Compliance, defiance, and the dependency trap: International Monetary Fund program interruptions and their impact on capital markets

Alexander Kentikelenis,Thomas Stubbs,Bernhard Reinsberg

doi:10.1111/rego.12422

Abstract

AbstractThe International Monetary Fund (IMF) is infamous for its structural adjustment programs, requiring countries to undertake policy reforms in exchange for loans. Yet, not only do countries routinely fail to implement these reforms, but they also frequently return to the IMF to start the process anew. What explains this compelling case of transnational regulatory ineffectiveness? We argue that countries are caught in a dependency trap: politically contentious policy prescriptions drive non‐compliance, triggering adverse market reactions that leave countries with few sources of financing beyond the IMF, leading to their eventual return to the doors of the organization for a fresh loan. Using new data on 763 IMF programs from 1980 to 2015, we initially demonstrate that the prevalence of market‐liberalizing structural reforms increases the likelihood of program interruptions. We then show that program interruptions undermine investor confidence and increase sovereign borrowing costs. Our study uncovers hitherto neglected relationships between the international institutions of regulatory capitalism, country compliance, and financial market responses.

Highlights

International organizations powerfully shape regulatory governance within nation-states by diffusing ideas and practices about appropriate policy (Barnett & Finnemore 2004; Simmons et al 2008; Shaffer 2015; Križic 2019)
In line with scholarship linking implementation problems to domestic veto players (Mayer & Mourmouras 2008), we argue that structural conditions are politically more difficult to implement because they concentrate losses on vested interest groups in the political economy (Reinsberg et al 2019a,b,c)
If an International Monetary Fund (IMF) program is interrupted, borrowing country institutional investor ratings will decrease and costs of sovereign refinancing will increase. These two hypotheses feed into our theoretical conjecture of a dependency trap: poor program design leads to poor compliance, which contributes to inferior market evaluations of creditworthiness that can result in a country returning to the IMF to request a new loan

Summary

Introduction

International organizations powerfully shape regulatory governance within nation-states by diffusing ideas and practices about appropriate policy (Barnett & Finnemore 2004; Simmons et al 2008; Shaffer 2015; Križic 2019). To the extent that implementing conditions is conducive to improvements in economic conditions (but see Przeworski & Vreeland 2000; Easterly 2005; Dreher 2006), non-compliance can inhibit progress on program objectives and improvements in macroeconomic fundamentals (Nsouli et al 2004) It can undermine market confidence in borrowing countries, leading to a deepening of economic crises and increased financial instability If an IMF program is interrupted, borrowing country institutional investor ratings will decrease and costs of sovereign refinancing will increase Taken together, these two hypotheses feed into our theoretical conjecture of a dependency trap: poor program design leads to poor compliance, which contributes to inferior market evaluations of creditworthiness that can result in a country returning to the IMF to request a new loan

Determinants of program non-compliance

Market responses to compliance failure

Conclusions