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How to strengthen the IMF’s effectiveness in fragile and conflict-affected states

Written by Alastair McKechnie, Fiona Davies, Marcus Manuel

Previous ODI research has shown that deprivation is increasingly concentrated in fragile and conflict-affected states (FCS). One in five people globally live in FCS, and with the number of violent conflicts doubling since 2000 and displacement on an upward trend, these populations could continue to grow. FCS will be home to around 85% of those remaining in extreme poverty – some 342 million people – by 2030.

The International Monetary Fund (IMF) is currently developing a strategy to enhance its engagement in FCS. ODI welcomes the IMF’s efforts to seek feedback from stakeholders with experience of working in FCS. Through our work advising governments and donors in some of the most challenging FCS contexts, we have seen at first hand the positive impact that effective IMF engagement and support can have, as well as the negative impact when the IMF has been absent or weakly engaged.

The IMF has laid out a clear framework for its FCS engagement, based on its core competencies, mandate and instruments. It plans to tailor its engagement according to specific manifestations of fragility and conflict, along with a focus on building long-term institutions, country engagement strategies based on key drivers of fragility, stronger partnerships with other actors, and greater field presence to engage at the country level.

The strategy is a bold step forward, and our subsequent dialogue with the IMF showed that we share a common understanding of the challenges of engaging in FCS. We encouraged them to continue to give priority to and build on five key elements of the strategy:

  1. Prioritising conflict prevention over longer-term reforms
  2. Providing broader and deeper support on fiscal policy
  3. Diversifying FCS interlocutors
  4. Working in all FCS
  5. Investing in its own institutional capacity for FCS engagement.

We are encouraging the Fund to give priority to key actions in each of these areas.

1) Prioritise conflict prevention over longer-term reforms

Violent conflict can pose the greatest macroeconomic risk in countries with underlying fragility irrespective of income levels. Economic shocks – shifts in commodity prices, drops in economic growth, economic contractions, banking crises, capital flight and poorly designed reforms – can be conflict triggers. Other potential triggers include drought and extreme weather induced by climate change and natural disasters that affect food production, prices and livelihoods, and spillovers from conflicts in other countries.

The IMF should seek to do no harm in its engagement in all countries by ensuring that its programmes and the reforms it supports do not tip underlying fragility into violence and conflict. The FCS strategy should emphasise the role that IMF support for macroeconomic stability, inclusive growth, fiscal arrangements and institutions can play in conflict prevention. IMF programmes and technical support in FCS should resolutely prioritise those macroeconomic policy and structural reforms that will have the greatest impact on reducing the risk of conflict.

The underlying causes of conflict and fragility in FCS are fundamentally political and have much to do with intense contestation about how power and resources are shared. How economic rents are shared can play a key role in either maintaining social and political stability without violence, or creating inequalities, dissatisfaction and loss of legitimacy that can spiral into violence and conflict. A recent ODI report on Afghanistan shows the complex linkages between different sources of government revenues, and rents extracted by pro- and anti-government actors.

A focus on conflict prevention therefore necessitates investment in understanding political and resource dynamics, in addition to a focus on good governance. The IMF has a reputation of technocratic excellence in macro-fiscal matters but is less known for its expertise on political economy. It needs to increase its capacity to understand how its own role in a ‘conflict system’ where public authority is divided may affect the legitimacy of incumbents or/and challengers, the prospect of violence or violent conflict, and/or create the conditions for consolidating and sustaining peace.

The IMF should also take advantage of its unique mandate to explore how to operate more fully in political spaces in support of conflict prevention. Unlike other international financial institutions (IFIs), its mandate extends to countries of all income levels. Its engagement with higher-income countries means that it can often detect signs of underlying fragility even in these jurisdictions, through indicators such as deterioration in the condition of the banking system, breakdown of budget processes, policy distortions caused by rent-seeking elites and accelerating inequality of wealth and income. While dialogue with incumbent authorities to prevent conflict is seldom easy, the IMF is one of the few organisations with a mandate and financial leverage to operate at the interface of economic with other drivers of conflict in countries at all income levels.

2) Provide broader and deeper support on fiscal policy

Challenges to achieving sustainable and inclusive growth in FCS include food insecurity, high levels of youth unemployment and low levels of investments in social services like healthcare, infrastructure and education.

In order to support sustainable and inclusive growth, the IMF’s engagement in FCS needs to go beyond balance of payment imbalances to encompass broader and deeper support on fiscal policy, particularly in the context of the Covid-19 pandemic. Transformation from fragility to resilience will sometimes require bold, well-executed investment in physical, human and social capital and the fiscal space to accommodate this.

The IMF is increasingly extending its focus to fiscal policy. Key dimensions of fiscal policy that require IMF attention in FCS include the management of natural resource revenues and other economic rents, and the balance of expenditure policy. Security expenditure on the police, military, counterterrorism, anti-insurgency and intelligence typically makes up a large portion of public expenditure in fragile settings. Higher security expenditures are to be expected in countries facing armed revolt or threats from neighbours, but they tend to crowd out expenditure on education, health and social protection. FCS governments may also use finite and volatile natural resource revenues to fund security sector expenditures, building up future macroeconomic imbalances. Recent IMF work on the links between conflict and public finances in FCS is encouraging and needs to be built on.

