Energy costs have risen markedly, but the U.S. economy hasproven resilient, remaining a force for growth in a period ofglobal slack. Still, there is work to do. With strong short-termgrowth rates in prospect, the country is well positioned to beginto address some longer-term concerns. These include a histori-cally low national saving rate and severe underfunding in key federal programs—Medicare and Social Security.

With 2.5 million people directly affected by Niger’s severe foodshortage, UN agencies have launched a series of appeals for inter-national aid. The IMF is also playing a role, working closely withinternational donors to mobilize additional resources andencouraging the government to take every possible step to dealwith the country’s immediate needs. Within the next few weeks,an IMF mission is due to go to Niger to assist the authorities.

In the 1990s, the number of structural conditions attached to IMF lending rose sharply but con-cerns deepened about the strength of national ownership of Fund-supported policy programs.As a result of a major review, the IMF in 2002 began to place greater emphasis on streamlining.How well are the IMF’s new guidelines on conditionality being implemented? A look at experienceto date suggests that progress has been made in terms of clearer and more focused conditions.Ultimately, the new guidelines will be judged successful if they contribute to better economic outcomes, but it is too early to gauge whether this has been the case.

How significant a role do the right policies play in a country’s ability to attractforeign direct investment (FDI)? Not as much as some policymakers mighthope, but enough to suggest that the right policies can make a difference andtheir effects can vary above and below a certain FDI threshold. SoutheasternEurope, which has attracted limited FDI, is a case in point, according to a recentIMF study. It stands to benefit from policies that encourage FDI, notably infra-structure reforms and a liberalization of foreign exchange and trade regimes.

NEWS: IMF focuses on Niger relief

POLICY: Streamlined conditionality?

COUNTRY FOCUS:The U.S. locomotive

REGIONAL FOCUS: FDI in Southeastern Europe

IN THIS ISSUE

234 What’s on234 At a glance235 In the news

Niger relief effortDebt reliefKato in Mozambique

and Zambia

237 Country focusU.S. economy on trackAustria looks eastward

242 Regional focusFDI in Southeastern

Europe

244 PolicyIMF conditionality

246 ForumHedge funds

247 IMF lendingArrangements

248 EvaluationIEO work program

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I N T E R N AT I O N A L M O N E TA R Y F U N D A u g u s t 1 5 , 2 0 0 5 V O L . 3 4 , N O . 1 5

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234 IMF SURVEY

AU G U S T

22–26 IMF–Singapore RegionalTraining Institute seminar,“Creditor Rights in EmergingEconomies,” Singapore

24–September 2 APEC Smalland Medium Enterprise Minis-terial, Daegu, Republic of Korea

SE P T E M B E R

3 IMF–Singaporean governmenthigh-level seminar on regionalfinancial integration, Singapore

6–7 IMF high-level seminar,“Financial Stability—CentralBanking and SupervisoryChallenges,” Washington, D.C.

7 IMF Managing Director Rodrigode Rato to visit Seoul, Republicof Korea

8–9 APEC Finance MinistersMeeting, Jeju, Republic of Korea

8 IMF Economic Forum, “IMFConditionality: Good, Bad, orUgly?” Washington, D.C.

14–16 High-level plenarymeeting, UN General Assembly,to review progress on UNMillennium Declarationcommitments, New York

19–23 IMF seminar forparliamentarians from Bosnia andHerzegovina, Croatia, Macedonia,

and Serbia and Montenegro, JointVienna Institute, Vienna, Austria

22–23 Global Forum on TaxTreaties and Transfer Pricing,OECD Center for Tax Policy andAdministration, Paris

24–25 IMF and World BankAnnual Meetings, Washington, D.C.

26–30 International AtomicEnergy Agency GeneralConference, Vienna, Austria

OC T O B E R4–7 Meeting of the InternationalTask Force on the Harmonizationof Public Sector Accounting, IMF,Washington, D.C.

19 IMF Book Forum, PietraRivoli, Travels of a T-Shirt in theGlobal Economy: An EconomistExamines the Markets, Power,

and Politics of World Trade,Washington, D.C.

NO V E M B E R

3–4 IMF Jacques Polak SixthAnnual Research Conference,Washington, D.C.

4–5 Fourth Summit of theAmericas, Mar del Plata,Argentina

16–18 World Summit on theInformation Society, Tunis, Tunisia

27–29 World Economic Forum,India Economic Summit, NewDelhi, India

DE C E M B E R

13–18 The Sixth WTOMinisterial Conference,Hong Kong SAR

At a glance

What’s on

IMF Executive BoardFor an up-to-date listing of IMFExecutive Board meetings, seewww.imf.org.external/np/sec/bc/eng/index.asp.

Note on IMF Special Drawing RightsSpecial Drawing Rights (SDRs) are an international reserve asset, created by the IMF in 1969 to supplement the existing official reserves of member countries. SDRs are

allocated to member countries in proportion to their IMF quotas. The SDR also servesas the unit of account of the IMF and some other international organizations. Its valueis based on a basket of key international currencies.

IMF financial data

NonconcessionalBrazil 14.21Turkey 12.19Argentina 7.69Indonesia 5.85Uruguay 1.67

ConcessionalPakistan 1.02Zambia .53Congo, Dem. Rep. of .49Ghana .28Tanzania .26

Largest outstanding loans(billion SDRs, as of 6/30/05)

1Cumulative disbursements under the Heavily Indebted Poor Countries Initiative.

0.0

0.5

1.0

1.5

2.0

as of 8/4/0520042003200220012000

0

20

40

60

80

Latin America and the CaribbeanMiddle East

Europe (includes Turkey and Russia)AsiaAfrica

as of 6/30/0520042003200220012000

SDR interest rate, rate of charge on IMF nonconcessional loans outstanding, and dollars per SDR

Dollars per SDR(right scale)

SDR interest rate(left scale)

Rate of charge(left scale)

8/04/0520042003200220012000

0

1

2

3

4

6

1.2

1.4

1.6

Survey15_REV.qxd 8/12/05 12:24 PM Page 234

235August 15, 2005

In the news

I n recent weeks, the world’s attention has been focused onthe severe food shortages afflicting Niger as a result of theconfluence of natural disasters: prolonged drought and a

locust invasion. According to the United Nations, about2.5 million of Niger’s 12 million people are directly affectedby the crisis.

UN agencies have launched a series of appeals for interna-tional donations totaling $57.6 million. While the initialresponse to the call for aid was slow, donations and assistancenow are arriving more rapidly because of the intense mediaattention given to the issue.

Disaster relief is the responsibility of the whole interna-tional community, especially the UN agencies, the WorldBank, and nongovernmental organizations. The IMF also isplaying a role—working closely with international donors tomobilize additional resources to address the food shortagesand assist long-term development. In addition, the IMF is inclose consultation with the Nigerien authorities on a range of related issues. The IMF has encouraged the government to take every possible step to deal with the immediate needs,fully supporting all government spending aimed at address-ing the food crisis and alleviating the effects of the drought.

In addition, the IMF has signaled that it is prepared toincrease Niger’s access to IMF financing if grant aid provesto be insufficient. An IMF mission is expected to visit Nigerlater this month to assess recent developments and to assistthe government in its efforts to address the food crisis.

