IMF-SUPPORTED ADJUSTMENT PROGRAMS: ECONOMIC COMPLIANCE AND POLITICAL FALLOUT

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T00586R000300270003-6
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 17
• Document Creation Date: December 22, 2016
• Document Release Date: April 11, 2011
• Sequence Number: 3
• Publication Date: March 1, 1985
• Content Type: REPORT

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Intelligence
Directorate of Seer-et-
and Political Fallout
IMF-Supported Adjustment
Programs: Economic Compliance
P 7
CONTROL B?ANCH/CPAVPVG/Ti'T
tCl:CN 7G(1,7 HQ5
GI 85-10084
March 1985
COPY 3 2 9
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Directorate of Secret
Intelligence
and Political Fallout
IMF-Supported Adjustment
Programs: Economic Compliance
Economics Division, OGI,
This paper was prepared by the
Office of Global Issues. Comments and queries are
welcome and may be directed to the Chief,
Secret
GI 85-10084
March 1985
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Secret
IMF-Supported Adjustment
Programs: Economic Compliance
and Political Fallout
Key Judgments The financial community's primary demand on LDC debtors has shifted
Information available from simple adoption of an IMF standby agreement to vigorous compliance
as of 15 February 1985 with economic performance targets. Not only are nearly 90 percent of IMF
was used in this report.
drawings now tied to strong economic policy conditions, but the IMF is en-
forcing these conditions with closer scrutiny and greater resolve. Compli-
ance with IMF targets-the key to obtaining official reschedulings and
new money commitments from banks-is becoming an increasingly impor-
tant factor in pledges of bilateral and multilateral assistance as well. We
believe that debtors will continue to improve their current account
performance but will have more difficulty meeting domestic performance
targets set under IMF guidance.
Greater emphasis on compliance will force governments to attempt closer
adherence to austerity programs than has been true in the past. For some
countries, this could lead to greater levels of political unrest in the short
term, especially in cases where restrictive economic policies have been in
place for some time. Intensified compliance efforts have already led to civil
unrest in a number of LDCs with IMF-supported programs. Sporadic
protests have erupted over price hikes in Jamaica and the Dominican
Republic, while wage-related strikes have plagued Brazil.
In the absence of other political tensions, the risks of adjustment leading to
government-threatening instability are limited, especially in countries with
more diversified economies like Turkey and Brazil. However, we believe
that in countries like Sudan, with very narrow resource bases and other po-
litical problems, the prospects for compliance with IMF programs while
maintaining political stability remain dim.
Argentina and the Philippines are countries where we might see increased
political unrest this year as the governments strive for compliance to
qualify for needed debt restructuring. As key interest groups-labor unions
and student groups in particular-are adversely affected by drastic
changes in economic policy, we anticipate more riots, protest demonstra-
tions, and strikes.
Over the longer term, we believe the linkage between economic compliance
and political stability will take one of three forms:
? If implementation and adherence to an adjustment program is compre-
hensive and the economic benefits are realized, serious political unrest
often can be avoided.
iii Secret
GI 85-10084
March 1985
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? In those cases where austerity measures are watered down, few economic
benefits will be realized and, as the difficulties of austerity drag on, the
potential for unrest heightens.
? Countries that choose to postpone austerity measures risk fueling
underground economic activity that would lengthen the adjustment
process and increase the likelihood of more serious and prolonged unrest.
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IMF-Supported Programs: A Basic Framework 1
Compliance and Political Fallout: A Country Look 4
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IMF-Supported Adjustment
Programs: Economic Compliance
and Political Fallout
As the financial adjustment programs enacted by
debtor LDCs have begun to take hold, the pace of
drawings on IMF financial resources has slowed
considerably. Total drawings equaled $7.3 billion in
1984, down from a peak of $13.1 billion in 1983.0
the reduction in current account deficits
in major debtor countries as the key reason for the
decline. At the end of 1984, 29 standby arrangements
and four extended arrangements were in effect, com-
pared with 33 standbys and 10 extended arrange-
ments in 1983 (see table).
While the level of borrowings has abated, the propor-
tion of loans coming from the upper, highly condition-
al credit tranches continues to increase. Almost 90
percent of the drawings made in 1984-up from 75
percent in 1983-were made by countries under
agreements requiring extensive economic policy
changes in exchange for IMF funding. Moreover, this
high degree of conditionality means that the strenuous
economic adjustment process currently under way in
the debt-troubled LDCs will continue for the rest of
1985-and well into 1986 in some cases.
