Conditionality

Also called: IMF conditionality, Loan conditionalities · Topic: The 1991 Crisis and LPG Reforms: An Appraisal · NCERT: Class 11, Ch 3 "Liberalisation, Privatisation and Globalisation: An Appraisal"

Meaning

Conditionality means the policy changes a borrowing country must promise to make to get a loan from the IMF or the World Bank. The money is usually released in instalments, and each instalment depends on whether the promised changes are being made.

It matters because it links foreign money to policy at home. In 1991, India's loans in a balance of payments crisis came with conditions to liberalise, and these shaped the New Economic Policy (NEP) of July 1991.

Explanation

How it works

• Why a lender sets conditions:
• The lender wants its money back.
• So it asks the borrower to fix the causes of the crisis. Examples are a high fiscal deficit (the government spending much more than it earns), a closed trade regime and an overvalued currency (a rupee kept at a higher value than the market would give it).

• Money comes in stages, and each stage depends on progress.

• Stand-By Arrangement (SBA):

• It is the IMF's standard short-term loan for balance of payments problems.

• Money is released in tranches (instalments), and only if the conditions are met.

• Quota:

• It is each member's share in the IMF.

• It sets how much the member pays in and how much it can borrow.

• SDR (Special Drawing Right):

• It is the IMF's own reserve unit, valued against a basket of major currencies.
• IMF loans are counted in SDRs.

Two kinds of conditions (NCERT Class 11 framing)

• Stabilisation measures:
• Short-term steps to fix the balance of payments and control inflation.

• They mainly follow the IMF approach, for example fiscal tightening and devaluation.

• Structural reform measures:

• Long-term steps to make the economy more efficient and competitive.
• They mainly follow the World Bank approach.
• The World Bank's 1991 Structural Adjustment Loan/Credit (SAL) named five priority areas: the investment regime, the trade regime, the tax system, the financial sector and public enterprises [4].

What makes conditions stricter or lighter

• Size of borrowing compared with quota:
• Borrowing within the first 25% of quota is lower-tranche borrowing, with lighter conditions.

• Upper credit tranche means borrowing above that first 25%. It carries stricter conditions [2].

• Purpose of the facility:

• The Compensatory and Contingency Financing Facility (CCFF) lends when export earnings fall or import costs rise because of events outside the country's control, such as an oil price rise.

• It is meant for outside shocks, not for deep policy failure.

• Size of a country's reserves:

• Forex reserves are the stock of foreign currency and gold held by the RBI.
• A country with enough reserves does not need emergency loans. So it avoids forced conditionality and does not have to pledge gold [6].

Worked example: devaluation, a typical stabilisation condition

• Devaluation means the government or central bank deliberately lowers the official value of the home currency.
• Say the rate before was US$ 1 = ₹21 (illustrative).
• An 18.7% devaluation cuts the rupee's dollar value to 81.3% of its old value.
• New rate: ₹21 ÷ 0.813 ≈ ₹25.8 per US$.
• Exports:
• A US$ 100 export now earns ₹2,580 instead of ₹2,100.

• Exporting pays more, so exports rise.

• Imports:

• A US$ 100 import now costs ₹2,580 instead of ₹2,100.

• Imports cost more, so imports fall.

• Result: the balance of payments gap narrows.

In India

• The crisis (1990–91):
• By end-1990, forex reserves could pay for only about three weeks of imports [6].
• By June 1991, the reserves India could easily use were only weeks away from running out completely [6].
• April 1991: India raised US$ 200 million by selling gold to the Union Bank of Switzerland, with an option to buy it back [6].

• July 1991: the RBI pledged gold for a short period to raise loans [6]. A pledge means the gold was given as security for a loan and could be taken back later.

• The loans that came with conditions (1991):

Date	Lender and facility	Amount
18 Jan 1991	IMF SBA (25% of quota [7])	SDR 551.9 mn, fully drawn [2]
Jan 1991	IMF CCFF, mainly for costlier oil imports during the Gulf War [6]	SDR 716.9 mn (32.5% of quota) [7]
31 Oct 1991	IMF upper credit tranche SBA, until 30 Jun 1993	SDR 1,656 mn (≈ US$ 2.2 bn), paid over about 20 months [2][6]
Dec 1991	World Bank SAL, split equally between IBRD and IDA	US$ 500 mn [4]

• The World Bank SAL (December 1991):
• It was the Bank's first adjustment loan to India [4].
• The IBRD part had a 20-year term with a 5-year grace period, at a variable interest rate [4].
• The IDA part had a 35-year maturity [4].