Given the fungibility of public expenditures and the negative implications of high-security spending for peace and social sector spending, the IMF should review security budgets in FCS with the same rigour it applies to the rest of the government budget. A more active IMF role in reviewing the security sector budget could also involve partnering with others who have deeper levels of expertise in this area and acquiring its own capacity in security budgets.

The IMF should also encourage spending for inclusion on specific items (e.g. public works to provide jobs) as foundations for inclusive growth, and on priority thematic areas (e.g. decentralisation) and public financial management (e.g. transparency) that can help mitigate political fractures and low levels of trust.

3) Diversify FCS interlocutors

Formal IMF dialogue in any country is conducted with the ‘recognised authorities’. However, FCS environments in particular are characterised by high levels of social and political fragmentation, and low levels of trust. In some cases, they even have parallel sets of governing authorities. Whilst IMF missions do in some cases engage informally with non-official interlocutors, the Fund needs to work more systematically to engage with all key stakeholders whose actions can influence macroeconomic stability and growth. This is particularly important in FCS contexts where there is, de facto, more than one expenditure or monetary authority. At best, the IMF’s exclusive focus on dialogue with the recognised authorities can lead to marginalisation of FCS regions which operate autonomously or semi-autonomously of them (e.g. Southern Sudan in 2006–2011, Somaliland, parts of Eastern Ukraine), with potential long-running consequences for the quality of their institutions and economic policy-making. At worst, it can mean that opportunities are missed to prevent macroeconomic destabilisation arising from economic warfare between the recognised and de facto authorities (as in Yemen, for example).

The IMF also needs to engage with actors working on issues that are critical to FCS stability, such as climate change, youth unemployment, food security, violence and the role of the financial sector in combating illicit financial flows. This is to ensure that it understands any issues arising that could have potential implications for macroeconomic stability and growth, particularly because of the influential role the IMF plays in shaping access to finance for FCS from other sources. It also provides an opportunity to ensure that synergies are maximised with FCS expenditure policies.

FCS are often cut off from developments in other countries and many key stakeholders need time to understand and catch up. The IMF should play a significant public education role to help stakeholders develop a realistic understanding of the current macro and fiscal constraints in the country, how other countries have overcome similar constraints, and the potential positive role that the IMF can play. The IMF can also play a key role as an independent source of advice on how other countries have managed to implement macroeconomic policies to exit from fragility.

4) Work in all FCS

It should seem self-evident that in order to build understanding and trust with the FCS authorities and other key stakeholders, and engage effectively, the IMF needs a robust in-country presence. However, a partial survey of the IMF website and ODI contacts suggests that the IMF does not currently have resident representatives present in-country in Afghanistan (prior to immediate crisis), Iraq, Libya, Somalia, South Sudan and Yemen. Although the World Bank and/or the United Nations have representation in these countries, the IMF representative is either absent or based in a neighbouring country. Being present on the ground is key to understanding political dynamics, being listened to by in-country interlocutors, and facilitating appropriate prioritisation and sequencing of reforms. The IMF should be present in all FCS where the UN or World Bank are present. The IMF strategy commits to exploring ways of doing this, and we encourage them to bring these explorations to a successful conclusion by seeking solutions to issues around security of staff in conflict settings.

The IMF’s delivery of capacity development support in FCS is considered to have improved in recent years. However, more still needs to be done to ensure that policy advice and paper-based programme conditionalities (e.g. passage of a law or issuance of a circular) are followed through with long-term, country-based support on implementation. Otherwise, there is a risk that IMF requirements simply result in an increasing gap between form and function in FCS, rather than any meaningful change in practice.

Being physically present is a necessary condition for effective IMF engagement in FCS, but it is not sufficient per se. The IMF also needs to develop stronger processes for engagement in FCS which do not have an IMF programme. These are some of the most difficult environments for the IMF to gain traction in. Options include working more closely with other partners to support economic and institutional reforms and creating a framework for regular pre-programme monitoring.

5) Invest in institutional capacity

While fragile environments vary, they tend to be more challenging than non-fragile contexts and require strong analytical, risk management, facilitation and negotiation skills. ODI colleagues who have observed the IMF in action in fragile contexts have seen that staff members with skills that do not fit the standard IMF macroeconomist profile sometimes perform more effectively than those who do, yet appear to have limited opportunity for career progression within the organisation. The IMF needs to recalibrate its required skills profile for FCS, so that it recruits staff with the right mixture of skills, beyond macroeconomists and econometricians, to staff with a mix of skills, including sensitivity to political and social analysis. It also needs to invest in the right set of incentives to attract talent to working in FCS. It is encouraging that the strategy commits to strengthening career incentives to attract and nurture talent, as well as recognise staff who develop experience and expertise on FCS.

As the IMF engages in FCS differently and adapts its style, prescriptions and internal processes to the specific needs and conditions in these countries, it should also consider establishing a discrete FCS division with senior management oversight and representation. A strategy dissipated (mainstreamed) amongst a large number of divisions will not get the real attention it needs, will not accelerate lesson learning on FCS and will certainly not create a strong enough incentive mechanism to ensure that the brightest and the best staff spend time in FCS countries. Most IFIs have established such units. The IMF has a centralised process for review and quality assurance which also will need to be aligned with the new strategy, particularly as the design of activities adjust from the status quo.