As a result of its support of adjustment programs, the
IMF has become a key player in the quest for
financial stabilization of debt-troubled countries. Nei-
ther official government creditors nor commercial
banks will act on a debtor's request for a rescheduling
until an IMF program is in place. Standby and
extended arrangements link a member's use of IMF
resources to its adoption of an economic adjustment
program designed to correct its balance-of-payments
position. Adjustment programs typically include mea-
sures that affect key economic policy areas including
government expenditures, credit ceilings, foreign bor-
rowings, exchange rate policies, and trade restrictions.
It is on the condition of policy changes in these areas
that creditors agree to restructuring terms and new
IMF Standby and
Extended Arrangements,
As of 31 December 1984
Expiration
Date
Amount
Agreed
Undrawn
Balance
14,795.2
6,570.6
6,673.9
3,557.1
Mar 86
1,419.0
1,419.0
Mar 86
7.2
5.9
Central African
Republic
Jul 85
15.0
10.0
Dominica
Jul 85
1.4
0.4
Gambia, The
Jul 85
12.8
10.2
Ghana
Dec 85
180.0
120.0
Haiti
Sep 85
60.0
39.0
Hungary
Jan 85
425.0
0.0
Ivory Coast
Aug 85
82.8
41.4
Jamaica
Jun 85
64.0
36.0
Korea (South)
Mar 85
575.8
95.9
Liberia
Jun 86
42.8
34.3
Madagascar
Mar 85
33.0
6.0
Mali
May 85
40.5
6.5
Morocco
Mar 85
300.0
90.0
Niger
Dec 85
16.0
12.8
Peru
Jul 85
250.0
220.0
Philippines
Dec 86
615.0
530.0
Portugal
Feb 85
445.0
185.7
Sierra Leone
Feb 85
50.2
31.2
Sudan
Jun 85
90.0
70.0
Togo
May 85
19.0
3.0
Turkey
Apr 85
225.0
56.3
Uruguay
Apr 85
378.0
226.8
Western Samoa
Jul 85
3.4
1.7
Yugoslavia
Apr 85
370.0
90.0
Zaire
Mar 85
228.0
70.0
Zambia
Apr 86
225.0
145.0
Extended arrangements
8,121.3
3,013.5
Brazil
Feb 86
4,239.4
1,496.3
Dominican Republic
Jan 86
371.3
247.5
Malawi
Sep 86
100.0
66.0
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money allocations. And, in turn, it is this linkage as
well as its own lending that provides the IMF with the
leverage to insist on meaningful structural adjust-
ment.
Standby arrangements almost always include perfor-
mance criteria expressed in terms of quantitative
targets, which usually are reviewed on a quarterly
basis. The criteria normally take three general forms:
? A ceiling on central bank lending and the subceiling
on lending to the central government. These ceilings
are designed to limit government spending as one
method of restoring a balance-of-payments equilib-
rium. Because official borrowing can put pressure
on the availability of funds, these criteria protect
against preempting private-sector borrowing.
? Limits on the assets of the central bank, which are
designed to limit the expansion of the money supply
and, in turn, help to control inflation.
? A limitation on the amount and maturity of new
external debt to protect against foreign borrowings
being used to circumvent domestic credit ceilings.
The ceiling is also designed to improve the debt-
servicing burden of the borrowing country.
Adjustment programs may also include qualitative
performance criteria that outline such things as the
member's intention not to introduce or intensify exist-
ing import restrictions.
Compliance with these criteria is the principal moni-
toring instrument used by the Fund to assess whether
adjustment programs are on track. A small violation
that does not threaten a program's objectives usually
results in the granting of a waiver by the Fund's
Executive Board. A more substantial infraction,
which suggests the country may have difficulties
achieving a program's objectives, will lead to consul-
tations between the Fund and the respective govern-
ment that will probably result in the introduction of
modified performance criteria. In the meantime, the
country's ability to draw on Fund resources will be
suspended. Only when consultations reach a satisfac-
tory conclusion are the member's drawing rights
restored.