• The Bank said the programme aimed to end "four decades of centrally planned development" [4].

• Totals for 1991–93:

• India borrowed SDR 2.2 bn under the two SBAs [3].
• It borrowed SDR 1.4 bn under the compensatory facility in 1991 [3].

• NCERT's exam figure for all IBRD and IMF support together is about US$ 7 bn.

• India's 1991 conditions (NCERT):

• liberalise and open up the economy;
• remove restrictions on the private sector;
• reduce the government's role in many areas;

• remove trade restrictions between India and other countries.

• How India met them: the NEP, 1991

• The reforms were led by PM P.V. Narasimha Rao and FM Manmohan Singh.
• 1 and 3 July: a two-step devaluation of the rupee, about 18% in US dollar terms [5]. The exact figures were ≈ 18.7% against the US dollar and 17.38% against the pound sterling [6].
• 4 July: a trade policy package that reworked export incentives and eased import licensing.
• 24 July: the Statement on Industrial Policy was tabled in Parliament and the Union Budget was presented.
• November 1991: the Narasimham Committee Report proposed deep reforms of the banking sector [5].
• March 1992: LERMS, a dual exchange rate with one official rate and one market rate [5].
• 1993: the two rates were unified into a single rate [5].

Don't confuse with

• Collateral (gold pledge): collateral is an asset given as security for a loan, like the RBI's gold pledge in July 1991 [6]. Conditionality is a promise to change policy, not an asset handed over.
• Stabilisation vs structural adjustment: stabilisation is short-term and linked to the IMF (fixing the balance of payments and inflation). Structural adjustment is long-term and linked to the World Bank (making the economy efficient).
• Devaluation vs depreciation: devaluation is a deliberate official cut in the currency's value, as on 1 and 3 July 1991. Depreciation is a fall driven by the market.
• Lower vs upper credit tranche: borrowing within the first 25% of quota carries light conditions. Borrowing above it (the upper credit tranche, as in the October 1991 SBA) carries stricter conditions [2].

Prelims Hooks

• Conditionality means the policy conditions attached to an IMF or World Bank loan. In 1991 these meant liberalisation, a smaller role for government, freedom for the private sector and fewer trade barriers.
• India had two IMF stand-by arrangements in 1991: 18 January (SDR 551.9 mn) and 31 October (SDR 1,656 mn ≈ US$ 2.2 bn) [2][6].
• CCFF: in January 1991 India drew SDR 716.9 mn from it to meet higher oil import costs [7][6].
• World Bank SAL (December 1991): US$ 500 mn, split equally between IBRD and IDA. It was the Bank's first adjustment loan to India [4]. IBRD lends at near-market rates. IDA lends on soft terms (35-year maturity in this loan) [4].
• Trap: stabilisation is short-term and IMF-linked. Structural reform is long-term and World Bank-linked.
• Trap: the Industrial Policy Statement and the Union Budget both came on 24 July 1991. The trade package came earlier, on 4 July.

Mains Points

• Imposed or home-grown?
• The loan conditions (the SBA and the SAL) set the direction of reform [2][4].
• India set the pace and order of steps itself. For example, the exchange rate moved step by step: devaluation (1991), then a dual rate (1992), then a unified rate (1993) [5].
• The 1981 Extended Fund Facility of SDR 5 bn, of which only SDR 3.9 bn was drawn, did not bring deep reform [2]. So domestic political will, not the lender, was decisive.

• Frame the answer as "crisis-triggered, domestically owned". Default or harsh import cuts alone would have cut India off from credit. The IMF route bought time.

• The legitimacy of conditionality (GS-II, international institutions):

• IMF and World Bank conditions face a "one-size-fits-all" criticism.
• India's gradual "reform with a human face" and China's reform from 1978 without any IMF programme show that local conditions and the order of steps matter more than a standard template.

• The quick balance of payments recovery came alongside slower, disputed social effects, such as pressure on social-sector spending.

• Reserves are sovereignty (GS-III, external sector):

• In 1991 reserves could cover only about three weeks of imports, and India had to pledge gold [6].
• Enough forex reserves protect a country from forced conditionality. This is a strong case for careful reserve management and external-sector resilience today.

Related concepts

• New Economic Policy (1991)

Read more

• IMF-World Bank conditionality and the New Economic Policy