Chapter 5. Combating Poverty in Low-Income Countries
- Parmeshwar Ramlogan, and Bernhard Fritz-Krockow
- Published Date:
- April 2007
A central objective of the IMF in low-income countries is to support sustained poverty reduction through policies that promote economic growth, employment generation, and targeted assistance to the poor. This follows from the IMF’s mandate to contribute “to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.” In doing so, the IMF works in four main broad areas—policy advice and program design, capacity building, financial support and debt relief, and coordinated international efforts. The IMF focuses on its core areas of responsibility and expertise, where it has a clear comparative advantage, namely: the pursuit of stable macroeconomic conditions and macro-relevant structural reforms, with supporting financial and technical assistance. In its work in low-income countries, the IMF works in close collaboration with other development partners, particularly the World Bank, which is the lead institution for poverty reduction.90
The IMF, in conjunction with other development partners, has endorsed a two-pillar strategy for tackling poverty in low-income countries.* First, low-income countries must be proactive in implementing sound policies, strengthening institutions, and improving governance. Second, for those countries that implement sound policies and reforms, the international community must provide strong support through greater trade opportunities and increased and better-delivered aid flows.
The IMF has been working on both elements of the two-pillar strategy. The thrust of its efforts has been in assisting low-income countries in developing and implementing country-owned poverty reduction strategies and policies; mobilizing the necessary financial and technical support from the international community, including debt relief; and promoting an international economic environment that is conducive to poverty reduction and the attainment of the Millennium Development Goals (MDGs). In this last regard, examples include the support of efforts to improve market access for developing countries’ exports, reduce trade-distorting subsidies in advanced economies, or eliminate barriers to trade among developing countries.
The IMF and the World Bank have pioneered the development of two initiatives to tackle poverty in low-income countries. The first initiative is the Poverty Reduction Strategy (PRS) framework for the provision of international development assistance to low-income countries, including concessional lending from the IMF and the World Bank. The PRS framework has become the basis of IMF and World Bank concessional lending operations. The second initiative is the Heavily Indebted Poor Countries (HIPC) Initiative for the provision of debt relief by the international community to low-income countries. These two initiatives have been widely adopted by low-income countries and by the international donor community. In addition, the IMF also participates in the Multilateral Debt Relief Initiative (MDRI) in response to a proposal by the Group of Eight (G-8) industrial countries to cancel the obligations of low-income countries to specific multilateral institutions.
The IMF’s principal vehicle for concessional financial support to low-income countries is the Poverty Reduction and Growth Facility (PRGF). An IMF instrument available to low-income countries that may not need or want access to IMF financial resources is provided through the Policy Support Instrument (PSI). Additional instruments available to low-income countries are the Emergency Post-Conflict-Assistance (EPCA) and the Exogenous Shocks Facility (ESF). All these facilities or special instruments are described in more detail in Chapter 3.
The Medium-Term Strategy (MTS), discussed in Chapter 1, will have an impact on the IMF’s role in low-income countries, namely by envisaging a refocusing of the IMF’s work on macro-critical areas, improved collaboration with other institutions, greater flexibility in conditionality, increased involvement in managing the implications of debt relief, and assessing the relationship between aid inflows, resources needs related to the Millennium Development Goals and macroeconomic stability.
Poverty Reduction Strategy Framework
A central goal of the IMF’s engagement with low-income countries is to support their efforts for achieving their Millennium Development Goals. In that context, the Poverty Reduction Strategy (PRS) has been broadly accepted as the framework for coordinating the efforts of low-income countries and development partners to achieve the MDGs. The IMF supports, in line with the MTS, sustained poverty reduction and reaching the MDGs through its work promoting macroeconomic stability and sustained growth. Moreover, the IMF plays a critical role in helping low-income countries address the macroeconomic challenges of increased aid inflows.
