Mody and Saravia: Catalyzing Capital Flows: Do IMF Programs Work as Commitment Devices?

A Mody and D Saravia, “Catalyzing Capital Flows: Do IMF Programs Work as Commitment Devices?,” in , 2003, 25-27.

“An objective of IMF programs is to help countries improve their access to international capital markets. In this paper, we examine if Fund programs influence the ability of developing country issuers to tap international bond markets and whether they improve spreads paid on the bonds issued. We find that the Fund programs do not provide a uniformly favorable signaling effect, i.e., the mere presence of the IMF does not act as a strong seal of good housekeeping. Instead, the evidence is most consistent with a positive effect of IMF programs when they are viewed as deteriorated significantly. The size of the Fund’s program matters, but the credibility of a joint commitment by the country and the IMF appears to be critical” (1).

“In this paper, we explore the possibility that successful catalysis depends on a credible joint commitment by the country and the Fund that leads to improved prospects for honoring debt contracts. In other words, the catalytic effect—or the Fund’s ‘seal of approval’—is not automatic and the mere presence of a Fund program does not lead to more capital flows. Rather, an IMF program is effective as a commitment device when other available information does not negate its credibility. As such, the value of the commitment implied by a Fund program and its ability to catalyze capital flows, is likely to depend on initial country conditions, program design, and the country-Fund relationship. Our contribution then is to move from a presumption of undifferentiated effects to identify country, program, and relationship characteristics that create the conditions for credible commitments and hence contribute to enhanced capital flows under IMF programs” (3).

They reach four conclusions:

1. Having a Fund program operative in a country decreased possible negative effects from a country’s volatility in exports
2. If reserves have not been reduced beyond recoverable levels, Fund programs are possibly helpful
3. Bigger Fund programs can be effective even when funds are not deployed
4. If a country and the Fund have an iterated interaction that is timely, success is also more likely.

They use a model of Eichengreen and Mody (2001) for their empirical analysis.

There is an excellent overview of the relationship between fund lending and improving access to international capital: while Fund lending may be quite small, it does provide the necessary sign to international capital that this country’s macroeconomic policies are on the right track.

There is a review of literature surrounding IMF lending policies. “Two early studies (Edwards 1989 and Khan 1990) reached three conclusions that have stood the test of time. First, Fund programs help improve the external payments position, this improvement takes effect relatively quickly, i.e., within a year, and is sustained beyond the program. Second, the impact on inflation is statistically insignificant. Third, growth actually suffers during the period of an IMF program but recovers once the program ends, though possibly not to the level prior to the initiation of the program” (8).

We adopt an estimation approach developed in earlier papers (see Eichengreen and Mody 2001). We estimate a two-equation model: the ‘spreads’ equation, which specifies the determinants of spreads charged, and the ‘selection’ equation, which is a probit for the decision to issue the bond” (11).

Skipped much here.

“…a Fund program is not an automatic or standardized ‘good housekeeping’ seal of approval. Investors appear to value the Fund’s participation in resolving the country’s external payment difficulties but only when they view it is as likely that the effort will be successful. Our further contribution, we believe, is to suggest the conditions under which programs are likely to succeed. Successful outcome, measured in this paper as improved access to international markets, depends on the market’s perception of credible reform measures” (22).