Donor concern over IMF cap on aid increases

Joseph Hanlon
Joseph Hanlon (j.hanlon@open.ac.uk)
2006-01-26

In a repeat of a crisis a decade ago, donors now fear that the IMF is blocking aid increases to Mozambique. With public pressure in several European countries for increased aid, and with problems in Ethiopia and Uganda tainting these former donor darlings, donors are anxious to pump more money into Mozambique -- especially as budget support. But the IMF says no -- it will not allow Mozambique to accept more budget support. Instead, it wants donors to fund more projects outside the state budget -- which goes directly against the policy of many donors.

The issue came to a head with the shocked outcry of donors when the government on 7 November issued its draft PARPA (Plano de Accao para a Reducao da Pobreza Absoluta 2006-9; Mozambique's PRSP) which said aid would increase from $889 million in 2006 to $1,044 million in 2008, but remains constant after that. Donors were upset and said they had stressed to the government that more money was available. But the Ministry of Planning and Development appears to have based its figures on the IMF cap, rather than money actually available.

The core of the debate, which has been going on for more than two decades, is that the IMF believes that aid can be inflationary. Since inflation is the worst possible sin, aid must be limited. But a recent study by the IMF itself of five countries in Africa, including Mozambique, argued that substantial aid increases can be controlled and need not be harmful (see article below).

The issue is expressed in arcane accounting terms. Mozambique's agreement with the IMF is set out in the 17 October 2005 "letter of intent". Mozambique is unusual in that the IMF puts a limit on what it calls "domestic primary deficit", which is the government's current spending and locally financed capital spending, less government revenue (from taxes, customs duties, etc). Government is committed to cutting this deficit from 4.5 bn new meticais ($225 million) in 2005 to 3.8 bn new meticais ($190 mn) in 2006. This is, in effect, the amount of budget support the government is allowed to spend, yet budget support is predicted to increase from $274 million to $308 million.

This effective IMF cap on budget support contradicts donor policy in two ways.

One is that the IMF is putting pressure on Mozambique to tax aid spending. If donors were to pay tax, this would count as government income and it could be spent. Bizarrely, if donors give the same amount as additional budget support, it cannot be spent. This is serious, because most donor countries have laws saying that aid cannot be taxed by the aid recipient, so there is no chance of donors paying tax.

The other issue is that the cap excludes donor funded projects. Now, many donors are trying to reduce the number of projects outside the state budget, and are anxious to switch from funding individual projects to having the spending in the budget and funded by increased budget support. Yet the IMF is pushing exactly the opposite way, saying it will accept an increase in projects funded by donors outside the state budget, but not an increase is donor-funded spending within the state budget.

The letter of intent is available on http://www.imf.org/external/np/loi/2005/moz/101705.pdf

and the draft of PARPA II on http://www.open.ac.uk/technology/mozambique/pics/d53720.pdf

IMF STUDY SAYS BIG AID INCREASES ARE OK

An IMF study released last August says that, contrary to IMF assumptions, low income African countries, including Mozambique, are able to manage significant increases in aid. A big increase in aid to Mozambique did lead to an increase in inflation, but this was brought back to a reasonable level, the study found, both by Bank of Mozambique actions and because fiscal expansion brought rapid GDP growth.

The study goes on to challenge one of the IMF's own most central articles of faith by saying that it seems that periods of higher inflation actually achieve real growth, and that this should be tolerated in order to keep the exchange rate from depreciating.

Aid volatility is the problem, it says, and low income countries can make good use of "significant increases in aid" if they are planned.

But it appears that the IMF team which negotiated the letter of intent with Mozambique last year had not read the institution's own study.

The study is "The Macroeconomics of Managing Increased Aid Inflows: Experiences of Low-Income Countries and Policy Implications, August 8, 2005" and is on http://www.imf.org/external/np/pp/eng/2005/080805a.pdf