Recent theoretical and empirical research suggests that under certain conditions IMF agreements induce additional inflows of finance from other private sources. This paper provides new empirical evidence on this catalytic effect using a treatment effects model to correct for selectivity. It concludes that catalysis remains weak or negative overall, with nuances that support recent theory.IMF, catalysis, international capital flows

Dane Rowlands

Graham Bird

English

Research Papers in Economics

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Discussion Papers in Economics 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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ISSN: 1749-5075 
 
THE IMF’S ROLE IN MOBILIZING PRIVATE CAPITAL 
FLOWS: ARE THERE GROUNDS FOR CATALYTIC 
CONVERSION? 
 
By 
 
Graham Bird 
(SCIES, University of Surrey) 
& 
Dane Rowlands 
(The Norman Paterson School of International Affairs 
Carleton University) 
 
DP 02/07  
 
 
 
 
 
 
 
 
 
 
The IMF’s Role in Mobilizing Private Capital Flows: Are There 
Grounds for Catalytic Conversion? 
 
 
Graham Bird  
Surrey Centre for International Economic Studies 
University of Surrey 
 
And 
 
Dane Rowlands 
The Norman Paterson School of International Affairs 
Carleton University 
Email: dane_rowlands@carleton.ca 
 
 
Abstract 
 
Recent theoretical and empirical research suggests that under certain conditions IMF 
agreements induce additional inflows of finance from other private sources. This 
paper provides new empirical evidence on this catalytic effect using a treatment 
effects model to correct for selectivity. It concludes that catalysis remains weak or 
negative overall, with nuances that support recent theory. 
 
JEL Classification: F33, F34, O19 
 
Keywords: IMF, catalysis, international capital flows 
 
Acknowledgements: The authors wish to thank the British Academy for financial 
assistance and Mejlina Modanu and Jano Bourgeois for research assistance. 
 
 
 
 
Corresponding author: Dane Rowlands, NPSIA, Carleton University 1125 Colonel By 
Drive, Ottawa, Ontario Canada K1S 5B6; phone: 613 520 2600 x 8884; fax: 613 520 
2889; dane_Rowlands@carleton.ca   2
Introduction. 
 
The IMF has traditionally claimed that its programs exert a catalytic effect on other 
international financial flows by overcoming liquidity shortages and signalling a 
government’s commitment to economic reform. This “stylized fact” was challenged 
by early critics because its stated theoretical foundation was ambiguous, and initial 
empirical investigations typically failed to find a widespread and significantly positive 
effect.  These challenges were themselves criticized, however, especially for their 
treatment of selection bias. Recent research has made advances in terms of both 
theory and empirical evidence, implying that the catalytic effect is significant in 
certain circumstances. To those who have expressed scepticism, are there grounds for 
catalytic conversion? 
 
Three innovations on previous work are explored to answer this question. We use a 
treatment effects model to correct for selectivity; we disaggregate across different 
types of capital flows, and test the sensitivity of catalysis to the initial economic 
conditions of countries.  
 
The Catalytic Effect: A Critical Review of the Literature. 
Early studies showed that the response to IMF programs could be positive or negative 
depending on a number of subtle behavioral responses and conditions. Does signing 
an agreement with the IMF signal that a country is committed to economic reform, or 
is it an indicator of extreme economic distress? The various factors influencing the 
nature of catalysis are reviewed at length in Cottarelli and Giannini (2002), and Bird 
and Rowlands (2001). 
   3
Recent theoretical analyses of catalysis (Morris and Shin, 2003; Corsetti, Guimaraes 
and Roubini, 2003; Penalver, 2004) identify circumstances in which a positive 
catalytic effect may be important. These include situations of debt rollovers, when 
countries are on the margin of default, and when economic fundamentals are neither 
relatively strong nor extremely weak. Partial empirical support is provided in Mody 
and Saravia (2003), who find that IMF lending has a significant favorable effect on 
bond prices and spreads when the country’s economic fundamentals are only 
moderately weak.  
 
Three questions remain. Is there evidence of positive catalysis for a wider range of 
capital flows? Is catalysis sensitive to the economic conditions of the country? Does it 
matter whether and how selection bias is corrected for? 
 
New Evidence on the Catalytic Effect. 
Method and data 
Recent work on the different effects of IMF programs has used instrumental variables 
or Heckman correction procedures to deal with selectivity (Mody and Saravia, 2003; 
Barro and Lee, 2005). In some cases there is evidence of selection bias (Vreeland, 
2003) while in others the bias is not important (Edwards, forthcoming).  These varied 
results, the absence of a theoretical “best practice”, and only rudimentary agreement 
on what variables explain the presence of IMF agreements (Bird and Rowlands, 2005) 
necessitates some circumspection when correcting for selection.   
 
Here we use a treatment effects model as the primary estimation procedure and a 
general set of political and economic variables in the selection equation. The   4
treatment effects model first estimates which cases undergo “treatment” and then 
embeds that within the model estimating the treatment’s effects.   
 
