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International Monetary Fund
Washington, D.C. 20431 U.S.A.

?997 International Monetary Fund

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Good governance is important for countries at all stages of development. . . . Our approach is to concentrate on those aspects of good governance that are most closely related to our surveillance over macroeconomic policies—namely, the transparency of government accounts, the effectiveness of public resource management, and the stability and transparency of the economic and regulatory environment for private sector activity.

Michel Camdessus IMF MANAGING DIRECTOR Address to the United Nations Economic and Social Council July 2, 1997

Mirroring the greater importance the membership of the IMF places on this matter, the declaration Partnership for Sustainable Global Growth that was adopted by the IMF’s Interim Committee at its meeting in Washington on September 29, 1996, identified "promoting good governance in all its aspects, including ensuring the rule of law, improving the efficiency and accountability of the public sector, and tackling corruption" as an essential element of a framework within which economies can prosper. The IMF’s Executive Board then met a number of times to develop guidance for the IMF regarding governance issues.

The Guidance Note reprinted in this pamphlet, adopted by the Board in July 1997, reflects the strong consensus among Executive Directors on the significance of good governance for economic efficiency and growth. The IMF’s role in these issues has been evolving pragmatically as more was learned about the contribution that greater attention to governance issues could make to macroeconomic stability and sustainable growth. Executive Directors were strongly supportive of the role the IMF has been playing in this area in recent years. They also emphasized that the IMF’s involvement in governance should be limited to its economic aspects.

Taking into account lessons from experience and the Executive Board’s discussions, the guidelines seek to promote greater attention by the IMF to governance issues, in particular through:

• A more comprehensive treatment in the context of both Article IV consultations and IMF-supported programs of those governance issues within the IMF’s mandate and expertise;

• A more proactive approach in advocating policies and the development of institutions and administrative systems that eliminate the opportunity for bribery, corruption, and fraudulent activity in the management of public resources;

• An evenhanded treatment of governance issues in all member countries; and

• Enhanced collaboration with other multilateral institutions, in particular the World Bank, to make better use of complementary areas of expertise.

2. The IMF contributes to promoting good governance in member countries through different channels. First, in its policy advice, the IMF has assisted its member countries in creating systems that limit the scope for ad hoc decision making, for rent seeking, and for undesirable preferential treatment of individuals or organizations. To this end, the IMF has encouraged, among other things, liberalization of the exchange, trade, and price systems, and the elimination of direct credit allocation. Second, IMF technical assistance has helped member countries in enhancing their capacity to design and implement economic policies, in building effective policymaking institutions, and in improving public sector accountability. Third, the IMF has promoted transparency in financial transactions in the government budget, central bank, and the public sector more generally, and has provided assistance to improve accounting, auditing, and statistical systems. In all these ways, the IMF has helped countries to improve governance, to limit the opportunity for corruption, and to increase the likelihood of exposing instances of poor governance. In addition, the IMF has addressed specific issues of poor governance, including corruption,² when they have been judged to have a significant macroeconomic impact.

3. Building on the IMF’s past experience in dealing with governance issues and taking into account the two Executive Board discussions, the following guidelines seek to provide greater attention to IMF involvement in governance issues, in particular through:

• a more comprehensive treatment in the context of both Article IV consultations and IMF-supported programs of those governance issues that are within the IMF’s mandate and expertise;

• a more proactive approach in advocating policies and the development of institutions and administrative systems that aim to eliminate the opportunity for rent seeking, corruption, and fraudulent activity;

• an evenhanded treatment of governance issues in all member countries; and

• enhanced collaboration with other multilateral institutions, in particular the World Bank, to make better use of complementary areas of expertise.

Responsibility for Good Governance

Aspects of Governance of Relevance to the IMF

• improving the management of public resources through reforms covering public sector institutions (e.g., the treasury, central bank, public enterprises, civil service, and the official statistics function), including administrative procedures (e.g., expenditure control, budget management, and revenue collection); and

• supporting the development and maintenance of a transparent and stable economic and regulatory environment conducive to efficient private sector activities (e.g., price systems, exchange and trade regimes, and banking systems and their related regulations).