Toward debt and poverty reduction

The food crisis is occurring in a country that already facesmany economic difficulties. One of the poorest countries in Africa, Niger has been working hard in recent years toaddress the needs of its population. Over the past five years,Niger has made significant progress in restoring macroeco-nomic stability and liberalizing its economy. In recognition of those efforts, the international community agreed to pro-vide substantial debt relief when Niger reached the comple-tion point under the Heavily Indebted Poor CountriesInitiative in April 2004.

IMF policy advice to Niger draws largely on a PovertyReduction Strategy (PRS) outlined by the Nigerien authori-ties in 2002 after consultation with the country’s civil society.The PRS identifies priorities that are regarded as critical forstrengthening economic growth and reducing poverty. Inparticular, it focuses on increasing spending on human capi-tal, with an emphasis on access by vulnerable groups to basic

social services, and on agricultural development. Niger’s PRSalso underscores the need to preserve fiscal sustainability.Efforts are aimed at strengthening revenue mobilization,improving public expenditure management, and ensuringthat maximum government spending is directed toward pro-poor and pro-growth projects.

Since 2000, IMF financial support to Niger under thePoverty Reduction and Growth Facility (PRGF) has totaled$88 million. The IMF has also provided extensive technicalassistance, especially in the area of fiscal management. TheIMF-supported program mirrors the PRS’s focus on agricul-ture by stressing the need for Niger to deal with the effects of unfavorable weather through the introduction of muchneeded irrigation systems. The authorities have been urged toexpand their domestic revenue base and seek increased donorsupport. Notwithstanding relatively large donor financialassistance so far, it is recognized that Niger needs additionalresources to make adequate progress toward the MillenniumDevelopment Goals, which target a halving of key povertyindicators by 2015.

Briefing the press on August 3, Thomas C. Dawson,Director of the IMF External Relations Department, said thatas important as the long-term development issues are, thekey challenge at this stage for the international community isto provide “all possible assistance as quickly as possible” torelieve the food crisis. And that, he added, “is what we intendto do.”

IMF joins the Niger relief effort

Donations and assistance are now beginning to reach Niger, which has seenmore than one-fifth of its population affected by a severe food shortage.

Martin Specht/W

FP

Survey15_REV.qxd 8/12/05 12:24 PM Page 235

236 IMF SURVEY

In the news

During a visit to Mozambique, July 24–27, IMF DeputyManaging Director Takatoshi Kato lauded the work of Centrode Investigação em Saúde de Manhiça, a health research institutethat, he said, is providing groundbreaking research on theregion’s most critical diseases and help-ing improve health conditions inMozambique. Kato told reporters thatthe IMF is very concerned aboutendemic diseases, such as malaria,HIV/AIDS, and tuberculosis, whichhave had a serious negative effect onAfrican economies.

In meetings with President ArmandoGuebuza, Prime Minister Luisa Diogo,and other senior officials, Kato congrat-ulated the country on its impressiveprogress in recent years, noting thatsound macroeconomic policies hadprovided a solid underpinning for theeconomy’s growth at an annual average8 percent—a rate “well above its regional peers”—and declininginflation rates. To sustain this performance, he added,Mozambique needs to strengthen its revenue performance andpursue second-generation reforms focused on strengtheninginstitutions and removing obstacles to private sector activity, sothat the country can make a lasting reduction in poverty andachieve the Millennium Development Goals.

On the second leg of his trip, Kato met with Zambia’sPresident Levy Mwanawasa, Finance Minister Ng’anduMagande, other senior officials, and members of the donor andbusiness communities, parliament, and civil society. He praised

the country’s “remarkable progress”in recent years and underscored theFund’s “strong support for the overallthrust and direction of the policiesbeing pursued”—particularly theemphasis given to addressing socialneeds and improving conditions forinvestment and growth.

Looking ahead, Kato stressed theneed to keep public spending undercontrol, particularly during theremainder of 2005 and 2006, to sustainmacroeconomic stability. He alsopointed to the need to advance reformsto create an enabling environment forprivate sector development, including

by strengthening public expenditure management and financialaccountability, financial sector reform, and governance.

Kato highlights progress in Mozambique, Zambia

A staff member of the Manhiça center briefsIMF Deputy Managing Director Takatoshi Kato (left).

Joaquim Carlos Vieira for the IM

F

IMF’s Executive Directors reiterated their commitment to fur-ther debt relief as part of the “international support for low-income countries, including its poorest and most heavilyindebted members,” IMF Managing Director Rodrigo de Ratosaid on August 3. De Rato noted that the Directors had empha-sized that the Group of Eight (G-8) proposal to cancel debtowed by the Heavily Indebted Poor Countries (HIPCs) “couldgo a long way to complete the process of debt relief for thesecountries by providing additional balance of payments supportfrom the Fund,” and this could, in turn, free up countryresources to pursue the Millennium Development Goals.

In their discussion, the Directors stressed that to provideeffective benefits to its recipients, debt relief must be designedand implemented carefully. There was a clear consensus amongthe Directors, de Rato said, on the importance of preservingthe Fund’s ability to provide concessional financial support toits low-income members and preserving the IMF’s principle ofuniformity of treatment for all low-income member countries.

Going forward, the IMF’s staff will work on “potential modali-ties to implement the G-8 proposal as a basis for further dis-cussions” by the IMF’s Executive Board before the IMF–WorldBank Annual Meetings on September 24–25.

The August 3 discussion provided Directors with the oppor-tunity to explore in greater detail the financial, legal, and policyimplications of the G-8 proposal for the Fund. This recent dis-cussion also complemented the IMF’s ongoing efforts to findways to enhance its role in low-income countries—includingthrough such proposals as a nonfinancial mechanism to sup-port policies in low-income countries and the establishment ofa financing facility to help countries facing exogenous shocks.The Board is also considering the continued financing for theconcessional lending provided under the IMF’s PovertyReduction and Growth Facility.

IMF Executive Board reiterates commitment to further debt relief

The full text of Takatoshi Kato’s concluding remarks in Mozambiqueand Zambia are available on the IMF’s website (www.imf.org).

The full text of IMF Managing Director Rodrigo de Rato’s statement isavailable on the IMF’s website (www.imf.org).

Survey15_REV.qxd 8/12/05 12:24 PM Page 236

237August 15, 2005

U.S. locomotive: on track, but some curves ahead

T he U.S. economy has proved resilient in the face ofsharply higher energy costs, with its expansion and lowinterest rates providing a substantial boost to the world

economy at a time of significant global slack. As the IMF’sExecutive Board recently noted, this strong short-term growthoutlook leaves the United States well positioned to begin toaddress some longer-term concerns, including a historicallylow national saving rate and the severe underfunding of itsMedicare and Social Security systems.

As recent indicators suggest, the U.S. economic expansionremains on track. While the economy slowed somewhat inrecent quarters, growth continues to be above potential andseems set to speed up in the second half of the year. Householdspending has been robust, fueled by rising asset prices, lowinterest rates, income growth, and steady improvements inemployment. Growth remains broad-based, with a rebound ininvestment supported by low interest rates and strong corpo-rate profits. There are also few signs of overheating in the labormarket, despite an unemployment rate of only 5 percent.Inflation, too, remains contained, although in recent monthshigher energy prices have pushed headline consumer priceinflation to 2!/2 percent.

The global economy is likely to continue to benefit from theU.S. momentum. Net U.S. imports are estimated to haveincreased growth in the rest of the world by about !/4 percent-age point a year since 2001. Favorable financial conditions inthe United States have also helped to compress risk premiumson interest rates, lower interest rate spreads, and support activ-ity across a wide range of emerging markets.

