IMF lending and private sector investment decisions

Recent frequent economic headwinds facing countries, from the global financial crisis to the pandemic, supply chain problems, and geopolitical tensions, have increased economic policy uncertainty. In the absence of macroeconomic stability, misallocation of resources leads to lower aggregate productivity and investments, which are leading explanations for economic disparities across countries (Hsieh and Klenow 2009). The advent of repeated external shocks has reinvigorated the role of the IMF (e.g. Krahnke 2020). Over the past decade and a half, IMF resources have been tapped to deal with systemic debt crises in advanced economies such as in the euro area, as well as to increase the resilience of developing and fragile economies, while these countries implement adjustment policies to restore macroeconomic stability and growth. The set of corrective actions under an IMF arrangement provide a seal of approval that appropriate economic and financial policies are implemented, helping mitigate adverse effects of crises and thereby boosting future prospects during periods of heightened risks.

At the macro level, the effects of IMF programmes have been investigated focusing on two main channels. One strand of literature considers the liquidity effects of IMF lending, which can reduce the probability of self-fulfilling runs arising from liquidity problems (Barro and Lee 2005, Dreher 2006, Nier et al. 2019, Presbitero et al. 2013, Przeworkski and Vreeland 2004, Zettelmeyer 2000). More recently, the signalling argument is typically used to illustrate the catalytic effect of the IMF, namely, the propensity of private capital to flow into a country following the approval of an IMF programme (e.g. Corsetti et al. 2006, Gehring and Lang 2020, Marchesi and Thomas 1999, Marchesi 2003, Mody and Saravia 2006, Morris and Shin 2006).

The novelty of our research (Bomprezzi et al. 2023) links firm investment decisions, which are contingent on expectations about future macroeconomic and policy prospects, to the approval of IMF programmes. Where previous work documents the relationship between IMF lending and firm performance in the short term (Bomprezzi and Marchesi 2023), this paper provides evidence on the medium to long-term interplay between IMF lending and firm investment decisions. Although IMF financing makes additional funds available for governments to spend, this may not be sufficient to boost private investment. Rather, by providing a seal of approval, an IMF programme improves expectations about the country’s future economic prospects and reduces uncertainty about future economic policies, which is an important determinant of firm investment decisions.

Since investment decisions tend to be long-term and non-reversible, firms would favour precautionary delays before undertaking them, at least until future expectations improve. Numerous works by Alfaro et al. (2021), Bloom et al. (2007), and Bloom (2009) have indeed established the importance of reducing uncertainty on improving firm investment dynamics. We propose that IMF programmes provide a positive signalling mechanism about the expected macroeconomic environment in the country. Under this hypothesis, the reduction in policy uncertainty that accompanies the approval of an IMF programme ultimately triggers firms’ decision to increase tangible investments, even if no real macroeconomic effects have had time to materialise yet.

IMF lending has traditionally fallen into two categories. One category of loans from the General Resources Account (GRA) is available to all the membership at interest rates determined by an average of those prevailing among the world’s main currencies. To better meet the needs and specific circumstances of low-income countries, lending from the Poverty Reduction and Growth Trust (PRGT) is available on concessional terms (currently at zero percent interest rates) to those countries only, as middle- and high-income countries do not have access to the PRGT. Under GRA financing, a member’s balance-of-payment needs should be resolved by the end of the programme period and no follow-up programme would be anticipated. In contrast, PRGT programmes envisage a much longer duration for addressing economic problems, with repeated financial engagements expected ex-ante to achieve a stable and sustainable macroeconomic position consistent with strong and durable poverty reduction and growth. Since IMF programmes are not ‘one size fits all’, we distinguish in our paper between GRA and PRGT arrangements. This distinction is relevant to expectations about the reduction in policy uncertainty over the course of the IMF programme.

We start by giving a broad picture of the aggregate response of firm investments to the approval of an IMF programme using a local projection methodology and detailed balance sheet data of firms. Figure 1 illustrates that GRA financing arrangements increase firm investment by four percentage points over four years relative to programme approval, consistent with the requirement to resolve members’ balance-of-payments needs over the duration of the arrangement. In contrast, the effect of PRGT arrangements on firm investment is both more muted and short-lived, in line with the idea that successive PRGT arrangements are needed to deliver sustained progress towards macroeconomic stability.

Figure 1 Programme approval and firm investment response, AIPW estimates

Notes: Panel A shows the adjusted inverse propensity weighted (AIPW) average treatment effects for each h-step ahead cumulative change in tangible fixed asset investment rate with respect to base year (yt+h – yt) following the approval of the respective IMF programme (from the GRA or PRGT). Shaded areas show 90 and 95% confidence intervals. Standard errors are clustered at the country level.

We then exploit the role of firm-level information using a stacked difference-in-differences approach. Leveraging firm heterogeneity, we identify three main channels through which IMF financing, by reducing policy uncertainty, may increase private sector investment: external financial dependence (Rajan and Zingales 1998), sectoral uncertainty (Alfaro et al. 2021), and whether the firm operates within the country. Specifically, a reduction in the recipient country’s level of uncertainty improves future economic prospects, and for this reason influences the decision of lenders to finance firm investments as well as of firms to invest, especially for those firms relying more on external finance or more exposed to firm-level uncertainty. Moreover, firms with domestic ownership are also more constrained by the future prospects of their own country when making an investment plan, while foreign-owned firms gain a sort of natural hedge by being part of a foreign group and hence less sensitive to what happens in a country.

We find that, following either a GRA or a PRGT arrangement, firms undertake greater long-term non-reversible investments when they are more dependent on external finance.  On the other hand, only after a GRA programme, investments increase for firms that either operate in sectors that are riskier than others or that do not enjoy a natural hedge from being part of a foreign group. Furthermore, unlike for GRA financing arrangements that are not completed as scheduled, we find that a PRGT programme that goes off-track results in lasting damage to private sector investment. This finding underscores the importance of remaining engaged and completing PRGT programme reviews to be able to deliver growth and poverty reduction over time in low-income countries.

Figure 2 Firm frictions and dynamic stacked DiD estimates, GRA

Note: This figure shows the point estimates and the 10% confidence Interval for the stacked difference-in-differences regression.

Figure 3 Firm frictions and dynamic stacked DiD estimates, PRGT

Note: This figure shows the point estimates and the 10% confidence interval for the stacked difference-in-differences regression.

Our research contributes to the empirical literature on the effectiveness of IMF programmes, and in particular to the strand of macro-micro work studying the channels through which IMF programmed influence local economic activity. The success of IMF programmers hinges on the pay-off from undertaking reforms by raising economic growth. As the private sector is the engine for growth, the evaluation of the impact of different IMF financing on firm investment has practical relevance for programme stakeholders. To the best of our knowledge, ours is the first paper that investigates whether different types of IMF programmes could improve a country’s creditworthiness or credibility not just for external investors, but also domestically by encouraging the private sector to invest.

Source : cepr.org