7. Although it is difficult to separate economic aspects of governance from political aspects, confining the IMF’s involvement in governance issues to the areas outlined above should help establish the boundaries of this involvement. In addition, general principles that are more broadly applicable to the IMF’s activities should also guide the IMF’s involvement in governance issues. Specifically, the IMF’s judgments should not be influenced by the nature of a political regime of a country, nor should it interfere in domestic or foreign politics of any member. The IMF should not act on behalf of a member country in influencing another country’s political orientation or behavior. Nevertheless, the IMF needs to take a view on whether the member is able to formulate and implement appropriate policies. This is especially clear in the case of countries implementing economic programs supported by the IMF from the guidelines on conditionality that call on IMF management to judge that "the program is consistent with the IMF’s provisions and policies and that it will be carried out."³ As such, it is legitimate for management to seek information about the political situation in member countries as an essential element in judging the prospects for policy implementation.

Criteria for IMF Involvement

9. In considering whether IMF involvement in a governance issue is appropriate, the staff should be guided by an assessment of whether poor governance would have significant current or potential impact on macroeconomic performance in the short and medium term and on the ability of the government credibly to pursue policies aimed at external viability and sustainable growth. The staff could draw upon comparisons with broadly agreed best international practices of economic management to assess the need for reforms.

10. As regards possible individual instances of corruption, IMF staff should continue raising these with the authorities in cases where there is a reason to believe they could have significant macroeconomic implications, even if these effects are not precisely measurable. Such implications could arise either because the amounts involved are potentially large, or because the corruption may be symptomatic of a wider governance problem that would require changes in the policy or regulatory framework to correct. Instances could include, for example, the diversion of public funds through misappropriation, tax (including customs) fraud with the connivance of public officials, the misuse of official foreign exchange reserves, or abuse of powers by bank supervisors that could entail substantial future costs for the budget and public financial institutions. Corrupt practices could also occur in other government activities, including the regulation of private sector activities that do not have a direct impact on the budget or public finances, such as ad hoc decisions made in relation to the regulation of foreign direct investment. Such practices would be counter to the IMF’s general policy advice aimed at providing a level playing field to foster private sector activity.

11. Instances of corruption that do not meet the threshold of having significant macroeconomic implications are best addressed through the IMF’s efforts to promote transparency and remove unnecessary regulations and opportunities for rent seeking consistent with the broad principles that apply to other issues of economic governance. Staff recommendations could include improvements in government management processes and systems that would have the beneficial side effect of preventing a recurrence of corrupt practices or advice to the authorities to seek the assistance of competent institutions for advice in these areas.

Modalities of IMF Involvement in Governance Issues

Article IV Consultation Discussions

Use of IMF Resources

15. The use of conditionality related to governance issues emanates from the IMF’s concern with macroeconomic policy design and implementation as the main means to safeguard the use of IMF resources. Thus, conditionality, in the form of prior actions, performance criteria, benchmarks, and conditions for completion of a review, should be attached to policy measures, including those relating to economic aspects of governance that are required to meet the objectives of the program. This would include policy measures that may have important implications for improving governance but are covered by the IMF’s conditionality primarily because of their direct macroeconomic impact (e.g., the elimination of tax exemptions or recovery of nonperforming loans). While the IMF staff should rely on other institutions’ expertise in areas of their purview (e.g., public enterprise reform by the World Bank), it could nevertheless recommend conditionality in these areas if it considers that measures are critical to the successful implementation of the program.

16. Weak governance should be addressed early in the reform effort. Financial assistance from the IMF in the context of completion of a review under a program or approval of a new IMF arrangement could be suspended or delayed on account of poor governance, if there is reason to believe it could have significant macroeconomic implications that threaten the successful implementation of the program, or if it puts in doubt the purpose of the use of IMF resources. Corrective measures that at least begin to address the governance issue should be prior actions for resumption of IMF support, and, if necessary, certain key measures could be structural benchmarks or performance criteria. Examples of such measures include recuperation of forgone revenue and changes in tax or customs administration. The staff would need to exercise judgment in assessing whether the actions adopted by the authorities were adequate to address the governance concerns; as in the case of other policies in which the track record is weak and the commitment of the authorities is in doubt, it may be appropriate in some circumstances to call for a period of monitoring prior to a resumption of financial support. The authorities’ policy response could also entail changes in management in public institutions and, as appropriate, the removal of individuals from involvement in particular operations where corruption had occurred, and efforts to recover government funds that have been misappropriated. The staff must, of course, be mindful of the need to avoid action prejudicial to any related domestic legal processes in a particular case.