Unusual financial flows

The expansion has, however, been marked by a relativelyunusual—and likely unsustainable—set of domestic and exter-nal imbalances that is characterized by:

• An unprecedented external current account deficit. Withthe U.S. economy outperforming most of its trading partnersin recent years, the external current account deficit haswidened to an unprecedented 6!/2 percent of GDP, comparedto an average of around 2 percent of GDP over the past twodecades. Despite the dollar’s depreciation in recent years,import demand has remained strong, with higher oil pricesalso contributing to the trade gap.

• Massive foreign capital inflows. The counterpart of thehigh current account deficit has been massive foreign capitalinflows, with U.S. net international liabilities estimated to haverisen to over 20 percent of GDP—an unusually high level forlarge industrial countries.

• Record net lending by the corporate sector. Businesseshave used high profits to strengthen balance sheets. This, alongwith large foreign inflows, has contributed to low long-terminterest rates.

• Significant public sector borrowing. Tax cuts and govern-ment expenditure increases have turned the public sector intoa significant borrower in recent years, with the federal gov-ernment budget recording a 3!/2 percent of GDP deficit inFY 2004. Buoyant revenue growth, however, is likely to reducethe deficit appreciably over the medium term.

• Low household saving. The U.S. household saving rate hasrecently fallen to zero—a record low. Although partly reflectinga boost from strong asset markets (which tend to reduce the

Country focus

–5

–4

–3

–2

–1

0

1

2

3

042000969288841980

High corporate net lending . . .

–7

–6

–5

–4

–3

–2

–1

0

1

2

042000969288841980

and a widening current account deficit . . .

042000969288841980–6

–5

–4

–3

–2

–1

0

1

2

3

have financed large federal fiscal deficits . . .

0420009692888419800

2

4

6

8

10

12

14

and low household saving.

Unusual flows (percent of GDP)

Data: U.S. Bureau of Economic Analysis and U.S. Federal Reserve Board of Governors.

Survey15_REV.qxd 8/12/05 12:24 PM Page 237

incentive to save out of personal income), such a low savingrate is inconsistent with current levels of household incomeand wealth.

As a result, the U.S. economy is in the unusual situation ofhaving foreign savings and domestic corporate profits financ-ing a still-large government deficit and strong household con-sumption (see chart, previous page). The U.S. economy is,nevertheless, well positioned to sustain its strong performancein the next few years, underpinned by productivity growth,which—despite having eased somewhat as the recoverymatured—remains above longer-term trends. Barring shocks,growth is projected to be around 3!/2 percent in 2005 and 2006.This is slightly above potential and should allow for somerebalancing of domestic financial flows. The current accountdeficit, however, is projected to remain around 6 percent ofGDP, as growing foreign debt and higher interest rates increas-ingly weigh on the income balance.

On the policy side, the focus appropriately remains on theremoval of stimulus. The U.S. Federal Reserve, which cut the fed-eral funds rate aggressively over the downturn, reversed course asdeflation risks receded. Since mid-2004, it has raised the rate by acumulative 2!/4 percentage points, and markets expect furthercuts in the coming months. For its part, the U.S. Administrationhas made headway toward its commitment to reducing the

budget deficit to below 2 percent of GDP by FY 2009 throughrigorous spending restraint, and to making earlier tax cuts per-manent. Moreover, an advisory panel to the President is workingon proposals to streamline the tax system and strengthen incen-tives to boost private saving and investment.

Conditions in the financial sector remain conducive to eco-nomic growth. Equity prices have risen, long-term interestrates remain low, banks are well capitalized and highly prof-itable, and indicators of credit quality remain strong. Not-withstanding strong house price increases in many regions,securitization of mortgage debt has limited systemic financialsector risks by allowing significant diversification of real estateexposures (see box, below). That said, however, the robust

238 IMF SURVEY

Solid growth projectedThe U.S. growth momentum is expected to carry over into 2006, with thecurrent account deficit stabilizing around its current level.

2005 20062002 2003 2004 Projections

(growth in percent)Real GDP 1.9 3.0 4.4 3.5 3.6Household consumption 3.1 3.3 3.8 3.7 3.4Unemployment rate (percent) 5.8 6.0 5.5 5.2 5.2

(percent of GDP)Federal government deficit –2.4 –3.3 –3.3 –3.0 –2.8Current account balance –4.5 –4.8 –5.7 –6.2 –6.1Data: IMF Country Report No. 05/257.

The U.S. housing market has boomed in recent years, with real

estate prices in many regions rising considerably faster than per-

sonal incomes and rents. In 2005, increasing signs of speculative

activity—including more widespread purchases of second homes

and an uptick in the use of interest-only and other mortgage loans

that defer principal repayment—have concerned regulators and

fueled a debate over whether the market may be subject to a cor-

rection in the near future.

To better understand the attendant macroeconomic risks, IMF

staff examined how changes in the structure of mortgage finance

have affected the real estate market. It found that the shift from bank

to market financing—particularly the development of a national

securitized market for mortgages—has helped spread risk and may

also help reduce the amplitude of boom-bust financing cycles, thus

lowering the volatility of both real housing activity and prices.

What’s changed

Until the late 1980s, mortgage lending was mainly a local business,

and most mortgages were kept on the balance sheets of local

depositories for the lifetime of the loan. The availability of mort-

gage credit depended on local financial conditions, including the

level of deposits and capital at local banks and thrifts. In the after-

math of the savings and loan crisis in the 1980s, however, the U.S.

mortgage market saw a dramatic shift from local to nationwide

funding through mortgage securitization. This loosened the link

between depository balance sheets and mortgage flows, and

reduced the extent of stop-and-go credit cycles.

Changes in the structure of the mortgage market have also co-

incided with sharply lower volatility in real housing activity (see

chart, next page). Residential investment spending exhibited pro-

nounced cycles prior to the 1990s, with growth rates of 40 percent

or more during booms, and similar declines during busts. This

cyclical volatility has now diminished markedly, with housing

activity growing at a more stable pace.

Housing fundamentals

Housing prices have shown a similar convergence toward moresteady growth over this period, helped by securitization and lessvolatile lending conditions. With mortgage lending subject to (partlyregional) boom-bust financing cycles prior to the 1980s, even quali-fied home buyers were at times unable to obtain financing. This mayhave induced households to pay a premium over a home’s funda-

Has mortgage securitization stabilized U.S. housing markets?

Country focus

Survey15_REV.qxd 8/12/05 12:24 PM Page 238

mental value during periods of easyfinancing, and vice versa. The shift inmortgage financing to a securitizednational market has reduced thevolatility of credit flows, lowering theincentive for such “over” and “under”payments, and possibly reducingswings in house prices.

Empirical evidence supports thishypothesis. The link between funda-mentals—such as interest rates,income, and unemployment—andhousing prices appears to have becometighter after the mid-1980s, with fun-damentals accounting for a largershare of variation in housing prices inthe 1990–2004 period than before. Theunexplained portion of house price developments (“pricing errors”)has also tended to shrink in the later period, suggesting the reductionwas associated with mortgage market securitization rather than withan overall reduction in macroeconomic volatility.

This analysis should help allay some concerns about the housingmarket’s future. It suggests, first, that current pricing errors are not

particularly large and that ris-ing incomes, employment,and low interest rates stillexplain much of the recentgains in housing prices.Second, recent above-trendgrowth in the real estate mar-ket follows a decade of nega-tive surprises, especially onthe coasts. This may meanthat recent housing pricegains partly reflect a catch-upof prices relative tofundamentals.