Poverty Reduction Strategy documents are prepared by the member countries through a participatory process involving domestic stakeholders and external development partners, including the IMF. The PRSP framework is intended to focus policies and resources of both low-income countries and the international donor community on poverty reduction. The strategy to combat poverty is embodied within a poverty reduction strategy document, which can be Poverty Reduction Strategy Paper (PRSP), an Interim PRSP (I-PRSP), a PRSP preparation status report, or a PRSP or Annual Progress Report. The PRSP describes the country’s macroeconomic, structural and social policies and programs over a three year or longer horizon to promote broad-based growth and reduce poverty, as well as associated external financing needs and major sources of financing. It is updated every three years with Annual Progress Reports. I-PRSPs summarize the current knowledge and analysis of a country’s poverty situation, describe the existing poverty reduction strategy, and lay out the process for producing a fully developed PRSP in a participatory fashion. The country documents are made available on the IMF website by agreement with the member country.
These documents form the basis on which the IMF, the World Bank, and other donors base their concessional lending decisions and debt relief.91 However, IMF and the World Bank Boards do not need to endorse the poverty reduction strategy documents as a satisfactory basis for concessional lending.92 IMF support under the PRSP framework is provided under the Poverty Reduction and Growth Facility (PRGF).
Preparation of a Poverty Reduction Strategy Document
Requests for a PRGF arrangement with the IMF require that a PRS document be issued within the previous 18 months. Countries also need to have a PRSP in order to qualify for debt relief under the Heavily Indebted Poor Countries (HIPC) Initiative, as explained below.
Where a country is unable to prepare a full PRSP in a timely manner to support its request for financial assistance or debt relief under the HIPC Initiative, it may submit an I-PRSP under a transitional arrangement. In this case, the full PRSP should be completed prior to the start of the second year of the program. Where completion of the full PRSP is expected to be delayed beyond the start of the second year, a progress report on the implementation of the I-PRSP and the status of preparation of the full PRSP can provide the basis for continued access to concessional assistance.
Countries should preferably update their PRSPs every three years, to ensure that the PRSP and PRGF cycles coincide and to ensure that PRGF arrangements are based on updated PRSPs. In between updates, countries need to prepare an annual progress report on implementation of the PRS.
A key element of the PRSP framework is the country’s ownership. The PRSP or I-PRSP should be prepared using a broad participatory process, involving consultations among a wide spectrum of the civil society and the international donor community. This helps to ensure that there is a national consensus regarding the appropriateness of the poverty reduction strategy, and a political commitment to its successful implementation.
Content of a PRSP or I-PRSP
PRSPs reflect country-specific circumstances, and therefore their content will vary from country to country and over time within a given country. However, the IMF and the World Bank have suggested the following as possible core elements of a PRSP:
- A comprehensive diagnostic of the nature, causes, and incidence of poverty;
- A clear and detailed statement of the medium- and long-term outcome-oriented targets for the country’s poverty reduction strategy, and the macroeconomic, structural, and social policies that together comprise a comprehensive strategy for achieving these outcomes;
- A description of the framework and mechanisms for monitoring implementation, including the extent and planned development of participatory processes designed to strengthen accountability, the indicators to be monitored, and the planned frequency of reporting and monitoring; and
- An assessment of the external financial and technical assistance that would be required to achieve the objectives of the poverty reduction strategy.
The I-PRSP includes the following:
- An interim report by the government presenting its commitment to poverty reduction, the main elements of its poverty reduction strategy consistent with the extent of diagnosis that has been conducted, and a timeline and a consultative process by which the PRSP will emerge.
- A jointly agreed but tentative three-year macroeconomic framework and three-year policy matrix, focusing on poverty reduction, which will be revised when the interim document is replaced by a full PRSP.
Joint Staff Advisory Note on the PRS Document
A request for a PRGF arrangement is granted only if the Executive Boards of the IMF and the World Bank are satisfied that the PRS document constitutes a sound basis for concessional lending to the country. The Executive Boards’ judgment on the PRS document is based in large part on the Joint Staff Advisory Note (JSAN), which is an assessment report prepared jointly by the staffs of the IMF and the World Bank.93 The JSAN is circulated to the Executive Boards at the same time as the PRS document and provides detailed feedback to the country authorities on the strengths and weaknesses of their poverty reduction strategies. The Medium-Term Strategy is contemplating the elimination of JSANs.