Our main dependent variable is aggregate net private flows as a percentage of GDP. 
Since the composition of capital flows may also be affected by IMF programs, we 
look at various component parts, including all private non guaranteed (PNG) debt, 
public and publicly guaranteed (PPG) debt, bond flows (PNG and PPG), foreign 
direct investment (FDI) and portfolio flows. We then estimate all net private flows for 
sub-samples of the data to examine the importance of initial levels of indebtedness 
and reserve adequacy.   
 
The independent variables measuring the economic conditions of the country are 
listed in the first column of Table 1.
1 Variables indicating robust (weak) economic 
conditions are expected to have positive (negative) estimated coefficients. Additional 
variables capture other potential IMF effects: recent use of IMF programs, IMF 
financial flows, and the presence of past incomplete agreements.  
 
The IMF treatment variable indicates the signing of either a non-concessionary 
standby (SBA), or an Extended Fund Facility (EFF) agreement. The economic and 
political variables selected to explain the presence of agreements are commonly used 
in the literature, although some were eliminated in a step-wise fashion to expand the 
sample and facilitate convergence without significantly changing the results. These 
variables were all lagged one year behind the capital flow measures, and hence are 
contemporaneous with the actual IMF agreement. 
                                                 
1 Specific data definitions and sources are available from the authors.    5
 
The data used constitute an unbalanced panel of 857 observations covering 68 
different countries (for the full estimation), all of them currently classified as middle-
income countries by the World Bank. Missing data and lag structures restrict the 
sample to the period 1979-2000.   
 
Findings 
Table 1 presents the main findings for the full sample estimation on aggregate net 
private capital flows using the treatment effects model. The equation performs 
reasonably well and the results generally conform to expectations in terms of the sign 
of the statistically significant estimated coefficients. For brevity, therefore, we focus 
on the estimated coefficients on the signing of SB and EFF agreements. Table 2 
compares the IMF treatment effect for the different types of capital flow.    
 
Three points emerge. First, there is statistically significant evidence of negative 
catalysis; IMF programs are associated with significant outflows of private capital in 
the year after the agreement. This conclusion is valid for all of the estimations 
conducted on the full sample period and for all of the sub-categories of net private 
flows examined, with the exception of private non-guaranteed bonds and portfolio 
flows, for which positive catalysis is observed. Therefore, while the evidence 
presented here points to an overall negative catalytic effect, there may also be 
important substitution effects between different types of financial flow, with some 
responding positively and others negatively.  
   6
Second, the nature of the catalytic effect does vary with the initial conditions of the 
country, as seen in Table3. These results are robust to marginal changes in the 
category ranges; trial and error was used to define ranges that were sensible, 
reasonably balanced, and for which the estimation converged. Highly indebted 
middle-income countries experience relatively weak negative catalysis compared to 
somewhat less indebted countries, for which coefficient suggests a capital inflow 
decline of over 11 percent of GDP. Countries with lower debt levels did not seem to 
experience any statistically significant catalysis. These results are consistent with the 
suggestion that catalysis will be more powerful under conditions of debt rollover.  
 
In contrast, countries with very low reserve adequacy exhibited the largest negative 
catalysis of any sub-sample. High reserve countries experienced relatively moderate 
declines in net inflows, while countries with intermediate levels of reserve adequacy 
experienced positive catalysis. If reserve adequacy is taken as a proxy for overall 
economic strength, these results support the contention that catalysis is strongest in 
countries that are neither too weak nor too strong in their fundamentals.  
  
The third and final point is that the method for correcting for selectivity does matter. 
When the equations were re-estimated using instrumental variables instead of the 
treatment effects model, there was no statistically significant evidence of either 
positive or negative catalysis. Furthermore, there was greater sensitivity to the choice 
of variables in the selection equation. In the absence of more compelling models of 
selection, the results regarding catalysis need to be viewed with caution.  
 
Concluding Remarks   7
It is critically important to know how IMF programs affect other capital flows. If IMF 
adjustment programs assume the presence of positive catalysis that fails to 
materialize, countries will be forced to endure harsher restructuring trajectories.   
Earlier studies casting doubt on the reliability of the traditionally assumed positive 
catalysis were criticized for not taking selection bias formally into account.  The 
results of the treatment effects model used in this paper demonstrate that scepticism 
about catalysis is warranted even when selection problems are accounted for.   
Although selection correction remains problematic, the estimations also support the 
contention that a country’s initial conditions modify the extent of the catalytic effect.  
Consequently our analysis provides few grounds for converting to the belief in a 
universal and reliable positive catalytic effect.  
   8
References 
 
Barro, R. and J.W. Lee, 2005, IMF programs: Who Is Chosen and What Are the 
Effects?  Journal of Monetary Economics,  52,  1245-1269  
  
Bird, G. and D. Rowlands, 2001, IMF Lending: How Is It Affected by Economic, 
Political and Institutional Factors? Journal of Policy Reform, 4, 223-271. 
 
Graham Bird and Dane Rowlands (2005) Can We Explain the Pattern of IMF Lending 
in: Gustav Ranis, James Vreeland, and Stephen Kosack eds. Globalization and the 
Nation State: the impact of the IMF and the World Bank (Routledge: London). 
 
