Article

Stabilization Program in Sierra Leone

Author(s):
International Monetary Fund. Research Dept.
Published Date:
January 1969
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I. Introduction

THE PURPOSE OF THIS PAPER is to review the stabilization program that Sierra Leone has been implementing since late 1966 and that has been supported through stand-by arrangements approved by the International Monetary Fund. The program is of interest because of the mix of policy instruments employed to achieve the objectives, which were to bring about an improvement in the balance of payments without resorting to restrictions on the liberal exchange system and to restore conditions for growth. The balance of payments objective was conceived in terms of specific goals for foreign exchange reserves. In order to attain these goals, the authorities reduced financial deficits of the public sector, increased liquidity requirements on commercial banks, and varied producer prices for major agricultural exports. In November 1967, when the pound sterling was devalued, the Government also devalued the leone by the same percentage.

Sierra Leone has a population of about 2.2 million and a gross domestic product (GDP)—including the subsistence sector—of about $310 million. The main activity of the country is agriculture (31 per cent of GDP), followed by mining (20 per cent of GDP). However, the mining sector supplies about 85 per cent of the country’s exports. The main mineral exports are diamonds (which account for about 65 per cent of Sierra Leone’s exports), iron ore, bauxite, and rutile. Agricultural exports consist mainly of palm kernels, coffee, cocoa, and piassava, the marketing of which is handled by a public corporation, the Sierra Leone Produce Marketing Board (SLPMB).

II. Background to the Stabilization Program

Until 1965 Sierra Leone experienced a moderate rate of growth in GDP, accompanied by relative price stability and equilibrium in the balance of payments. Between 1961 and 1964, real GDP increased by an annual average rate of about 3 per cent, money supply by 3.3 per cent, and prices by about 2 per cent. The Government’s cash deficit, financed by either bank credit or the use of accumulated balances, averaged about Le 2.0 million per annum during the fiscal years 1963/64 to 1965/66. The balance of payments was in approximate balance in 1964; the deficit on the goods and services account was offset by a surplus of roughly the same size on the capital account.

Beginning in 1965, however, the economic and financial situation deteriorated rapidly. In its desire to accelerate the rate of growth, the Government undertook a relatively large development program, which was financed partly by external short-term contractors’ credits and partly by the increased use of accumulated cash balances and bank credit. In addition, the SLPMB embarked upon an extensive agricultural development program, involving the establishment of new plantations and industrial ventures, which was financed by the use of the Board’s accumulated trading surpluses. Consequently, the economy experienced a large monetary expansion. While exports declined, imports increased and the balance of payments deficit, which had been Le 0.6 million in 1964, rose to a record Le 11.6 million in 1965. The total official foreign exchange reserves, including those of the Bank of Sierra Leone (BSL), declined from Le 29.2 million at the end of 1964 to Le 17.6 million at the end of 1965—the equivalent of less than three months’ imports. For the fiscal year 1966/67 the original budget estimates, as approved by the House of Representatives, showed an uncovered deficit of Le 19.3 million. In these estimates, the Government budgeted for an increase of almost 100 per cent in its development expenditures. The SLPMB, which had committed its liquid assets to long-term projects, was unable to meet current liabilities to the buying agents of approximately Le 3.0 million and did not have the financial resources needed to purchase produce for export. At the same time, large repayments were falling due on external suppliers’ credits, and it was anticipated that the balance of payments would deteriorate further. Faced with this situation, the Government undertook a program of financial reform designed to reverse the above-mentioned trends.

III. The Stabilization Program

The strategy

The financial developments in the public sector were considered to have been the main cause of the deterioration in the balance of payments. Hence, the authorities placed primary emphasis on reducing the size of the deficits in the financial operations of the Government and public corporations. At the same time, they wished to avoid a substantial reduction in the tempo of their development effort and aimed for a resumed growth in capital expenditures within a short period of time. However, the authorities realized that some initial reduction in development expenditures was inevitable and that the budget deficit could be reduced only gradually. In the meantime, it was accepted that the economy would continue to experience some excessive monetary expansion and balance of payments pressures. The immediate questions to be considered, therefore, were the extent of total foreign exchange resources that could be drawn upon to meet the payments deficits and the period over which these resources would be needed. With these questions in mind, a determination had to be made of the quantitative relationship between domestic monetary expansion and loss of external reserves, in order to estimate the maximum permissible monetary expansion. This relationship formed the basis for the stabilization program pursued by the authorities during 1966–68, and the maximum permissible monetary expansion was the overriding constraint that shaped the budgetary, monetary, and pricing policies of the authorities over this period.

