Is the IMF Excessively Restricting the Spending of Aid?

April 16, 2007
A recent evaluation by the IMF Independent Evaluation Office (IEO) suggests that some of its programs with low-income countries may be unduly restricting the spending of additional aid. But the results vary a lot from country to country. According to the IEO, at the margin an IMF program targets only 27 cents of each additional dollar of aid for use towards higher public expenditures (i.e., a fiscal expansion). The rest is supposed to go to building up external reserves or paying down domestic debt.Surprising? Sure. But when this overall result is broken down by countries' initial conditions the conclusions are even more striking. It turns out that what the IMF recommends for the use of additional aid depends critically on a country's starting conditions:
  1. If external reserves are low (less than 2 ½ months of imports), virtually all aid is programmed to be saved in the form of higher reserves
  2. If reserves are above this level, but domestic macro conditions fail a very high test of stability--which the IEO proxies by a low inflation rate--the vast bulk of extra aid (85 cents on the dollar) is channeled to reducing domestic debt
  3. Only if reserves are high and domestic macro conditions are highly "stable" is most additional aid programmed for higher fiscal spending
The IMF is right to take account of the level of reserves and domestic macro conditions when considering how additional aid should be used, but the degree to which these factors are influencing the allocation seems excessive. Yes, reserve accumulation is an appropriate initial response to higher aid when reserves are low. But the share allocated to reserves should depend on how long the higher aid flows are expected to last. IMF programs seem to be assuming that all aid increases will be very temporary.Also, it is not clear that countries with relatively high reserves but less than perfect domestic macro conditions ought to use virtually all additional aid to reduce their domestic debt. The exact linkages between domestic debt reduction and objectives such as growth are opaque at best, and are highly country-dependent. Even assuming that domestic debt reduction allows for "crowding in" of private investment, there are other key tradeoffs to be considered, including the effect of government spending on both growth and social objectives. It is impossible to say what the appropriate tradeoff is without some analysis of how effective additional public spending would be--which in most cases has not been done. While undertaking this type of analysis is not the IMF's job, it should be careful not to just assume it knows the answer.


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