239August 15, 2005

Before the 1990s, real residential investment in the United States was highly volatile, with booms and busts of 30 percent and more.

Data: U.S. Bureau of Economic Analysis.

-40

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2004199819911985197919731966196019541948

This article is based on IMF Country Report No. 05/258, United States:Selected Issues. Copies of the report are $15.00 each and can be ordered fromIMF Publication Services. See page 248 for ordering information. The fulltext is also available on the IMF’s website (www.imf.org).

housing market recently prompted financial regulators totighten oversight of home equity and other residential loans.

Challenges ahead

The IMF’s Executive Board saw broadly favorable prospects forthe U.S. economy (see table, previous page). It noted some risks,citing continued higher oil prices (which could begin weighingmore heavily on domestic demand) and an external currentaccount deficit that is expected to remain large well into themedium term.

With slightly above-potential growth slowly eroding eco-nomic slack and real interest rates at low levels, Directors viewedthe Federal Reserve’s gradual removal of monetary stimulus aseffective and appropriately balanced for achieving the twin goalsof price stability and growth. They also noted that a key elementof the strategy’s success has been the combination of interestrate hikes with clear messages that more forceful action wouldbe required if price pressures continued to intensify.

The Board welcomed the U.S. authorities’ commitment to fis-cal deficit reduction, as well as recent revenue-driven improve-ments in the budget outlook. Most Directors argued that thepresent cyclical strength of the U.S. economy provided an auspi-cious opportunity to accelerate the pace of fiscal consolidation,which is still critically important given the impending pressures

on entitlement programs as the baby boom generation begins toretire. In this context, most Directors felt that options for rev-enue enhancements—including a broadening of the income taxbase or consumption or energy taxes—should be explored,given the strict spending discipline already assumed in U.S.budget projections.

Fiscal consolidation would also help raise national saving—a U.S. Administration priority and a concern for the IMF Execu-tive Board, which viewed the extremely low saving rate as a keypolicy challenge going forward. Directors stressed that comple-mentary efforts were needed in other parts of the world toimplement the agreed strategy for reducing global imbalances.

Directors continued to emphasize the need to address thesevere underfunding of major entitlement programs, whichwould be key to restoring long-term fiscal sustainability. Withpublic health care spending projected to triple as a ratio to GDPin coming decades, they called for further steps to improve theefficiency of the overall health care system. Directors also wel-comed the Administration’s recent support for specific measuresto place the Social Security system on a sustainable basis, stress-ing that delays in legislative action would only increase theadjustments that will eventually be needed.

Kornélia Krajnyák and Martin MühleisenIMF Western Hemisphere Department

Calvin SchnureIMF Western Hemisphere Department

Survey15_REV.qxd 8/12/05 12:24 PM Page 239

Situated at the heart of the European continent, Austriabenefits from access to diverse markets, both matureand emerging. Historically, Austria’s strong economic

ties to Germany have provided a relatively stable growth pathand a buffer against external shocks. Signs are emerging,however, that the Austrian economy is gradually becomingless dependent on Germany than before, while its links withthe faster-growing economies of the Central and EasternEuropean countries are strengthening.

Austria’s economic outlook is increasingly affected by itschanging international economic and financial relationships.In particular, its growing economic and financial links withCentral and Eastern Europe have helped diversify the econ-omy and, recently, cushion it from relatively less favorabledevelopments in Western Europe and Germany in particular.Indeed, among the Euro-pean Union (EU)-15 coun-tries, Austria is likely to havebenefited most from Centraland Eastern Europe’s transi-tion to market economiesand the subsequent entryinto the EU of 10 newmember states.

Austria’s early focus onbuilding economic andfinancial relationships withCentral and Eastern Europe,including through the bank-ing, industry, and transportsectors, is now bearing fruit;it has increased its exposureto a relatively fast-growingarea in Europe, while reducing its dependence on traditionaltrade partners. This diversification of the economy is likelyto bolster both future economic growth and stability.

The Austrian-German connection

Austria’s output growth rates averaged 2.2 percent annually overthe past 10 years, in line with average growth rates in the euroarea (see chart, this page). But, in recent years, Austria’s real GDPhas outperformed its euro area counterparts. Between 2002 and2004, Austria’s real GDP rose, on average, by 1.6 percent a year,compared with growth rates of 0.6 percent in Germany and1.2 percent in the euro area.

For decades, developments in the Austrian economy havebeen closely associated with economic conditions in Germany,particularly on the trade side. Austria had much to gain fromits close proximity to a large, prosperous economy. Over thepast 20 years, Austria’s exports to Germany more than tripledin constant U.S. dollar terms, accounting for just under13 percent of Austria’s GDP in 2004—roughly double the ratein the early 1980s. Today, Germany remains Austria’s largesttrading partner by far, responsible for about 31 percent ofAustria’s total exports.

Austria continues to enjoy increased exports to Germanyas a percent of Austria’s GDP, but with greater diversificationof Austria’s trade patterns, the intensity of trade withGermany has diminished. The share of Austria’s total exportsgoing to Germany has been trending downward steadilysince the early 1990s. In terms of total trade intensity

(exports and imports),Austria’s trade withGermany has also beentrending lower, even thoughthe share of imports fromGermany has remained rela-tively stable.

Less synchronization

German and Austrian busi-ness cycles also appear to be less synchronized thanthey once were. Estimates ofthe degree of comovementamong key Austrian macro-economic aggregates and theGerman economy suggestssome decline in correlation

of growth rates between the two economies. For example,the correlation between Austrian and German real GDPgrowth, calculated over a 10-year rolling window, has fallenin recent years, albeit moderately.

More revealing is the pronounced downward shift, sincethe late 1990s (see chart, next page), in the 10-year rollingcorrelation between the growth rates of Austria’s real GDPand Germany’s domestic demand. This development reflectsthe divergence in recent years between the growth rates of theAustrian economy, which averaged 1.6 percent between 2002and 2004, and German domestic demand, which contractedin each of those three years.

240 IMF SURVEY

Austria looks eastward

Country focus

0.0

0.5

1.0

1.5

2.0

2.5

2002–20041995–2004

Euro areaGermanyAustria

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Looking eastward

Austria’s economic performance is increasingly influenced byits growing economic and financial links with Central andEastern Europe, which have provided it with important newmarkets. Austrian foreign direct investment (FDI) in theregion has also played an important role in the integrationprocess, having risen significantly over the past decade andreaching close to €16 billion on a cumulative basis. On anannual basis, Austrian FDI in Central and Eastern Europe hasrisen to about 2 percent of Austrian GDP.

The role of Austrian FDI has been particularly crucial inthe financial sector. Austrian banks’ market share in Centraland Eastern Europe, based on total assets, has reachedapproximately 20 percent, and in several countries this shareis appreciably larger. Furthermore, in 2004, the three largestAustrian banks derived more than 40 percent of their pretaxearnings from operations in the region.

Austria’s stronger ties to Central and Eastern Europeappear to have coincided with reduced dependency onGerman economic conditions. On the trade side, Germany’smarket share of Austrian exports fell from nearly 40 percentin 1992 to about 32 percent in 2004. Conversely, Central andEastern Europe saw its market share of Austrian exportsroughly double to about 15 percent (see chart, right).Moreover, while comovement indicators between Austria andGermany have weakened, the correlation of macroeconomicaggregates between Austria and key Eastern European

economies (particularly Hungary, Austria’s largest tradingpartner among the Central and European countries) appearsto show a steady increase in business cycle synchronization inrecent years.