The performance criteria and targets found in adjust-
ment programs provide little cushion against the
impact of an external shock. Shocks such as high
interest rates and fluctuating oil prices endanger
adjustment programs and any early return to credit-
worthiness. Debtors feel they are beingforced to bear
the brunt of global economic conditions that are
beyond their control. Their primary concerns include
continued protectionism, the relative strength of the
US dollar, and high real interest rates. The recent
period of unfavorable economic conditions including
historically high interest rates and global recession
forced some debtors to adopt unexpectedly harsh
austerity measures they felt were politically intoler-
able. Debtors, in particular the Cartagena Group, are
calling on the developed countries to do their `fair
share" and adopt an attitude of "coresponsibility. " In
this same spirit, the debtors would like to see the
IMF.
? Establish a compensatory fund to cushion the
impact of high real interest rates.
? Allow restructuring of arrearages owed to the
Fund.
? Make conditionality more flexible.
Conditionality: The Economic and Political Impact
Austerity and economic adjustment under IMF pro-
grams have led to significant positive economic bene-
fits in many countries. in
1984 those countries under standby or extended ar-
rangements saw their current account deficits decline
to one-half the preadjustment levels of 1981. Brazil
led all others in eliminating its huge $11.8 billion
current deficit. Furthermore, IMF-supported adjust-
ment programs keep international financial markets
open to some LDCs because new money packages and
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official and commercial reschedulings are all an-
chored to Fund arrangements.
Government leaders hoping to implement needed eco-
nomic measures and avoid political fallout face a
limited number of options:
in Mexico, for example, every dollar of Fund
lending in 1983 and 1984 unleashed seven times that
amount in new loans and refinancing. Restructurings,
in turn, have helped to bring about an improvement in
the maturity profiles of outstanding debt and have
eased the debt service burden. Determined adjust-
ment efforts have resulted in multiyear reschedulings
for Mexico and Venezuela.
While unrest is often politically or socially induced, as
in the Philippines, we believe the high degree of
conditionality required for IMF assistance also has
had deleterious political effects. Indeed, previous re-
search shows that IMF-supported programs require
precisely the type of economic changes that can lead
to political unrest.' Traditionally, cuts in government
subsidies, which result in higher prices on food and
fuel, are the actions that are most likely to trigger
public unrest. Strikes, protest demonstrations, and
riots are the most prevalent forms of unrest and
usually are initiated and organized by labor unions or
student groups. These forms of protest rarely evolve
into government-threatening instability, but they have
caused governments to relax austerity measures for
fear of further alienating their constituencies.
some countries under IMF conditionality.
the Diouf government
in Senegal, the Houphouet government in Ivory
Coast, and the Barletta government in Panama have
all been forced to soft-pedal their austerity programs
at one time or another or risk losing their political
power base. While averting civil unrest in the short
run, implementation of halfhearted austerity mea-
sures could compound a government's political prob-
lems in the medium term. Watered-down adjustment
efforts will bring few of the economic benefits the
population has been promised, and, as the difficulties
of austerity continue-for a longer period of time
than would have been the case under a fully imple-
mented program-political tensions usually will
heighten.
? Publicity campaigns can be initiated to educate the
people on the need for adjustment and on the long-
run benefits they can expect. There are risks, how-
ever, if the government fails to make good on its
promises.
? Exchange rates could be adjusted on a daily or
weekly basis rather than through a massive one-
time devaluation, thereby partially diffusing a polit-
ically sensitive issue.
? Price increases can be implemented in stages to
limit negative public reaction. In Egypt, for exam-
ple, the Mubarak government initiated bread price
increases only in wealthy neighborhoods in an at-
tempt to avoid rioting reminiscent of 1977, when
more than 100 people were killed.
? In politically tense situations, the government can
attempt to move away from the passionate issues of
price increases into less sensitive areas such as
divestment of publicly owned enterprises.
? Civil anger can actually be directed away from the 25X1
local government and toward the IMF and other 25X1
foreign lenders. In Sudan, for example, the Nimeiri
government is aided by the population's perception 25X1
that international donors, the drought, and the
influx of drought refugees are responsible for a large
part of their economic ills.
A government's prospects for peaceful implementa-
tion of austerity measures will be dimmed by political
opposition groups using austerity as a rallying point to
strengthen their own political power base. In Jamaica,
for example, Prime Minister Seaga claimed the Janu-
ary protests against price hikes were politically in-
spired, while former Prime Minister Manley claimed
the protests reflected the people's deep-seated discon- 25X1
tent and frustration with the Seaga government.