Technical Assistance

Identification of Governance Problems

19. It is recognized that there are clear practical limitations to the ability of the staff to identify deficiencies in governance. The availability, quality, and reliability of information are likely to be important factors affecting IMF involvement in corruption cases. The staff should continue to rely on information provided by the authorities. If inconsistencies in public accounts and reports suggest that a problem exists, the staff should, in the first instance, raise the issue with the authorities. In its endeavor to seek information, the staff may need to be prepared to face some tension in the working relationship with country authorities in specific cases potentially involving corrupt practices. The staff may also point out that, in an atmosphere of widespread rumors of corrupt practices, and where the rumors have some genuine credence, an independent audit may be desirable to address such concerns. If the staff considers that further information is required to resolve an issue that has a significant macroeconomic impact, it may be appropriate to make use of information from third parties, including other international organizations and donors. In view of the confidential nature of the information obtained by the staff from member countries, staff inquiries will need to be handled with due discretion and regard for the sensitive nature of the issue.

Coordination with Bilateral Donors and Other Multilateral Institutions

21. Given the commonality of interest with other multilateral institutions, the IMF should seek to strengthen its collaboration on issues of governance with them and, in particular, with the World Bank. This should include, especially when requested by the authorities concerned, coordination of action to improve governance.

22. As regards bilateral donors, it is useful to distinguish two different cases in which donor responses to economic and noneconomic governance issues affect the IMF’s relations with its members, although in practice there is seldom a clear separation between such economic and noneconomic aspects:

• In cases where bilateral donors or creditors withhold or interrupt external support because of concern over political and/or economic aspects of governance, the IMF should have an independent view on the economic implications. The IMF staff should examine whether these issues have a direct and significant impact on macroeconomic developments in the short or medium term. If this is the case, the staff should seek to assist the member country concerned through policy advice and technical assistance in areas of its expertise and coordinate as appropriate with donors, with a view to helping to address the governance issues before recommending provision of IMF financial support. If this is not the case, but donors continue to withhold support, the staff should seek to assist the authorities in reformulating a program with greater internal adjustment to compensate for reduced external financing, paying due regard to the medium-term sustainability in the absence of a resumption of external assistance. If this is not feasible because of a lack of financing assurances—that is, adequate external financing for the reformulated program is not in place—as a last resort, the staff should recommend that the IMF withhold its own financial support but continue to provide technical assistance support.

• In cases where governance issues significantly affect short- or medium-term economic developments but donors and creditors continue their financial assistance to the country concerned and do not assist the government in improving governance, the IMF staff nevertheless has an independent responsibility for raising the governance issue with the authorities and for reporting to the Executive Board on this issue. There may be occasions when the IMF staff may raise its concerns with donors and creditors, including at consultative group meetings and in roundtables. But these instances would need to be addressed with care, with the guidance of the Board and due regard to the confidential nature of such information. There are clear limitations to what the IMF’s contribution to improvements in governance in member countries can achieve without the active support from the rest of the international community.

Reporting to the Executive Board

Recent IMF Publications on Governance-Related Issues

Working Papers

97/100. Controlling Fiscal Corruption. Sheetal K. Chand and Karl O. Moene.

97/73. Corruption and the Role of Temptation: Do Low Wages in the Civil Service Cause Corruption? Caroline Van Rijckeghem and Beatrice Weder.

97/11. Toward a Market Economy: Structure and Governance. Pierre Dhonte and Ishan Kapur.

96/98. The Effects of Corruption on Growth, Investment, and Government Expenditure. Paolo Mauro.

94/99. Corruption, Governmental Activities, and Markets. Vito Tanzi.

94/86. On Corruption and Capital Accumulation. Carlos M. Asilis and V. Hugo Juan-Ramon.

Economic Issues Series

6. Why Worry About Corruption? Paolo Mauro.