Austria’s success in sustaining positive growth rates, espe-cially at a time when German domestic demand is contract-ing, is testament to the resiliency and flexibility of theAustrian economy and its ability to reorient itself to areaswhere potential growth rates are higher. Austrian companieshave been looking not only to Central and Eastern Europebut more recently to Southeastern Europe to diversify theirtrade and investment opportunities.

That said, it is too early to say whether this process is tem-porary or reflects a more permanent structural shift. Oncethe transition economies have matured and become less of amagnet for new investment and export markets, Austria’strade intensity may well shift back in the direction ofGermany and other Western European economies.

Natan EpsteinIMF European Department

241August 15, 2005

This article is based on IMF Country Report No. 05/249, Austria: SelectedIssues. Copies are available for $15.00 each from IMF PublicationServices. Please see page 248 for ordering details. The full text is alsoavailable on the IMF’s website (www.imf.org).

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

Austrian GDP—German domestic demand

Austrian GDP—German GDP

200320011999199719951993

Note: The group of Central and Eastern European countries included here are Bulgaria, Croatia, the Czech Republic, Hungary, Poland, Romania, the Slovak Republic, and Slovenia, representing the bulk of Austria’s trade and investment links with the region.Data: IMF, Direction of Trade Statistics.

Exports to Central and Eastern Europe

3030

3535

4040

4545

Exports to Germany

040402022000200098989696949419921992555

101010

151515

202020

Exports to Central p

C lEastern Europes to Ce tral and Eastern Europee

040402022000200098989696949419921992

While Germany’s share of Austria’s exports has dropped by nearly 8 percentage points, Central and Eastern Europe’s share has nearly doubled.

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242 IMF SURVEY

P olicymakers trying to attract foreign direct investment(FDI) to their countries often have exaggerated expec-tations of what their efforts can accomplish. A recent

IMF Working Paper confirms that factors outside the reach ofpolicymakers are at least as important as policies. But policiesdo matter, and the paper discusses what influences FDI andwhat does not. It also argues that above a certain level of for-eign investment, some policies lose significance while othersbecome more important. By estimating “potential FDI” andcontrasting this with actual levels of FDI, the paper tries togive authorities a more realistic expectation of what the rightpolicies can achieve.

The benefits of FDI for a host country have long been rec-ognized: knowledge and technology transfer, productivityspillovers, enhanced competition, and improved access forexports abroad, notably in the source country. But FDI canhave negative aspects, too. Largeforeign companies often try tocoax concessions from host coun-try governments, and sometimesabuse their dominant marketposition or use transfer pricing tominimize their tax obligations.On balance, however, the consen-sus is that the benefits of foreigninvestment tend to outweigh itscosts, especially in transitioneconomies that have extensiverestructuring and modernizationneeds and limited domestic capitaland other resources.

Southeastern Europe lagging

The decidedly mixed experience ofthe European transition economies provides an interesting casestudy (see chart, this page). Some Central European countries,like Hungary and the Czech Republic, have been very successfulin attracting foreign investment, accumulating a stock of FDIper capita of $4,000–$4,500 by the end of 2003. Others, notablythe countries of Southeastern Europe (Albania, Bosnia andHerzegovina, Croatia, the former Yugoslav Republic ofMacedonia (FYR of Macedonia), Serbia and Montenegro,Bulgaria, and Romania) have been much less successful, withsome barely reaching the level of $500 of FDI per capita. Andthe gap between Central and Southeastern European countries

is persistent and significant whether FDI is measured inabsolute dollar terms or in per capita terms.

What explains FDI patterns in Southeastern European coun-tries—a region largely absent from the existing literature—andhow can policies help? To examine this, the study assembled adatabase with bilateral FDI stocks and flows between 15 hostcountries (all of Central, Eastern, and Southeastern Europe plusthe Baltics) and 24 source countries (the EU-15—the EuropeanUnion’s pre-expansion members—plus Croatia, Cyprus, theCzech Republic, Hungary, Poland, Russia, Slovenia, Switzerland,and the United States). Advanced economies of Central andEastern Europe that received FDI in the 1990s and more recentlyhave been sources of foreign investment appear in both groups.

The force of gravity

All previous empirical studies have found that gravity factors(size of the host country market and proximity to the source

country) are the most importantdeterminants of FDI. This studyuses population—either alone or inconjunction with GDP per capita—as a proxy for market size, the dis-tance between source and hostcapitals as a measure of geographicproximity, and a dummy capturingcultural or historical ties betweensource and host country as a proxyfor “cultural proximity.” Its findingsconfirm that gravity factors explainabout 60 percent of FDI flowsbetween countries—a soberingfinding for policymakers eager tomake their countries more attractiveto foreign investors. Factors thatthey cannot influence, such as coun-

try size, location, and history, explain over half of the variationin foreign investment.

Do policies matter, then?

But there are steps that policymakers can take to improve theircountries’ chances of attracting FDI. The study finds that highunit labor costs, high corporate tax burdens, and, to a lesserextent, high import tariffs discourage foreign investment,whereas liberal foreign exchange and trade regimes and publicsector infrastructure reforms, including deregulation to improvecompetitiveness, stimulate it. In contrast, tax holidays and

Southeastern Europe: attracting foreign direct investment

Regional focus

0

1

2

3

4

5

MDABIHALBSCGMKDROMBGR

POL

SVK

EST, LAT, LTUSVN

HRV

CZEHUN FDI stock per capita, 2003

Survey15_REV.qxd 8/12/05 12:24 PM Page 242

domestic corruption do not seem to have a statistically signifi-cant impact. The results concerning institutional variables,however, should be interpreted with caution, because the indi-cators used as proxies are not always accurate.

Taken together, these results provide a basis for evaluatingthe policies aimed at attracting foreign investors and highlightthe limits of what these policies can achieve. Take, for exam-ple, the emphasis placed by international financial institutionsand policymakers in Southeastern Europe and elsewhere onliberalizing the trade and foreign exchange regime and con-trolling labor costs. The findings suggest that these policies areindeed likely to have a direct impact on FDI. On the otherhand, efforts to improve gover-nance and combat corruption—their broader economic benefitsnotwithstanding—may not have amajor direct impact on FDI. Ofcourse, they could still stimulateforeign investment, indeed allinvestment, indirectly through theirpositive effects on the economy.

Identifying the policies that aremost effective in attracting foreigninvestment in a large sample ofcountries is only half the story. Theeffect that policies have on FDI isdependent upon individual coun-try circumstances. Using a quanti-tative technique that tests for“threshold effects,” the study finds that policies have differenteffects once FDI increases beyond a level of around 12 percentof GDP (excluding privatization receipts), roughly that inPoland in 2003 (see chart, this page). When FDI is below thatlevel, gravity variables and labor costs are the predominantdeterminants of foreign investment. As FDI rises above thatlevel, however, the importance of these factors declines, andthe host country’s level of income and broader institutionalfactors increase in importance.

This suggests that the nature of foreign investment changesas the host country attracts more of it. The initial wave of for-eign investors is attracted primarily by market size, ease ofaccess, and low labor costs. But once a “critical mass” of foreigninvestment is reached, a new kind of investor appears, drawnmore by the level of development, the quality of the businessenvironment, and the prosperity of the host country.