25X1
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Compliance and Political Fallout: A Country Look
The economic gains and political fallout from the
IMF-supported adjustment process vary widely
among countries. Some countries-Mexico, Portugal,
and Turkey-have successfully completed programs
while maintaining political calm; their broadly based
economies and strong centralized governments have
provided an accommodating environment for adjust-
ment. Events of unrest, however, have been common-
place in other countries like Jamaica and the Domini-
can Republic, where a halfhearted commitment to
adjustment has resulted in little or no economic
improvement. New price hikes and spending cuts on
top of prolonged economic hardships have made for
politically volatile situations. As the IMF takes a
harder line on compliance, we believe that countries
like Brazil and Chile have a potential for higher levels
of unrest. These governments may no longer be able
to cushion austerity measures through the traditional
methods of implementing only partial reforms or
coupling price hikes with wage increases.
Countries on Track
After three years of sustained progress, in 1983
Turkey suffered significant economic setbacks-nota-
bly a deterioration in its external accounts and higher
inflation. As a result, the standby arrangement signed
in April-Turkey's fifth program in 10 years-was
designed to halt the rise in inflation and reduce the
current account deficit. To reverse the surge in the
rate of inflation, currently projected at almost 50
percent annually, the government initiated measures
to absorb excess liquidity and in July started selling
high-interest bonds and raised interest rates. Turkey's
arrangement with the IMF was amended following its
midcourse review in August, and we believe Turkey
will meet its revised targets and make its fourth and
final drawing on schedule. According to uncorrobo-
rated press reports, however, the government of Tur-
key plans to seek a new $250 million standby agree-
ment in 1985.
Turkey's almost continuous six-year relationship with
the IMF has been harmonious, in large part because
of its successful reorientation toward free market,
export-oriented policies. Internally, martial law,
which still exists in some of Turkey's 67 provinces, has
limited the amount of social protest. We believe the
political stability of Turkey will depend, in part, on
Prime Minister Ozal's ability to continue to control
the labor unions, but a high rate of inflation and
continued wage controls will make this increasingly
difficult.
After years of political instability following the 1974
revolution and the loss of its African colonies, interna-
tional bankers believe Portugal is turning around
under the leadership of Prime Minister Soares, Minis-
ter of Finance Lopes, and a strong economic team.
Under its IMF program, originally due to expire 28
February 1985, Portugal has trimmed its current
account deficit from $3.2 billion in 1982 to an
estimated $400 million in 1984. At the same time, it
has reduced its imports and improved its credit rating
in the international financial markets, and the struc-
ture of its external debt-about $14 billion-is now
more manageable.
Domestically, the Portuguese have exceeded the ceil-
ings on short-term debt and on domestic credit to the
public sector. The IMF granted Portugal a waiver on
technical grounds for violation of its July short-term
ceiling. The Portuguese had planned to seek a waiver
for the overrun of the domestic credit ceiling, but this
was strongly discouraged by the Fund as waivers are
granted only when the problem is being corrected.
Because the overruns continued unabated, the Portu-
guese decided not to pursue a waiver, and the standby
was terminated at the end of 1984.
The Portuguese met with the IMF in early January
and all parties agreed that a formal standby arrange-
ment for 1985 was not necessary, but the Fund will
continue to monitor and report on Lisbon's perfor-
mance. According to Embassy reports, the Fund
agreed to a visit in February to prepare a report on
1984 performance and to another visit in June for the
midyear review. The Portuguese were pleased at this
concession as it coincides with their syndication of a
$500 million loan and reassures bankers that the
country remains under Fund surveillance.
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Although economic prospects are improving for Por-
tugal, the domestic price of adjustment has been high.
Unemployment is still more than 10 percent and real
incomes are down, but there has been no sign of
significant political unrest. The presidential elections
in December could have a negative impact on Portu-
gal's international credit standing if the coalition
government collapses and a replacement is not easily
formed as was the case in 1983 when bankers cut off
lending.
Trouble Spots
The Dominican Republic has run into periodic trou-
ble both domestically and with the IMF. The govern-
ment introduced an adjustment program in 1982 that
was endorsed by the IMF in January 1983, at which
time a three-year extended arrangement was signed.'
