Conditionality is the practice used by international financial institutions (e.g., the International Monetary Fund and the World Bank) and bilateral donors to link their provision of financial support to developing and middle-income countries to the implementation of prespecified policy reforms.
Conditionality has its origins in the Articles of Agreement of the International Monetary Fund (IMF), adopted at the United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire, in 1944, and amended several times since. The Articles of Agreement state that one of the purposes of the IMF is to provide temporary balance-of-payment support to countries that need it under "adequate safeguards" that the loans will be repaid (Article I(v) of the IMF Articles of Agreement). Since the early 1950s, these safeguards have been achieved through the imposition of specific policy conditions, set out in the stand-by arrangements negotiated by the IMF with countries receiving its support. These conditions were designed to ensure that the recipient country adopted macroeconomic policies that would allow it to be in a position to repay the foreign exchange funds lent by the IMF in the foreseeable future. Conditionality therefore acted as a substitute for the collateral used to guarantee loans between private companies.
The nature of conditionality has evolved since the early practice of the IMF. Initially, conditionality only included macroeconomic policy reforms aimed at addressing the external disequilibrium experienced by the recipient countries (e.g., reduction in domestic absorption, policies to promote exports). In the 1970s and 1980s con-ditionality became more extensive, and included structural conditions too (e.g., privatization of state-owned entities), in order to address larger balance-of-payments crises. Moreover, donors other than the IMF (most notably the World Bank) started to impose conditionality too, to ensure that their project lending would take place in a sound policy environment. Conditionality is still being used by the IMF in its support of middle countries experiencing significant currency crises (e.g., several East Asian countries in the late 1990s and Argentina from 2000 to 2002) and by all donors that lend money or give grants to developing countries. Conditionality applies to a wide variety of policy areas (including governance), even though donors are seeking to streamline its use.
Conditionality has been frequently criticized for its lack of effectiveness. One area of criticism relates to the type of orthodox economic policies (e.g., sharp reductions in expenditures and tight monetary policies) typically demanded by donors through conditionality. Critics have seen these policies as ineffective in stimulating growth and reducing the social costs from adjustment.
The second reason why conditionality has been seen as not effective is because of its lack of credibility. Countries receiving donor support can often anticipate that even if they do not fully implement the policy reforms demanded under conditionality, they will still receive support from the donors. This is because donors may have an interest in providing support even if conditionality is not adhered to, due to, for example, geopolitical considerations, pressure to spend aid budgets, and the need to ensure the repayments of past loans. This undermines the effectiveness of conditionality, leading only to partial implementation of the policy reforms demanded by donors in return for financial support.