Alignment of the PRGF with the PRSP
The PRSP is the basis for IMF lending to the country under a PRGF arrangement. This is intended to ensure that PRGF-supported economic policies are fully consistent with the poverty reduction strategy.94 This is accomplished through the requirement that the PRSP contain a realistic macroeconomic policy framework that is fully aligned with the poverty reduction goals, targets, and policies. PRGF-supported economic programs are drawn directly from the PRSP by implementing the macroeconomic component of the PRSP, and thereby directly contributing to the attainment of the country’s poverty reduction goals. Where PRSPs lack specificity—i.e., do not contain sufficiently specific targets and policy measures—PRGF-supported programs, like other donor-supported programs, may include measures that are not specified or foreseen in the PRSP, but that are consistent with, and critical for, reaching the country’s growth and poverty reduction objectives.
Consistent with the PRSP approach, IMF-supported economic programs in low-income countries have been redesigned to make them more poverty-oriented, country-driven, and collaborative. They now place more emphasis on country ownership of economic policies; flexibility of fiscal policy to accommodate economic growth and poverty objectives; reorientation of public expenditure toward the social sectors; and improvement of public resource management, public accountability, and governance (Box 5.1). They are also more focused on the IMF’s core areas of expertise, in line with the IMF’s general move to streamline structural conditionality. This means greater reliance on, and coordination with, programs supported by the World Bank and other donors. The design and conditionality of PRGF-supported programs also increasingly integrates poverty and social impact analyses (PSIAs), which are led by the World Bank.
Box 5.1.Summary of Key Features of PRGF-Supported Programs1
Programs Are Based on Broad Participation and Ownership
- Main elements of PRGF are drawn from the country’s PRSP.
- Country authorities produce PRSP in a transparent process with broad participation.
Programs Are Embedded in the Overall Strategy for Growth and Poverty Reduction
- PRGF-supported program is derived from, and reflects, the overall growth and poverty reduction strategy.
- Macroeconomic and structural policies are fully integrated with growth and poverty objectives.
- Emphasis is put on policies to promote private sector development.
- PRGF support of the strategy is focused on areas within the IMF’s area of expertise and responsibility.
Budgets Are More Poverty-Oriented
- Government spending is oriented toward activities that benefit the poor, directly or indirectly.
- Priority is given to improving the efficiency and targeting of growth and poverty-related spending.
- Emphasis is put on improving data and monitoring in order to track expenditures.
- Tax reforms seek to improve tax efficiency and equity while generating resources for poverty reduction
Fiscal Targets Are More Flexible
- More normative macro-projections may be presented to signal financing needs.
- Where warranted, commitments of higher aid flows are sought from donors and built into the program.
- PRSP may identify contingent expenditures that could be added if more aid were forthcoming.
- Fiscal targets may be modified in the event of key shocks.
Structural Conditionality Is More Selective
- Conditionality is focused on key measures that are central to the success of the strategy.
- Conditionality is limited to measures that are in the IMF’s domain; exceptions must be justified.
Emphasis Is Placed on Measures to Improve Public Resource Management and Accountability
- Fiscal policies and objectives should be open to public debate.
- Transparent monitoring systems should be used to improve delivery of public services.
- For HIPCs, programs include specific mechanisms for monitoring use of debt relief.
- Selective conditionality on fiscal governance measures may be used.
Social Impact Analysis of Major Policies and Reforms Are Integrated into Program Design
- Distributional effects of substantial macro-adjustments or structural reforms are taken into consideration.
- Countervailing measures are incorporated to offset temporary adverse effects on the poor.
- World Bank leads impact analysis; PRGF documents describe work done and how analysis influenced policies.