Performance criteria were met until late 1983, when
negotiations with the IMF were suspended because of
a disagreement over the prices of essential commod-
ities, especially petroleum products. After bloody
protests against food price hikes in April 1984, negoti-
ations for the second year of the arrangement were
suspended in May when the government refused to
implement further subsidy cuts on petroleum and
electricity. According to Embassy reporting, the gov-
ernment felt such actions would prompt additional
violence.
After the violence in April 1984, President Jorge
Blanco began an extensive program to build support
for a standby arrangement among key labor, political,
and business groups. In August, the government
adopted a set of austerity measures for the next 18
months. The Fund welcomed the informal accord as a
transitional measure that could lead to a formal
program. President Jorge Blanco's troop deployments
to potential trouble spots helped prevent violent con-
frontations in the wake of food, fuel, and transit price
increases announced in January 1985. We believe,
however, that growing divisions in the ruling party
could sidetrack the President's austerity program and
further aggravate the country's economic problems.
Jamaica failed to comply with its performance targets
in September and December of last year. In Septem-
ber the Jamaicans exceeded the ceiling on new arrear-
ages because of delays in two loan disbursements, but
the Fund expected the loans to be disbursed in
November and, therefore, granted a waiver. Targets
on fiscal policies, which have been at the core of
Jamaica's economic problems, were met only by very
narrow margins, suggesting a need for further tight-
ening. The Jamaicans recently instituted a freely 25X1
floating exchange rate system. Despite a prohibition
against multiple currency rates, it was agreed that the
Bank of Jamaica would intervene in the spot markets
until the rates converge and an orderly transformation
has occurred. The intervention is to end no later than
15 March 1985, according to Embassy reporting.
Jamaica's economy continues to deteriorate. Since fall
1983, the Jamaican dollar has been devalued by 64
percent, and the government continues to remove
subsidies on basic food products. In January 1985 the
price of gasoline and other petroleum products was
boosted sharply. These moves led to widespread pro-
tests that left at least four dead. As a result, Prime
Minister Seaga is attempting to cushion the impact of
further price increases through food relief programs.
Economically, the unrest is hurting the tourism indus-
try, depriving the economy of needed foreign ex-
change, and jeopardizing the entire adjustment pro-
cess. Politically, we believe public unhappiness with
government policies could contribute to a resurgence
of popularity for opposition leader Manley.
Potential Problems
Sudan's standby arrangement became inoperative af-
ter its first drawing in June 1984 because of arrears
with the Fund-a continuation of Sudan's intermit-
tent difficulties in meeting its financial obligations to
the Fund since 1981. Arrearages currently total more
than $90 million and will rise to $257 million if no
' An extended arrangement is designed to meet the needs of
countries experiencing special balance-of-payments difficulties that
require support over a period longer than normally covered by a
standby arrangement. Conditionality is in effect for the entire
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further payments are made by yearend. Sudan is also
in arrears to several regional organizations as well as
government and commercial creditors.
In response, the Nimeiri government has announced a
combination of budget, price, and foreign exchange
reforms designed to win endorsement of the IMF and
thereby release at least partial disbursement of sus-
pended bilateral funds. According to State Depart-
ment reporting, a Sudanese economic team in Wash-
ington has given tentative approval to IMF demands,
but the plan still awaits Nimeiri's approval. However,
the resurgence of civil disturbances in the southern
region has led to an increase in government expendi-
tures on internal security that will adversely affect
medium-term balance-of-payments prospects. Sudan's
financial prospects are further complicated by Ni-
meiri's program of Islamization, which has confused
businessmen and limited investment.
Chile has been in and out of compliance with its IMF
programs as political pressures have led to backsliding
on austerity measures. Chile signed a two-year stand-
by arrangement with the IMF in January 1983. The
agreement limited government spending, credit ex-
pansion, international reserve drawdowns, and the
level of public-sector debt. Chile soon fell out of
compliance with its program, but rather than termi-
nate its arrangement or negotiate a revised program it
instituted a four-month "shadow program." During a
shadow program, a country does not draw from the
Fund but follows policies that, while different from
IMF recommendations, are nonetheless designed to
eventually bring the country back in compliance.
Chile returned to compliance and resumed its regular
program in September 1983. In 1984 the government
successfully completed its adjustment program, and
a prelimi-
nary agreement with the IMF for a new $750 million,
three-year standby agreement has been reached. Ac-
cording to Embassy reporting, however, Santiago has
heightened its financial vulnerability for 1985 by
drawing $800 million in short-term credit to help
cover a $2 billion current account deficit.
