Working Paper
Conditionality: Facts, Theory and Policy

Three changes in conditionality of loans are proposed in this study, in order to improve the relations between developing country borrowers and international lending agencies, and make the international cooperative effort at development and stability more effective. First, the agencies should encourage member country governments requesting adjustment assistance to submit their own programmes of adjustment. The present practice of the agencies preparing country programmes should be discontinued. Secondly, the agencies should decide on their loans on the basis of their assessment of the debt servicing capacity and financial management of the borrowers, with loan conditions being normally confined to factors bearing on these two areas. This would modify the present primary emphasis of conditionality on influencing national economic policies of the borrowers in a particular direction. Thirdly, a system of regular exchange of information and economic policy views between the borrowers and the agencies should be instituted. This would enable the policy dialogue to be continued, but in a consultative manner. Brief comments on these proposals follow.Transfer of responsibility for preparing adjustment programmes to national governments would enable the adaptation of programmes — the choice of objectives and policy instruments — to economic and social conditions in each individual case. Furthermore, this would increase the commitment of government to the implementation of programmes.Serious doubts exist concerning validity of several important points of the economic theory and associated policy on which the present practice of conditionality rests, and this suggests the need for its modification. These doubts refer to, first, monetary programming with its pre-set money supply targets which may lead to restrictions on output more than needed to accomplish required balance of-payments turnaround; secondly, financial "liberalization" requested virtually under all circumstances, which may lead to exacerbation of inflation through rising money costs and to sustained excessive real interest rates destructive of investment over extended periods; thirdly, import liberalization when requested in countries experiencing foreign exchange shortages, which raises further their external deficits and may lead to reductions in output and employment; and fourthly, agency general resistance to selective policies and measures which many governments wish to apply in order to minimize the deflation due to adjustment and influence the burden-sharing among different social classes. On the other hand, there should be no serious objections to conditionality primarily focused on the debt servicing capacity and orderly financial management in debtor countries. Included here are orderly tax administration and enforcement, tight public expenditure controls, realism of investment and financing plans, control over foreign borrowing, anti-corruption drives and enforcement, drives for accountability and sound management of public enterprises, stopping the use of government service to provide jobs, speed in decision-making and in implementation of government decisions, policies to discourage, and measures to prevent capital flight. The proposed institution of regular periodic exchanges of information, experiences and economic policy views between the borrowing country officials and the staff of the agencies will enable the economic discussions to continue. The agencies have contributed to several important policy developments in borrowing countries in the past, such as increased emphasis on export expansion, improved public enterprise finances, higher domestic agricultural prices; and the proposed exchanges will enable them to make similar contributions in the future. The developing countries would thus continue to benefit from the staff expertise and accumulated knowledge in the agencies. The agency staff, in turn, would be able to continue to draw on the rising development management experience in developing countries and their increased ability to absorb and adapt modern technology in a number of cases. The consultative nature of the arrangement should reduce frictions between lenders and borrowers and, hopefully, make for a fruitful and continuing cooperative effort.