Given capacity and data constraints, many countries are as yet unable to engage in broader and deeper analysis of the macroeconomic frameworks and of policy choices in PRGF-supported programs. The IMF provides technical assistance to help countries build capacity in macroeconomic and financial programming, and in economic statistics.
Aid Coordination and Effectiveness
The PRS framework facilitates the coordination across different development agencies, reduces transactions costs, and increases the effectiveness of external aid in reducing poverty. To this end, the IMF systematically shares information with other donors—on the timing and results of negotiation and review missions, on the conditions and proposed timing of donor disbursements, and on the technical assistance provided by the IMF—and takes into account the impact of policies supported by other donors in PRGF-supported programs. Together with the World Bank, the IMF is also engaged in efforts to increase alignment of donor support with the PRS and the national budget cycle, so that individual donors can derive the content and conditionality of their programs directly from the PRS whenever possible. This helps address problems of focus and overly burdensome conditionality in uncoordinated donor programs. Finally, the IMF encourages donors to make medium-term commitments of aid, where possible, to increase the predictability of external financing and strengthen the national budgetary process.
The HIPC Initiative, established in 1996, provides exceptional assistance to eligible member countries to reduce their external public debt burdens to sustainable levels, thereby enabling them to service their external debts without the need for further debt relief and without compromising poverty reduction efforts or economic growth.95 It is a comprehensive approach to debt relief which involves other multilateral creditors as well as official bilateral and commercial creditors. The IMF’s launching of the HIPC Initiative is consistent with its mandate to provide balance of payments assistance as well as promote economic growth in member countries. In September 1999, the IMF and the World Bank agreed to strengthen the HIPC Initiative to provide broader, deeper, and faster debt relief by lowering the threshold and the performance period requirement, thereby increasing also the number of eligible countries. At the same time, the links between debt relief and poverty-reduction efforts were strengthened through the PSRP framework.*
The HIPC Initiative was defined as a temporary initiative, but has been extended a number of times. A sunset clause, which had already been extended four times since its introduction in 1996, is taking effect at end-2006. However, allowing the sunset clause to take effect without any modification would have left a number of countries with debt burdens in excess of the Initiative’s threshold and without a comprehensive framework. Instead, the Board decided in October 2006 to grandfather all countries that are assessed to have met the income and indebtedness criteria based on end-2004 data, including countries that might meet these criteria at some point in the future.96
Operational Aspects of the HIPC Initiative
An eligible member that has satisfied the necessary conditions for assistance under the Initiative receives a commitment of debt relief at the “decision point”, which is the date at which the IMF and the World Bank decide that the member country qualifies for assistance under the Initiative. The committed amount of debt relief is the amount calculated by the IMF and the World Bank, on the basis of a loan-by-loan debt sustainability analysis, as necessary to reduce the member’s external debt to a level deemed sustainable. Countries that reach the decision point may begin to receive limited interim debt relief. Once the member country meets the conditions for assistance established for it at the decision point, the full amount of debt relief committed at the decision point, less any interim assistance disbursed, is delivered at the “completion point”, which is the date at which the IMF and the World Bank decide that necessary conditions have been met and a decision is taken to disburse the assistance committed. A topping-up decision can also be taken, as is discussed later, but, briefly, involves the disbursement of assistance over and above that which was committed at the decision point. The debt relief provided to a member at the completion point is irrevocable and is provided with no further policy conditionality.
Eligibility Requirements for the HIPC Initiative
IMF assistance under the HIPC Initiative is limited to countries that:
- are PRGF-eligible (described in detail in Chapter 3);
- are pursuing a program of adjustment and reform supported by the IMF through a PRGF or Extended Arrangement, a Stand-By Arrangement, a decision on rights of accumulation, or Emergency Post Conflict Assistance; and
- have received, or are eligible to receive, assistance to the full extent available under traditional debt relief mechanisms. Even after the full application of these traditional debt relief mechanisms, the member’s external debt situation, based on end-2004 data, is unsustainable, as defined under the HIPC Initiative.
