- Olivier Basdevant, Patrick Imam, Tidiane Kinda, and Aleksandra Zdzienicka
- Published Date:
- October 2015
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WAEMU countries are Benin, Burkina Faso, Côte d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal, and Togo. They share the same currency, the CFA franc, which is pegged to the euro.
The causality is uncertain, as larger deficits may precisely be a result of lower growth performance; however, there is no indication that growth can be achieved through a demand-driven policy of increasing deficits. Indeed, fiscal multipliers tend to be small in developing countries (Spilimbergo, Symansky, and Schindler 2009). Instead, fiscal policy can foster growth through macroeconomic stability and by making space for development spending.
This criterion was set at a time when countries were still heavily indebted, and restoring fiscal sustainability was a critical issue. Now WAEMU countries face a different challenge, which pertains more to preserving fiscal sustainability rather than achieving sustainability, per se.
Under the Excessive Deficit Procedure, a deviating country is given 30 days to develop an adjustment strategy, which can benefit from financial support from the nion. Otherwise, the country would expose itself to potential sanctions.
Automatic correction mechanisms have been adopted internationally. Here are three examples that the WAEMU could consider. In Switzerland, the fiscal rule specifies a one-year-ahead ceiling on central government expenditures. If budget target balances and outcomes exceed 6 percent of expenditures, the government must bring it below 6 percent in three years. In the Slovak Republic, a constitutional bill was adopted in 2011, limiting public debt at 60 percent of GDP. Automatic sanction mechanisms take effect when the debt-to-GDP ratio reaches 50 percent. Finally, in Jamaica, a fiscal rule is being prepared that will establish an automatic correction mechanism that would be triggered by substantial cumulative deviations from the annual overall balance target.
The WAEMU directives harmonize the rules for the preparation, submission, approval, execution, and control of the budget, and encourage efficient and transparent management of public finances.
There is significant variation with regard to these three functions. For instance, the Netherlands Bureau for Economic Planning Analysis performs extensive forecasting and costing functions; however, it does not make judgments on the appropriateness of the government’s budgetary plans. In contrast, the Swedish Fiscal Policy Council and the Irish Fiscal Advisory Council engage in normative analysis but do not produce their own forecasts or costing. Some countries have even established a division of labor between different institutions. In Belgium, the Federal Planning Bureau focuses strictly on the provision of macroeconomic forecasts, whereas the High Council of Finance (Public Sector Borrowing Requirement Section) performs oversight and monitoring functions, and must provide policy recommendations, including on the distribution of the eventual fiscal effort among central and subnational entities to comply with general government rules.
This is the case particularly during very severe downturns, symmetric and terms-of-trade shocks, and periods of civil conflict. Social conflicts, recurrent in WAEMU countries, have detrimental economic effects and can significantly affect the ability of risk-sharing mechanisms to absorb shocks (Zdzienicka 2013).
There could be also alternative options to finance shock-smoothing. If some WAEMU countries were to meet donors or IMF criteria for credit lines, they could also use these lines to respond to asymmetric shocks.
This assumes a timely reaction to negative shocks.
The ability of social benefits to smooth shocks significantly increases over time but remains small compared with the role that these transfers plays in developed countries.
Asdrubali, Sorensen, and Yosha (1996) find that federal tax-transfer and grant systems smooth about 13 percent of shocks to per capita gross state product in the United States. Hepp and von Hagen (2012) find that the federal budget smoothed about 50 percent of shocks to state gross product in Germany before 1990. Malkin and Wilson (2013) provide a more recent analysis of the U.S. tax-transfers system and find that the federal tax system has the most stabilizing impact in the short term.
More developed financial markets could reduce some government financing constraints and allow for more countercyclical fiscal policies. Moreover, they could improve the effectiveness of market discipline in the region (IMF 2013b).
The WAEMU financial sector appears sound on average, but vulnerabilities have increased recently (IMF 2014).
Banking licenses (and their ultimate withdrawal) remain a prerogative of national authorities. In addition, the ultimate sanction by the banking commission to close down a bank lacks credibility, due to political interference at the national level.
For instance, WAEMU sovereign debt receives favorable tax treatment, thereby segmenting the market by creating a tax-driven public sector bias.
The debt restructuring of the sovereign of Côte d’Ivoire in 2011, however, is an example where the shock was partially diffused across the region, notably to the stronger members, such as Senegal.
Supplement 1 to IMF (2013b).
The deposit insurance system is calibrated to cope with the failure of two medium-sized banks in the WAEMU, and it can therefore absorb limited losses among its insured pool. The way the deposit insurance system is conceived right now is as a simple “pay box” administered by the central bank. Part of the deposit will cover banks, while the other part will cover microfinance institutions. Constituted over a 10-year period, it is expected to cover 80 percent of depositors (40 percent of deposits, given the concentration of wealth), with a maximum guarantee of FCFA 1.4m per account. The authorities have also launched an insurance fund to guarantee all payments through the RTGS system, financed through a tax on banks.
Private credit markets tend to freeze under severe stress and amplify the impact of shocks (Furceri and Zdzienicka 2013). Under severe crises, the public smoothing channel in the WAMEU is also significantly less efficient.
Not only do countries in a monetary union not control interest rates and exchange rates, but they also lose the capacity to issue debt in a currency over which they have full control, leading to a “sovereign liquidity risk.” This implies that a loss of confidence of investors—especially given the high rollover rate of public debt—can drive any country in the region to default, as the BCEAO is legally not able to finance states in the primary market. The analogy is similar to a bank run. When solvency problems arise in one country, bondholders may sell this country’s and other nations’ bonds as they fear the worst. This loss of confidence can trigger a liquidity crisis in the sovereign bond markets because there is no buyer of last resort. Without such a backstop, fears can grow until the liquidity problem degenerates into a solvency problem. The loss of confidence increases the interest rates governments must pay to roll over bonds, but the higher interest harms governments’ solvency. The cycle of fear and resulting rising interest rates may lead to a self-fulfilling default. Countries can be pushed into this sort of bad equilibrium—a self-fulfilling debt crisis (see de Grauwe 2011).