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Working Papers Temi di discussione (Working Papers) The catalytic role of IMF programs by Claudia Maurini and Alessandro Schiavone April 2021 April Number 1331 Temi di discussione (Working Papers) The catalytic role of IMF programs by Claudia Maurini and Alessandro Schiavone Number 1331 - April 2021 The papers published in the Temi di discussione series describe preliminary results and are made available to the public to encourage discussion and elicit comments. The views expressed in the articles are those of the authors and do not involve the responsibility of the Bank. Editorial Board: Federico Cingano, Marianna Riggi, Monica Andini, Audinga Baltrunaite, Marco Bottone, Davide Delle Monache, Sara Formai, Francesco Franceschi, Adriana Grasso, Salvatore Lo Bello, Juho Taneli Makinen, Luca Metelli, Marco Savegnago. Editorial Assistants: Alessandra Giammarco, Roberto Marano. ISSN 1594-7939 (print) ISSN 2281-3950 (online) Printed by the Printing and Publishing Division of the Bank of Italy THE CATALYTIC ROLE OF IMF PROGRAMS by Claudia Maurini* and Alessandro Schiavone* Abstract This paper investigates the impact of IMF programs on private capital flows in the assisted countries. We look at the impact on inflows and outflows of both traditional and precautionary programs, also taking into account the characteristics of the programs. Using the entropy balancing method to address the selection bias, we find that traditional IMF programs have an anticatalytic effect on private capital inflows; this effect is mainly driven by programs that went off-track and by exceptional access programs. By contrast, precautionary programs are found to have a catalytic effect, working mainly through outflows. JEL Classification: F33, F34, G11, G15. Keywords: International Monetary Fund, catalysis, capital flows. DOI: 10.32057/0.TD.2021.1331 Contents 1. Introduction ........................................................................................................................... 5 2. Related literature.................................................................................................................... 6 3. Data ........................................................................................................................................ 9 4. Strategy ................................................................................................................................ 11 4.1 Addressing the selection bias: entropy balancing.......................................................... 11 4.2 Outcome variable: capital flows .................................................................................... 14 4.3 Treatment variable: IMF programss .............................................................................. 14 5. Results ................................................................................................................................. 15 5.1 The cases of exceptional access and off-track programs ............................................... 17 6. Robustness checks ............................................................................................................... 19 6.1 Other issues ................................................................................................................... 20 7. Conclusions ......................................................................................................................... 21 Tables and figures .................................................................................................................... 23 References ................................................................................................................................ 33 * Bank of Italy, Directorate General for Economics, Statistics and Research, International Relations and Economics Directorate. 1 Introduction1 According to the IMF Articles of Agreement, the aim of the financial assistance provided by the IMF is to help countries undergoing a balance of payments crisis restore external equilibrium without having to resort to measures entailing a disproportionate cost for the economy.2 Even though, at a first glance, this definition may appear straightforward, from an empirical perspective assessing the success of IMF programs is challenging. First, there is no consensus in the literature about the transmission channels and the various factors affecting the effectiveness of IMF programs. Second, the empirical strategy adopted to investigate the effectiveness of IMF programs needs to address the selection bias stemming from the fact that countries asking for IMF’s assistance are faced with actual or potential balance of payments problems, and hence are different from countries that do not request such assistance. In this paper, we focus on the catalytic effect of IMF programs, investigating whether the intervention of the Fund increases the propensity of private investors to lend to pro- gram countries. Note that private financing represents a crucial ingredient for the success of IMF programs, since the task of the IMF is not to finance the external deficit of bor- rowing countries, but to provide a breathing space to national authorities, allowing them to implement reforms aimed at restoring external viability. In some theoretical works (Corsetti et al. (2003)) the success of IMF programs depends on the strategic interaction between the country and private investors. The country will restore external equilibrium only if it implements the package of reforms agreed with the Fund; on the other hand, private investors will finance countries assisted by the Fund only if they believe that the program will work out. The coordination role of the Fund is crucial since it enables the alignment of the incentives of borrowing countries to investors’ expectations: in fact, on the one hand, the IMF’s financial assistance alleviates the burden of the economic adjust- ment; on the other hand, by approving programs, the IMF provides its seal of approval on the policy measures that the country’s policy-makers commit to in order to push through the economic reforms needed to restore external viability. Previous studies find no systematic evidence on the catalytic effect; aside from method- ological aspects, there seems to be heterogeneity across countries, as private investors tend to discriminate among program countries according to their economic fundamentals (Mody & Saravia (2003)). Some papers (see Erce & Riera-Crichton (2015)) point also to asym- metric effects depending on the type and the direction of investment flows. Other factors that need to be taken into account concern the size of the financial assistance (Krahnke 1The views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Italy. 2Article 1(V) of the Articles of Agreement states that one of the purposes of the IMF is “to give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with the opportunity to correct maladjustments in their BoP without resorting to measures destructive of national or international prosperity”. 5 (2020)), and the degree of compliance with program conditionality (Kutan et al. (2012)). Our paper aims to contribute to the empirical literature, using a relatively new method- ology (entropy balancing) that allows us to deal with selection bias, without having to make strong assumptions on the counterfactual; moreover, we analyze the catalytic effect, having care to distinguish between IMF traditional and precautionary programs,3 and to account for the size of IMF loans, and the degree of compliance with IMF conditionality. Our analysis covers Stand-by Arrangements and precautionary programs approved af- ter 2002. The sample includes 44 countries and 84 arrangements; we use quarterly data for a larger number of economies since we compare program countries with a synthetic counterfactual obtained from other countries having similar characteristics in terms of macroeconomic variables. In our model we also take into account capital account open- ness as program countries often resort to capital flows management measures to prevent disruptive outflows. The main results of this study are: i) Stand-by Arrangements are associated with an anticatalytic effect on inflows whereas precautionary programs show a catalytic effect on outflows; ii) exceptional access programs (a subset of the Stand-by Arrangements) are as- sociated with a strong anticatalytic effect; with regard to Stand-by Arrangements within normal access limits, the adverse impact of IMF programs is much smaller on gross inflows and not significant on net inflows; iii) the anticatalytic effect is accentuated for Stand-by Arrangements featuring a low level of compliance with IMF conditionality (i.e. programs that go off-track). To sum up, we find evidence of a catalytic effect for precautionary programs; by contrast, the ability of the Fund to stimulate private financial flows towards countries proves significantly hampered in the case of exceptional access programs and when countries fail to comply with IMF conditionality. 2 Related literature The objective of IMF programs is to contribute to restore external viability of countries facing balance of payments crises, by providing support in such a way that recipient coun- tries are not forced to adopt measures detrimental for national prosperity. The implication is that for IMF intervention to be effective, it is paramount that private investors resume lending to program
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