What the right policies can accomplish

Even if policymakers know exactly which levers to pull toattract FDI, there is a limit to the discretion they have. Tax or

tariff rates cannot be driven to zero, even if this were beneficial.In the real world, policymakers often look over each other’sshoulders and use the policies of their most successful neigh-bors and competitors as a benchmark.

To estimate the impact that policies can have on FDI, thestudy distinguishes between exogenous variables—the gravityfactors—and endogenous variables that are under the policy-makers’ control. It defines a “potential” level of FDI for eachcountry using the actual values of exogenous variables (size,location, and cultural links to source countries) and the bestvalues of the policy variables across the entire sample ofcountries. In other words, it identifies the highest value of

the foreign exchange and trade liberalization and infrastructurereform indices, and the lowest unitlabor cost, tariff level, and corpo-rate tax burden across the coun-tries in Central and SoutheasternEurope in 2003. The gap betweenactual FDI and this “potential”measures how much each countrystands to gain from getting itspolicies right.

The comparison between“potential” and actual nonprivati-zation FDI at the end of 2003shows that Bosnia and Herze-govina, Albania, the FYR ofMacedonia, Croatia, and Serbia

and Montenegro have the most to gain from getting theirpolicies right. That margin is smaller for Romania andBulgaria, which have already attracted considerable FDI.

This concept of “potential” FDI should, of course, be seen asa benchmark, not a ceiling. Using the best values of the policyvariables across the sample does not mean that “better” valuesare not possible. But this approach can give policymakers anidea of the amount of FDI that could realistically be expectedif each country emulated its most successful neighbors. Tocontinue attracting sizable FDI inflows, countries that arecloser to their “potential” should strive to go beyond the policynorms prevailing in the region.

Dimitri G. DemekasIMF European Department

243August 15, 2005

0

10

20

30

40 HUN

HRVEST, LVA, LTU

CZE

ALBROMBIH

MKDPOLBGRSVK

SVNSCG

Nonprivatization FDI, 2003against estimated threshold

Estimated threshold

This article is based on the work of Balázs Horváth, Elina Ribakova, andYi Wu, who, with Dimitri Demekas, authored IMF Working PaperNo. 05/110, Foreign Direct Investment in Southeastern Europe: How (andHow Much) Can Policies Help? Copies are available for $15.00 from IMFPublication Services. See page 248 for ordering details. The full text isalso available on the IMF website (www.imf.org).

Survey15_REV.qxd 8/12/05 12:24 PM Page 243

In 2000–02, the IMF conducted a major review of the condi-tions it attaches to its lending—its conditionality—andreplaced guidelines dating back as far as 1979. The new policy

chiefly stems from concerns that there had been a large expan-sion of structural conditionality in the 1990s and that disap-pointing implementation suggested relatively weak ownershipof IMF-supported programs by national authorities. Newguidelines highlight the need for greater focus and streamlin-ing, but has there been real progress? In many areas, yes, saysTessa van der Willigen (IMF Policy Development and ReviewDepartment). She summarizes here the findings of a recentIMF evaluation on the application of the new guidelines.

Conditionality remains a subject of controversy and debate.Some argue that conditions should be done away with alto-gether, but from the IMF’s point of view conditionality is notoptional. The IMF must be sure that its resources are supportingpolicies that help countries resolve their balance of paymentsdifficulties and allow them to repay loans so that these resourcescan, in turn, be used by other countries. Conditionality also clar-ifies the terms on which future installments of IMF loans will beavailable, thus giving countries the confidence to embark onprograms that could not be sustained without such support.

Of course, that conditionality is here to stay does not meanthat it is, or has been, perfect. The new policy is the culmina-tion of a long process of internal and external discussion thatled the IMF to embark on streamlining. These efforts actuallybegan in 2000, even before the new policy was formally inplace, and in March 2005, the IMF’s Executive Board assessedhow much progress had been made.

The 2002 guidelines are based on five key principles:national ownership of policy programs; parsimony and clarityin the application of conditions; tailoring of policies to circum-stances; and coordination with other multilateral institutions.These principles are intended to reinforce each other andimprove program design and implementation. The guidelinesdepart from earlier practice primarily in that they call forstreamlining structural conditionality and formulating pro-grams in a way conducive to national ownership of policies.These issues were the focus of the recent review. Ultimately, thenew guidelines will be judged successful if they contribute toimproved economic outcomes, but it is too early to gaugewhether this has been the case. This review sought instead toserve as an interim checkpoint, focusing on whether the guide-lines are being implemented, and how that implementationcan be improved.

What’s being covered?

If structural conditionality is becoming more focused on thosemeasures critical to program success, it should become moreconcentrated in especially relevant areas and it should be morestrongly linked to the country’s initial economic conditions.This is exactly what the review found has happened. Structuralconditionality has shifted out of “noncore” areas and into “core”areas that are likely to be most closely linked to the goals ofFund-supported programs. Specifically, structural conditional-ity has become more concentrated in areas related to economicmanagement and vulnerability, and less dispersed across sec-tors. Moreover, econometric evidence suggests that the linkbetween the numbers of conditions in a particular area (such asfiscal management) and economic circumstances (for example,the level of the fiscal deficit) has become stronger, suggesting asharper focus on priorities.

At the same time, the 2005 review points to some scope forfurther streamlining coverage. First, in examining staff reportson IMF loans, the review found that program strategies forthose areas of action considered crucial are not always set outclearly. While this could be only a presentational issue, there isno doubt that focusing on a few key strategies in the process ofdeveloping a policy program is conducive to parsimonious con-ditionality. Second, greater care needs to be taken to set “struc-tural benchmarks” in only critical areas. These differ from“structural performance criteria” in that disbursements of loaninstallments are not automatically interrupted if benchmarksare not observed. This makes it tempting to use benchmarks forless-than-critical measures when, in truth, they should be usedfor small steps in a critical process of reform, where a failure ordelay in implementation of one step is not sufficient to derailthe entire process.

Of course, streamlining the coverage of structural condition-ality is not without risks. Clearly, conditionality has shiftedaway from growth- and efficiency-related reforms—even inlow-income countries, where a focus on growth is especiallyneeded. And World Bank conditionality does not appear tohave stepped in to fill this “gap.”

Is this something to worry about? Not necessarily, as coun-try ownership, rather than conditionality, ultimately drivespolicy agendas forward. Gaps in analytical work, policyadvice, or technical assistance would thus arguably be moreworrisome. Still, the issue clearly deserves to be kept underreview and assessed in more depth once the outcomes of“streamlined” programs are known.

244 IMF SURVEY

PolicyHas IMF conditionality really been streamlined?

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Numbers and clarity

Intuitively, streamlining could be expected to produce fewerstructural conditions. In fact, there has been only a small declinein the number of conditions associated with Poverty Reductionand Growth Facility loans and none at all with regard to non-concessional loans. This is disappointing, but it is also necessaryto recognize that numbers are a crude metric; indeed, some-times a clearer focus on what is critical may bring with it a needfor more conditions rather than fewer.

In fact, in the IMF’s nonconcessional lending there has been alarge increase in conditions related to financial sector vulnerabil-ity, reflecting the growing understanding of the importance ofthis area. Other factors may also keep the numbers of conditionshigh, including detailed specification of conditions and a ten-dency to set more conditions when countrieshave weak track records. Both tendencies are inaccordance with the guidelines—and indeedsome borrowing countries prefer conditions set ata high level of detail, as they function as helpfulguideposts—but they should not be allowed toget out of hand.