To qualify for assistance (i.e., to reach the decision point) under the Initiative, an eligible member must have:
- an unsustainable external debt, even after the application of traditional debt relief mechanisms, based on the latest available external debt data;
- a satisfactory poverty reduction strategy set out in an PRS document issued to the Executive Board within the previous 18 months;
- not agreed on an exit operation with Paris club creditors on Naples terms after September 1999;
- established a track record of strong policy performance under IMF-supported programs, covering macroeconomic policies and structural and social policy reforms; and
- a commitment from all other creditors (holding debt claims above a certain minimum amount) to participate in the Initiative.
Definition of Debt Sustainability and Debt Relief
A sustainable debt is defined under the HIPC Initiative as an external public debt that is equal in net present value terms to no more than 150 percent of exports of goods and non-factor services calculated on the basis of data available at the decision point. Thus, the total amount of HIPC Initiative assistance to the country committed at the decision point by all creditors is calculated so as to bring the net present value of the debt down to 150 percent of exports. In the special case of a country that has, at the decision point, (i) an exports-to-GDP ratio of at least 30 percent and (ii) a fiscal revenue-to-GDP ratio of at least 15 percent, a debt sustainability target of below 150 percent for the debt-to-exports ratio at the decision point may be set, with the specific target set to reduce the external debt in net present value terms to 250 percent of fiscal revenue at the decision point.
Requirement of a Track Record
The requirement of a track record of strong policy performance is normally satisfied by an initial three-year performance period leading up to the decision point, followed by a second performance period leading up to the completion point. In the case of the first three-year period leading to the decision point, the member’s economic program could be supported by arrangements under the PRGF, ESF or EFF. In some cases, these programs could also be supported by a Stand-By Arrangement, decisions on rights accumulation, or the policy on emergency assistance for post-conflict countries. Members could receive credit toward the decision point for programs that were underway prior to the adoption of the HIPC Initiative. In the case of the second performance period leading up to the completion point, the member’s program must be supported by PRGF, ESF or Extended Arrangements.
The second performance period is not fixed; it ends when the member has satisfactorily implemented a set of pre-defined key policy reforms, has a stable macroeconomic position, and has kept on track with its IMF-supported program. In addition, the member would need to have prepared a PRSP and implemented the poverty strategy satisfactorily for at least a year by the completion point. The completion point is thus described as a “floating” completion point: it triggers whenever the above conditions are satisfied. The use of floating completion points provides an incentive for countries to implement reforms quickly, thereby permitting strong performers to reach the completion point earlier. It also allows HIPC countries greater ownership over the reform timetable.
Amount of IMF HIPC Assistance
The IMF’s share of total HIPC Initiative assistance is based on:
- the IMF’s share in the present value of the multilateral debt of the member at the decision point; and
- the assistance to be provided by multilateral creditors in terms of a reduction in the net present value of the debt owed to them by the member sufficient to achieve the debt sustainability targets. This is calculated taking into account the exceptional assistance to be provided by Paris Club creditors and at least comparable action by other official bilateral and commercial creditors under the Initiative.
During the interim period between the decision point and the completion point, the IMF may advance to the member, as interim assistance, a portion of its committed assistance not to exceed (i) 20 percent of the total assistance committed for each 12-month period following the decision point and (ii) a maximum of 60 percent of the total assistance committed. These amounts may be raised to 25 percent and 75 percent respectively, in exceptional circumstances. However, the amount of interim assistance in any 12-month period cannot exceed the amount of debt service falling due to the IMF during that period.
At the completion point, the IMF disburses the amount committed at the decision point, less any interim disbursements made after the decision point. The HIPC Initiative allows for the provision of additional debt relief under exceptional circumstances to countries at the completion point. However, a reassessment of the amount of debt relief committed at the decision point is not automatic. Additional debt relief—referred to as “topping-up assistance”—under the Initiative could be considered, to achieve a sustainable debt ratio, only if the deterioration in debt sustainability since the decision point is attributable primarily to a fundamental change in the member’s circumstances owing to exogenous factors.97 The IMF approves all disbursements under the HIPC Initiative in the context of satisfactory assurances regarding the assistance to be provided under the Initiative by the member’s other creditors.