The economic austerity measures have been accompa-
nied by high levels of political unrest since the
adjustment program was launched in 1982. The Pino-
chet government, however, has been able to minimize
the political backlash through political repression and
selective loosening of the economy at critical times.
We believe austerity measures were a major factor in
the antigovernment demonstrations in 1983. In an
attempt to restore political stability, in early 1984 the
government appointed a team of economists who
advocated a more interventionist role for the govern-
ment. This relieved some of the political pressure as
the new team offered limited relief to some sectors of
the economy. After antigovernment protests in Sep-
tember failed to gain momentum, the government
took some stronger steps toward adjustment. Adverse
public reaction was limited as the government timed
implementation of the measures to coincide with the
traditional December-to-March vacation period. If
the government continues to concentrate on improving
Chile's external accounts by squeezing the domestic
internal sector, the political fallout could be more
strident than in the past, and we believe Pinochet
again will be pressured to relax his austerity program.
Brazil is having difficulty with IMF guidelines in the
third year of its three-year extended agreement with
the Fund. Under this extended arrangement, perfor-
mance criteria and targets are set for three-month
periods. Brazil has sent the IMF a letter of intent
covering the final year of its program, but the Fund
has decided to delay any final action until the Neves
government comes to power in March.
The contrast in compliance between the external and
domestic targets is dramatic:
? The 1984 trade balance showed a surplus of $13
billion-higher than for 1983 and $4 billion greater
than the target of $9 billion. The current account
and international reserve targets were also sur-
passed by comfortable margins.
? Brasilia, however, has had serious difficulty in
meeting its domestic sector targets. According to
Central Bank figures, the money supply grew by
204 percent and the monetary base by 244 percent
in 1984-more than double targeted levels. The
IMF withheld a $400 million payment in February
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1985 because of Brazil's failure to meet fourth-
quarter public spending and money supply targets.
According to press reports, inflation soared to an
annual rate of 300 percent in January, more than
double the targeted level of 120 percent. Inflation
has been fueled by indexation, a larger-than-expect-
ed inflow of capital, and uncontrolled state spend-
ing.
Brazil's commercial creditors.
Because of these shortfalls, the IMF has been dealing
harshly with Brazil since late 1984, and the new
government will be under intense pressure to meet
both IMF requirements and the demands of Neves's
constituency. Brazilian workers continue to protest
against wage controls and cuts in public job spending.
There may be a political temptation for the new
government to engage in some populist measures,
such as increasing real wages or devoting more funds
to social security programs, which would further fuel
inflation. Any of these measures would clearly put the
government at odds with the IMF and, thus, could
jeopardize or at least postpone an agreement with
In the first two years of its program, Mexico became
a prototype for demonstrating how adjustment mea-
sures can revitalize an economy. Since the summer of
1981, Mexico has engineered an $18 billion positive
swing in its trade balance. In addition, the govern-
ment has reduced its public-sector deficit to slightly
more than one-third its crisis level. Furthermore, the
country has made substantial progress in regaining
the confidence of international lenders. Begun in
1983, the IMF program aimed at restoring Mexico's
economy, primarily through a reduction in the public-
sector deficit, slowing inflation while reducing reli-
ance on foreign borrowing, and liberalizing the trade
and exchange systems. In 1983 and 1984 Mexico's
economic performance was satisfactory to the IMF,
even if an agreement is signed this spring, Mexican
officials are concerned about their ability to meet
targets. Their concern focuses on falling oil prices and
pressures to increase government spending prior to the
1985 local elections.
Mexico's unique political and social structure has
helped the country endure two years of wrenching
economic austerity without serious political conse-
quences. The key to continued stability has been
labor's support for the ruling Institutional Revolution-
ary Party (PRI). Unlike the situation in Argentina
where the unions are the wild card, in Mexico they
are among the government's strongest supporters. We
believe, however, that the economic situation is begin-
ning to take a political toll. Resentment is growing
against the PRI; and, for the first time in 55 years of
single party rule, a second party-the center-right
National Action Party-is drawing a sizable vote.
With midterm elections approaching, there will be
heavy political pressure against continued strong aus-
terity measures.
In our judgment, debtors will make further gains in
external sector performance in 1985 but will continue
to have difficulty meeting internal monetary and
fiscal targets. Banks, official creditors, and the IMF
will increase their pressure on debtors to meet these
domestic targets or risk forfeiting financial assistance.