The recent record is unambiguously positiveon the clarity of conditions. The 1990s had seenboundaries blurred between measures critical fordisbursements to continue and others thatmerely signaled IMF encouragement or theauthorities’ commitment. Five years into thestreamlining initiative, program-related conditions are nowalmost always clearly specified and transparently distinguishedfrom the rest of the authorities’ program.

Program implementation

Although it is too soon to judge whether IMF-supported pro-grams under the new guidelines have contributed to better eco-nomic outcomes, some improvement is evident in programimplementation. Early evidence suggests that programs now suf-fer fewer irremediable interruptions, although temporary inter-ruptions and their counterparts—delays in completing programreviews—have not declined.

At first sight, developments in the implementation of struc-tural performance criteria have been disappointing, althoughlooking below the surface suggests a rather better picture.Performance criteria require waivers if they have not beenimplemented and if disbursements are to proceed. The reviewfound that waiver rates have not fallen (and have even risen innonconcessional loans). Tracking waived performance criteriathrough to the end of the arrangement, however, shows that anincreasing proportion of these criteria is implemented eventu-

ally. This better implementation is in line with a greater focus oncritical conditions, although waivers continue to be used to givethe authorities leeway, in particular with respect to timing ofimplementation. Realistic timetables will be key to reducingwaiver rates, while maximizing the assurance given to a borrow-ing country that it will be able to access IMF resources.

Ownership and process

The 2005 review looked at the process of program developmentin 10 country cases. While the evidence is preliminary—and theIMF Independent Evaluation Office (IEO) upcoming review ofstructural conditionality will go into greater depth—indicationsare that IMF staff are making serious efforts to implementprocesses conducive to ownership: for example, by establishing

an active dialogue with the authorities andaccommodating their preferences where possi-ble, seeking to involve all the key officials respon-sible for implementation, and helping theauthorities work toward broad public ownershipof the policy program.

Of course, good processes do not guaranteeownership and, indeed, gauging the level ofownership is, and will remain, a major challenge.Similarly, whether to proceed with a loan in thepresence of uncertain ownership remains a deli-cate matter of judgment. Certainly, substitutingconditionality for ownership is not the answer.

Conditionality, especially prior actions, can be used as a devicefor governments to demonstrate their commitment. But thereview advises caution. In its findings, programs with manyprior actions tended to have worse implementation of subse-quent conditionality than average, leaving one to wonder aboutthe extent of ownership as a whole and the durability and qual-ity of implementation of even the prior actions. In some of thesecases, rather than loading programs with conditions and prioractions, it may be preferable to exercise greater selectivity and,where possible, make use of staff-monitored programs to estab-lish a track record of implementation.

The IMF will continue its efforts to implement the new pol-icy, guided by the findings of this review and, no doubt, by therecommendations of the forthcoming IEO evaluation of struc-tural conditionality. A new review of the 2002 conditionalityguidelines will be conducted in 2008. By that time data onmultiyear economic outcomes of a number of “streamlined”programs will be available. That will allow the 2008 review toask the key question that eluded this year’s review: have thenew guidelines achieved their objective of helping borrowingcountries reach better outcomes?

245August 15, 2005

Evidence suggests thatprograms now sufferfewer irremediableinterruptions, althoughtemporary interruptions. . . and delays in . . .

program reviews . . .have not declined.

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W hen launched four decades ago to appeal to a selectgroup of wealthy private individuals, the hedge fundindustry went relatively unnoticed by both financial

regulatory authorities and the general public. Much has sincechanged, however. Over $1 trillion in assets are now managedby more than 8,000 hedge funds, which share a fee structurewhereby fund managers retain a portion—typically, 20 per-cent—of profits earned. Many funds today reach ordinaryretail investors, with the minimum investment having fallenfrom an average $1 million to $25,000 and to as low as $2,500for a few funds.

To increase public understanding of hedge funds, theAmerican Enterprise Institute for Public Policy Research(AEI) is sponsoring a series of conferences. The first one,on the role these funds play in capital mar-kets, was held June 26 and featured a panelof practitioners and academics discussingassociated policy issues includingprospects for regulating hedge funds andthe industry’s future direction. AdamLerrick (AEI and Carnegie MellonUniversity) moderated the discussion.

Evolution of hedge funds

How did hedge funds come into being?The first hedge fund was set up in 1949 asa way to use (then) innovative investmentstrategies to seek to minimize risk whileenhancing returns. But as John Makin(Caxton Associates) explained, the industryreally took off in the 1980s as an alternativeto the equity-focused, benchmark-evaluated mutual and pen-sion fund industries. The largest hedge funds emerged aroundmajor traders in volatile markets for commodities, currencies,and fixed-income instruments.

But since 2000, the role of many new hedge funds haschanged radically, Makin said, with increasing numbers ofinvestors viewing them as “a kind of octane additive” to theirpension and mutual fund portfolios. Today’s numerous hedgefunds follow a wide range of investment strategies, with someindistinguishable from mutual funds—although hedge fundsare less stringently regulated.

Moral hazard problems

As with other investment activities, Makin pointed out, amoral hazard problem exists both across the industry and

within hedge funds themselves. He warned that a scenariowhere a number of hedge funds simultaneously pursue a“shoot-for-the-moon” investment strategy could heightensystemic risk, as occurred with the collapse of major hedgefund Long-Term Capital Management (LTCM) in 1998.

Protecting unsophisticated investors

Arguing that LTCM should have been allowed to fail, Makinsaid the “only way” to protect unsophisticated investors is to“show them what happens if they don’t do their homework.”He cautioned against central banks and other authoritiesstepping in to accommodate liquidity needs in these situa-tions because it could encourage some funds to again followoverly aggressive investment strategies.

In contrast, Chester Spatt (U.S.Securities and Exchange Commission)warned that regulation is needed for“issues involving the stability of themarket” and to protect less sophisti-cated investors, particularly since therecent “retailization” of these fundsmeans that newer investors often donot fully understand the risks involved.Some policymakers are also concerned,he added, because investment advisersmay have incentives to substantiallyadd to the risk their hedge funds bear ifthose risks are not fully understood ordetected in the marketplace. Systemicrisk—the possibility of correlateddefaults across the economy—is

another reason why hedge funds have been receivingincreased attention from policymakers, Spatt said, also draw-ing on the example of LTCM’s collapse.

Tanya Beder (Citigroup Alternative Investments) agreedthat there are critical questions about how best to regulatesuch an industry, especially since she expects it to undergosome “massive changes” over the next few years to meet newdemands. Beder took a more benign view of hedge funds,however, arguing that their activities can actually make formore stable markets, as hedge fund arbitrage trading hasbeen known to help “smooth out” volatility during periodsof high market turbulence.