Terms of IMF HIPC Assistance
IMF HIPC assistance may be given as grants or loans, as determined on a case-by-case basis, taking into account the objective of bringing the debt-to-exports ratio down to the debt sustainability target agreed at the decision point. Such loans and grants are used at the completion point as an early repayment of the member’s qualifying debt to the IMF. Debt-relief loans are provided interest-free, and have a grace period of 5½ - 10½ years and a maturity of 10-20 years. The actual maturity is determined on a case-by-case basis. Repayment of these loans cannot be rescheduled. To date, all HIPC Initiative debt relief has been given in the form of grants, in order to avoid a further accumulation of debt by HIPC countries.
Use of Resources Freed by Debt Relief
Debt relief under the HIPC Initiative is an integral part of international efforts to eradicate poverty in low-income countries. One of the main benefits of the Initiative is that, by reducing annual debt-service payments, it will make possible the accommodation of higher levels of expenditure to accelerate poverty reduction, including social spending. Therefore, beneficiaries of HIPC Initiative assistance are expected to use the resources released from debt service payments to finance spending that directly or indirectly reduces poverty and improves living conditions. In particular, spending on the social sectors is expected to be higher than what it otherwise would have been. However, the IMF and World Bank emphasize that, in addition to increasing spending, countries should take steps to improve the efficiency of public spending, in terms of both the inter-sectoral composition of spending and the allocation of spending within sectors.
To ensure that additional spending on poverty reduction takes place and is appropriately targeted, the IMF provides technical assistance to beneficiary countries to strengthen their public expenditure management systems and expenditure tracking mechanisms, so that countries can effectively track public spending. The IMF also emphasizes transparency and accountability in the management of the freed resources. This allows countries to demonstrate to the donor community that the resources are being used effectively for poverty reduction, and helps sustain or increase aid flows to low-income countries.
Multilateral Debt Relief Initiative
In November 2005, the IMF decided to adopt a new Initiative to provide debt relief to low-income countries (including two member countries that were not HIPCs) in addition to the debt relief provided under the HIPC Initiative. This initiative, called the Multilateral Debt Relief Initiative (MDRI), provides grant assistance to eligible low-income member countries to repay all of their qualifying outstanding debt to the IMF.98 The vehicles to facilitate these grants are the MDRI-I and MDRI-II Trust Accounts, which came into effect in January 2006, following consent of all contributors to the PRGF Subsidy Account to the transfer of their contributions to the MDRI-II Trust Account.
In order to receive MDRI Trust assistance, low-income member countries must meet eligibility criteria, and then pass a separate threshold for qualification.
The countries that may benefit from MDRI debt relief from the IMF include:
- all HIPC countries once they reach the completion point under the HIPC Initiative; and
- all non-HIPC counties at or below the US$380 per capita income threshold.
At the time when the MDRI was established, the Executive Board requested that the following qualification criteria be established:
- Post-HIPC completion point countries would need to meet a number of criteria to qualify for MDRI relief. In addition to being current on their obligations to the IMF, they needed to demonstrate satisfactory performance in three key areas:
(a) macroeconomic performance;
(b) implementation of a poverty reduction strategy detailed in a Poverty Reduction Strategy Paper (PRSP) or a similar framework; and
(c) public expenditure management systems.
- Countries that have not yet reached the completion point under the HIPC Initiative will qualify for MDRI relief upon reaching the completion point.
Upon determination of qualification, the applicable MDRI-I or MDRI-II Trusts will repay to the IMF an amount equivalent to the member’s outstanding eligible debt to the IMF, subject to the availability of resources. “Eligible outstanding debt” is that part of the member’s debt to the IMF (including to the IMF as trustee) outstanding as of December 31, 2004 that has not been (or is not scheduled to be) repaid by the member, or with assistance committed or disbursed under the HIPC Initiative.