Recently, the IMF issued a rare statement voicing its
concern over Brazil's internal accounts. This marks a
change of heart on the part of the Fund which has,
until now, been prepared to overlook a series of
failures by Brazil to meet domestic economic targets.
With greater reliance on IMF performance apprais- 25X1
als, the Fund will probably be less likely to grant
and funds were disbursed regularly. waivers in an effort to maintain its credibility.
Since then, however, problems have arisen. Talks with
the IMF on the program for 1985 have been dead-
locked since November 1984. Mexico had proposed a
public-sector deficit equal to 5.1 percent of GDP-
nearly 2 percentage points over the original goal set in
1982. Mexico City, however, recently announced bud-
get cuts designed to bring the program more in line
with IMF demands.
As pledges of official aid become more closely tied to
compliance, we anticipate that a number of ad hoc
committees, similar to the one established by the
official creditors of the Philippines, will be set up to
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The Changing Nature of Economic Adjustment
A large part of the international financial community
is pressuring the IMF and IBRD to become more
involved in the LDC longer term economic stabiliza-
tion process. At the upcoming IMF/IBRD Interim
and Development Committee meetings in April, dis-
cussion will focus on moving beyond adjustment and
toward sustained balance-of-payments positions and
stable levels of economic growth in the medium term.
Debtors that have complied with a short-term IMF
standby and have improved their economic situation
feel they deserve a longer leash than another standby
or one-year Paris Club rescheduling can provide. As
more countries seek multiyear reschedulings similar
to Mexico's, requests for IMF surveillance without a
formal standby arrangement are growing. However
uncomfortable the IMF may be in this new role, we
believe commercial creditors-who insist that some
monitoring take place-will demand continued Fund
involvement.
We believe debtors who have been unsuccessful in
their adjustment programs will intensify their efforts
to circumvent the IMF. Nigeria, for example, in a
deadlock with the IMF, issued promissory notes to
its uninsured trade creditors and, in effect, converted
its short-term debt into medium-term debt. Others
will avoid a formal IMF arrangement for political
reasons. In countries like Venezuela and Indonesia,
better economic situations grant the governments the
flexibility to take adjustment measures on their own
without a politically less palatable arrangement with
the IMF.
follow the progress of economic policy implementa-
tion. In the case of the Philippines, several key
bilateral donors in January postponed making aid
commitments until satisfied with Manila's policy-
reform efforts.
We believe the increased emphasis on economic com-
pliance in the next year could lead to greater levels of
political unrest as governments are forced to make
more painful economic adjustments. We anticipate an
increase in events of political unrest mainly in the
form of riots, protest demonstrations, and strikes
especially in countries-like Argentina and the
Philippines-where new IMF-led programs will be
taking effect. In other countries, for example Jamai-
ca, continued unrest is quite likely because austerity
has been in place for some time and economic gains
remain unrealized. Moreover, government leaders
who are forced to recant after having taken a strong
stance against an IMF program are the most likely to
be weakened. This could prove true for Nyerere in
Tanzania as well as Buhari and the Federal Military
Government in Nigeria.
For those debtors who back away from adjustment,
the consequences of delay will add to already serious
problems:
? Bolivia, which declared a moratorium on debt pay-
ments in May 1984, has an inflation rate of more
than 2,000 percent and high unemployment. An
IMF-supported program would, we believe, boost
short-run inflationary pressures and unemployment
much higher.
? Similarly, Peru stopped making interest payments
in June 1984 and is now more than $300 million in
arrears. Concerns about the July elections have
prompted the Belaunde government to postpone
negotiations with the IMF, which, in turn, has
delayed discussions with Lima's creditors on debt
restructuring.
In both cases, continued economic stagnation will
enhance the attractiveness of illegal drug activity and
further jeopardize the legitimacy of the respective
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governments. Moreover, postponing needed austerity
will lengthen the adjustment process and, in our
judgment, will increase the probability that more
serious and prolonged unrest will occur.
In the medium term, we believe the potential for
political unrest will decrease as the economic benefits
of the adjustment process are realized. Provided im-
provements do occur, and in the absence of other
political tensions, the risks of government-threatening
instability should diminish, especially in countries
with more diversified economies like Brazil, Argenti-
na, and Turkey. For other countries, like Sudan-
with very narrow resource bases and other serious
political problems-prospects will remain dim.
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