Corsetti, G., B. Guimaraes and N. Roubini, 2003, International Lending of Last Resort 
and Moral Hazard: A Model of IMF Catalytic Finance, NBER Working Paper No 
10125. 
 
Cottarelli, C. and C. Giannini, 2002, Bedfellows, Hostages or Perfect Strangers? 
Global Capital Markets and the Catalytic Effect of IMF Crisis Lending, IMF Working 
Paper 02/193, (IMF, Washington DC).  
 
Edwards, M, forthcoming, Signalling Credibility? The IMF and Catalytic Finance, 
Journal of International Relations and Development, 9. 
 
Mody, A. and D. Saravia, 2003, Catalyzing Capital Flows: Do IMF-Supported 
Programs Work as Commitment Devices? IMF Working Paper, 03/100 (IMF, 
Washington DC). Forthcoming in Economic Journal. 
 
Morris, S. and H. S. Shin, 2003, Catalytic Finance: When Does It Work? Cowles 
Foundation Discussion Paper No 1400, (Yale University, New Haven) 
 
Penalver, A, 2004, How Can the IMF Catalyse Private Capital Flows? A Model, Bank 
of England Working Paper No 215 (Bank of England, London).  
 
Vreeland, J, 2003, The IMF and Economic Development (Cambridge University 
Press, Cambridge).   9
 
Table 1: Treatment Effects Estimation Results on Net flows (different categories) 
Variable All  Private 
Flows 
GNP per cap. 
 
Lagged Growth  
 
Lagged Investment  
 
Exports/GDP 
 
Real LIBOR 
 
Inflation 
 
Lagged depreciation 
 
Lagged Reserves  
 
Debt Service 
 
Debt/GDP 
 
Past Arrears 
 
Rescheduling 
 
Past IMF 
 
IMF Flows 
 
IMF Failure 
 
IMF treatment 
 
Constant 
 
-0.000211 
(-0.80) 
-0.293 
(-1.40) 
0.286*** 
(4.30) 
2.18 
(1.32) 
-0.0529 
(-0.44) 
-0.00114* 
(-2.21) 
-0.0098 
(-0.3) 
-1.48 
(-1.05) 
-5.26*** 
(-3.12) 
2.33* 
(2.00) 
0.00104 
(0.20) 
0.12 
(0.30) 
0.125*** 
(2.96) 
-97.5** 
(-2.53) 
-0.789 
(-1.60) 
-16.3*** 
(-3.77) 
0.817 
(0.44) 
No. of obs. 
P(β) = 0 (χ
2 test) 
ρ  
P(ρ) = 0 (χ
2 test) 
857 
0 
0.96 
0.0012 
 
Robust normal test statistics appear in parentheses. ***, **, and * indicate statistical 
significance at the 2%, 5%, and 10% levels for two-tailed tests. The parameter ρ is the 
covariance between the estimating and selection equation. If ρ = 0, then the selectivity 
correction is not statistically important.   10
Table 2: IMF treatment effect for different net capital flow categories 
 
Capital Flow category  Estimated IMF treatment 
coefficient 
Z statistic 
PNG and short-term debt  -15.9  3.97 
PPG private debt  -0.615  -2.30 
PNG and PPG Bonds  -0.303  -1.74 
PNG bonds  0.437  5.95 
FDI -2.49  -3.53 
Portfolio   1.13  3.38 
 
 
 
Table 3: The Effects of IMF programs on total net private flows to different middle 
income country groups 
 
Country Group  Defining range 
of the group 
Number of 
Observations
Estimated IMF 
treatment coefficient 
Z 
statistic 
Country groups based on previous year’s debt-to-GDP ratio 
Low debt  < 0.15  374  7.47  1.36 
Medium debt  0.1 to 0.37  242  -11.2  -4.42 
High debt  > 0.37  241  -0.593  -2.41 
Country Groups based on previous year’s international reserves-to-imports ratio 
Low reserves  < 0.29  437  -19.8  -3.40 
Medium reserves  0.27 to .4  199  5.96  2.41 
High reserves  > 0.4  252  4.14  -2.10 
 
 

Bedfellows, Hostages or Perfect Strangers? Global Capital Markets and the Catalytic Effect of IMF Crisis Lending,

Can We Explain the Pattern of IMF Lending

Catalytic Finance: When Does It Work? Cowles Foundation Discussion Paper No 1400,

Catalyzing Capital Flows: Do IMF-Supported Programs Work as Commitment Devices? IMF Working Paper, 03/100 (IMF, Washington DC). Forthcoming in Economic Journal.

IMF programs: Who Is Chosen and What Are the Effects?

International Lending of Last Resort and Moral Hazard: A Model of IMF Catalytic Finance, NBER Working Paper No 10125.

The IMF's Role in Mobilizing Private Capital Flows: Are There Grounds for Catalytic Conversion?

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The IMF's Role in Mobilizing Private Capital Flows: Are There Grounds for Catalytic Conversion?

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