Jacqueline IrvingIMF External Relations Department

246 IMF SURVEY

ForumDemystifying hedge funds

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247August 15, 2005

IMF lendingStand-By, EFF, and PRGF arrangements as of July 31

Date of Expiration Amount UndrawnMember arrangement date approved balance

(million SDRs)

Stand-By

Argentina September 20, 2003 September 19, 2006 8,981.00 4,810.00 Bolivia April 2, 2003 March 31, 2006 171.50 60.00 Bulgaria August 6, 2004 September 5, 2006 100.00 100.00 Colombia May 2, 2005 November 2, 2006 405.00 405.00 Croatia August 4, 2004 April 3, 2006 97.00 97.00 Dominican Republic January 31, 2005 May 31, 2007 437.80 385.26 Paraguay December 15, 2003 September 30, 2005 50.00 50.00 Peru June 9, 2004 August 16, 2006 287.28 287.28 Romania July 7, 2004 July 6, 2006 250.00 250.00 Turkey May 11, 2005 May 10, 2008 6,662.04 6,106.87 Uruguay June 8, 2005 June 7, 2008 766.25 735.60 Total 18,207.87 13,287.01

EFFSri Lanka April 18, 2003 April 17, 2006 144.40 123.73 Serbia and Montenegro May 14, 2002 December 31, 2005 650.00 62.50 Total 794.40 186.23

PRGFAlbania June 21, 2002 November 20, 2005 28.00 4.00 Armenia May 25, 2005 May 24, 2008 23.00 19.72 Bangladesh June 20, 2003 December 31, 2006 400.33 184.55 Burkina Faso June 11, 2003 August 15, 2006 24.08 10.32 Burundi January 23, 2004 January 22, 2007 69.30 35.75 Chad February 16, 2005 February 15, 2008 25.20 21.00 Congo, Democratic Republic of June 12, 2002 October 31, 2005 580.00 53.23Congo, Republic of December 6, 2004 December 5, 2007 54.99 47.13 Dominica December 29, 2003 December 28, 2006 7.69 3.48 Georgia June 4, 2004 June 3, 2007 98.00 70.00 Ghana May 9, 2003 October 31, 2006 184.50 79.10 Guyana September 20, 2002 September 12, 2006 54.55 27.79 Honduras February 27, 2004 February 26, 2007 71.20 40.69 Kenya November 21, 2003 November 20, 2006 225.00 150.00 Kyrgyz Republic March 15, 2005 March 14, 2008 8.88 7.62 Mali June 23, 2004 June 22, 2007 9.33 6.67 Mozambique July 6, 2004 July 5, 2007 11.36 6.50 Nepal November 19, 2003 November 18, 2006 49.91 35.65 Nicaragua December 13, 2002 December 12, 2005 97.50 41.78 Niger January 31, 2005 January 30, 2008 6.58 5.64 Rwanda August 12, 2002 February 11, 2006 4.00 1.14 Senegal April 28, 2003 April 27, 2006 24.27 13.86 Sri Lanka April 18, 2003 April 17, 2006 269.00 230.61 Tajikistan December 11, 2002 February 10, 2006 65.00 9.80 Tanzania August 16, 2003 August 15, 2006 19.60 8.40 Uganda September 13, 2002 December 31, 2005 13.50 4.00 Zambia June 16, 2004 June 15, 2007 220.10 49.52 Total 2,644.86 1,167.96

EFF = Extended Fund Facility.PRGF = Poverty Reduction and Growth Facility.Figures may not add to totals owing to rounding.Data: IMF Finance Department.

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248

Evaluation

T he IMF’s Independent Evaluation Office(IEO) recently outlined its work program forFY 2006. In addition to a study on the IMF’s

structural conditionality that is already under way,it committed to review the following three topics:

Advice on exchange rate policy. While the IMF’sArticles of Agreement clearly obligate membercountries to “avoid manipulating exchange rates”and “follow exchange policies compatible” with anorderly and stable exchange rate system, clear andcandid discussions of exchange rate issues remain a challenge. This partly reflects the market-sensitivenature of these issues as well as the lack of consen-sus about what constitutes a sus-tainable exchange rate under agiven set of conditions. The IEOreview will ask questions on boththe IMF’s policy advice on thechoice of an exchange rate regimein various circumstances and themethodology the organizationuses to assess or identify competi-tiveness, sustainability, and manip-ulation. The evaluation willexamine a representative sampleof developing, emerging market, and industrialcountries in recent years.

The IMF’s role in African countries. Calls for asizable scaling up of aid to African countries haveraised questions about just how that aid is accom-modated in the IMF’s policy advice and programdesign. How does the IMF gauge the sustainabilityof aid-financed fiscal spending, its effects onexchange rates and competitiveness, and the behav-ior of private sector savings and investment? TheIEO will base its evaluation on in-depth case stud-ies of a small number of sub-Saharan Africancountries, with a focus on the IMF’s actual policyadvice and program design inputs, the analyticalbasis for this advice, and the outcomes. Morespecifically, it will address the setting of themedium-term resource envelope, aid predictability,and related issues such as revenue erosion and“Dutch disease” (in which aid inflows makeexports less competitive).

Bilateral surveillance. Surveillance is one of theIMF’s core responsibilities, and its effectiveness hasbeen a top priority for the organization’s Inter-national Monetary and Financial Committee andExecutive Board.

The IEO’s evaluation will ask three questions:What value added does surveillance provide fordomestic policymakers, the international commu-nity, and markets? How are bilateral (country) andmultilateral (global) surveillance—especially forsystemically important countries—integrated, andis there scope for adjusting the modalities so as toimprove impact? And to what extent have the

IMF’s internal biennial reviews of surveillance translated intogreater effectiveness?

The IEO study will draw oncross-country analysis andreviews of surveillance in variouscountry groupings, includingindustrial, emerging market, andlow-income developing. The pre-cise scope of the country analysis,including the emphasis given tocountry groups, will be influenced

by the findings of the earlier evaluation of multi-lateral surveillance.

Next steps

Following IEO practice, detailed issues papers ordraft terms of reference will be prepared for eachproject. Before finalizing the scope of an evalua-tion, the IEO will seek comments from both IMFand external stakeholders, such as academics andcivil society organizations. Final terms of refer-ence will then be posted on the IEO website(http://www.imf.org/external/np/ieo) and inter-ested stakeholders will be invited to submit inputson any aspect of the subjects covered in the termsof reference.

Laura WallaceEditor-in-Chief

Sheila MeehanManaging Editor

Jacqueline IrvingProduction Manager

Christine Ebrahim-zadehConny Lotze

Senior Editor

Camilla AndersenAssistant Editors

Maureen BurkeLijun Li

Senior Editorial Assistants

Kelley McCollumEditorial Assistant

Julio PregoGraphic Artist

_______

Graham HaccheSenior Advisor

Prakash LounganiAssociate Editor

The IMF Survey (ISSN 0047-083X) is published in English,French, and Spanish by the IMF22 times a year, plus IMF inFocus. Opinions and materials in the IMF Survey do not neces-sarily reflect official views of theIMF. Any maps used are for theconvenience of readers, based on National Geographic’s Atlas of the World, Sixth Edition; thedenominations used and theboundaries shown do not implyany judgment by the IMF on thelegal status of any territory orany endorsement or acceptanceof such boundaries. Text from theIMF Survey may be reprinted,with due credit given, but photo-graphs and illustrations cannotbe reproduced in any form.Address editorial correspondenceto Current Publications Division,Room 7-106, IMF, Washington,DC 20431 U.S.A. Tel.: (202) 623-8585; or e-mail any comments toimfsurvey@imf.org.

To request an IMF Surveysubscription ($109.00 annuallyfor private firms and individuals)or IMF publications, pleasecontact IMF Publication Services,Box X2005, IMF, Washington, DC20431 U.S.A.Tel.: (202) 623-7430; fax: (202) 623- 7201; e-mail: publications@imf.org.The IMF Survey is mailed firstclass in Canada, Mexico, and theUnited States, and by airspeedelsewhere.

IEO identifies priority topics for coming year

IMF SURVEY

For more information about the IEO, including the full text announcing its FY 2006 work program, please seethe IEO website (http://www.imf.org/external/np/ieo).

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