look at each of these required reforms and ask the important questions: What will these reforms help achieve if implemented well? What are the professed goals of the reforms? 

I do not have the space to assess all the required reforms. So, let me take just a few as illustrative examples. 

Bangladesh needs high levels of public spending on human capital development, infrastructure building, addressing climate change and ensuring adequate levels of social protection for the vulnerable. It needs to do so without incurring unsustainable levels of public debt. Thus, the government needs to do two things: a) enhance domestic resource mobilisation, especially through increased tax revenues, and b) increase the efficiency of public expenditures.

As the IMF report indicates, Bangladesh has one of the lowest tax/GDP ratios in the world, with the tax effort being weakened by "extensive exemptions, complicated tax codes, and weaknesses in revenue administration." 

The reform measures related to tax revenues and government borrowing should be assessed in light of the above. The very first reform conditionality mentioned is the following: "Adopt tax revenue measures yielding an additional 0.5 % of GDP in the FY2024 budget". 

In other words, the government will have to adopt these measures by June 30, 2023, so that they yield the desired results during the FY24 (July 2023-June 2024) period. But this is not all. Additional measures are to be adopted in subsequent budgets, yielding additional tax revenues of 0.5 and 0.7% of GDP in FY25 and FY26, respectively. 

Now, taking some tax policy measures will not achieve much if there is not adequate tax compliance, i.e., if people who are supposed to pay taxes do not do so. Also, it does not help if you impose a tax and then exempt different groups in society or different activities from the obligation to pay the taxes. As mentioned above, excessive exemptions, often granted in an ad hoc manner, are an important reason why our tax revenues are low. 

Thus, it is no surprise that the IMF also requires the government to develop, adopt, and implement a tax compliance improvement plan and reduce tax exemptions. It may be mentioned that the IMF has not just asked for these measures. It has promised to provide technical assistance to the government to identify and implement the required actions. 

We may now pause and ask ourselves whether these 'conditionalities' are going to be good or bad for the country. There is widespread recognition in Bangladesh that we need to increase our tax revenues. Many also understand what is required to do so, i.e., enlarge the tax base, reduce non-compliance, and rationalise the practice of granting all kinds of tax exemptions. Given this domestic consensus, it is difficult to find anything wrong with these sets of IMF reform conditions. 

Let us now come to government expenditures and public debt. Unable to raise sufficient taxes, the government has resorted to other ways of raising revenues, such as heavy reliance on national saving certificates (NSCs). 

This has turned out to be expensive. It has significantly increased the government's borrowing cost, as reflected in high-interest payments. At the same time, it is also true that many households in Bangladesh benefit from such a practice; the interest earned from national savings certificates is a useful supplement to their incomes. 

So, there is a trade-off here. How do you protect the interests of such households, many of which come from middle or lower-middle-income classes, while also keeping government debt at a sustainable level? One option is to retain this practice but put a limit on it. 

The IMF is asking for just that. It is asking the government to develop a plan (by end-December 2023) to reduce the net issuance of NSCs to below one-fourth of total net domestic financing by FY26. So, there are two deadlines—a plan by the end of 2023 and an achievement of the target by the end of June 2026.

A more controversial reform measure is to adopt (by end-December 2023) a formula-based price adjustment mechanism for petroleum products and then implement the plan from 2024 onwards. This means that going forward, petroleum prices will be better aligned with world prices, thus reducing the need to provide unsustainable subsidies for petroleum products. Such a reform measure may create hardship for many people, especially the poorer segments of the population.

This is where social protection measures come in. The IMF report states: "Reform priorities in social protection include improving targeting, broadening coverage both in rural and urban areas, adopting the government-to-person (G2P) systems, and expanding social insurance. The program will leverage the ongoing programs to strengthen and expand social protection by other development partners". Recognising the importance of social protection, the IMF program has put a floor on the government's social spending, financed from domestic resources. For example, one target states that such spending cannot fall below Taka 1033 billion for FY23.

The IMF program requires several other reform actions intended to enhance monetary operations, increase exchange rate flexibility, enhance Bangladesh Bank's transparency and reporting standards, and its monitoring and its policy-making capacity. It also asks for actions to establish risk-based banking supervision and support the resolution of non-performing loans. There are also a host of actions to be taken to address climate change.   

As mentioned above, assessing all these conditionalities is beyond the scope of one article. What I have tried to do here is illustrate a sound approach to assessing IMF conditionalities instead of relying on speculations and sweeping generalisations. 

I have taken a few of the reform actions required by the program, clarified the reasons why the IMF is asking for these reforms and showed why these are useful reforms, consistent with what most objective observers of the economy have been saying for a long time. 

I have also demonstrated the way these reform programs are structured. For example, the IMF has not just asked for additional tax measures but also for taking steps to enhance tax compliance. It has asked to reform the pricing of petroleum products but, recognising that this may hurt many people, also emphasised the importance of social protection measures.

This is a recognition that piecemeal reforms are not of much use and can even be harmful. One needs a critical mass of reforms to have a meaningful impact and also address important trade-offs. 

The IMF has also set specific targets for different variables, such as tax revenue increases and a floor on the government's social spending. This reminds us of the saying, "what gets measured gets done". 

Such structuring of a reform program, with complementary reforms and time-bound implementation targets, is also something our government can learn from. We must move away from piecemeal reforms to comprehensive reform programs. We must move away from vague declarations of intent to precisely monitorable performance targets. 

Syed Akhtar Mahmood, Economist. Sketch: TBS

Syed Akhtar Mahmood is an economist who previously worked for an international development organisation.