At the end of June 1966, Sierra Leone’s own foreign exchange reserves comprised mainly the reserves held by the BSL (Le 13.1 million) and by other official institutions (Le 2.5 million). The BSL considered the equivalent of two months’ imports (i.e., about Le 11.5 million) as the desirable minimum level of reserves. The reserve holdings of the official institutions were in the nature of working balances and could be reduced only marginally. Hence the estimated permissible drawdown of Sierra Leone’s holdings of foreign exchange was no more than about Le 2.0 million. This amount was not sufficient to cover the anticipated payments deficits. Accordingly, Sierra Leone sought temporary external balance of payments assistance. The authorities prepared a stabilization program in support of which a stand-by arrangement was approved by the Fund.

Sierra Leone’s quota in the Fund was $15 million and its initial gold tranche position, $2.3 million. The authorities considered it desirable to use only a part of these facilities, in order to leave a secondary line of reserves to meet emergencies. Accordingly, they assumed that drawings from the Fund should not exceed about $10 million (about Le 7.0 million at the then prevailing rate of exchange) during the period of stabilization. Thus, total foreign exchange available to meet the payments deficits was felt to be about Le 9.0 million. The utilization of this amount had to be spread over the minimum period needed to achieve equilibrium in the balance of payments; this period was estimated to be about three years. The authorities aimed at realizing a surplus in subsequent years to restore some of the earlier losses in external reserves and to meet their repayment obligations to the Fund. The Government therefore adopted a reserves policy to limit the loss of reserves to about Le 5.5 million during the 1966/67 fiscal year (July-June), the first year of the program. It was planned to reduce this loss substantially in 1967/68 and to move close to a balance by 1968/69.

Given these reserves targets, estimates were made of the permissible amount of “monetary expansion.” This was defined as the change in domestic bank credit, plus the drawdown of accumulated nonbank foreign reserves of the public sector, plus the use of the counterpart of external bank loans and of Fund drawings. The relationship between monetary expansion and reserve changes was ascertained through the use of two approaches. First, data for the years 1962–65 were examined and changes in monetary expansion were imputed to changes in “savings” (in the form of quasi-money and other nonmonetary net liabilities of the banking system), external reserves, and money supply; the proportions of the changes in money supply absorbed by changes in real income, velocity of circulation, and prices were also ascertained. Second, the income-import approach developed by J. J. Polak,1 which states that import payments in any year are determined by export receipts, net capital movements, and net domestic credit expansion in that year and in the previous years, was applied. On this basis, the external reserves’ change in any coming year can be calculated in relation to any assumed domestic credit expansion by estimating exports and capital movements for that year.

The results obtained from these calculations are shown in the Appendix. The first approach indicated that, on the average, during the period 1962–65, approximately 64 per cent of monetary expansion was absorbed by reserve loss and the remainder by changes in prices (6 per cent), “savings” (25 per cent), real income growth (9 per cent), and velocity of circulation (-4 per cent). The income-import analysis suggested that, in order to limit the reserve loss in 1966/67 to Le 5.5 million, monetary expansion should not exceed about Le 7.5 million, i.e., implying a ratio of reserve loss to monetary expansion of about 73 per cent. Assuming that other relationships observed in the past would persist in 1966/67, the reserve loss ratio obtained under the Polak model would imply a real income change of about 2 per cent under the first approach. Similar calculations were made in the formulation of the program for the subsequent years.

Implementation

Although the above-mentioned approach provided the basis for the over-all strategy, the authorities maintained flexibility in the specific contents of the program for each year and adjusted policies to the circumstances. This was particularly true in their approach to the problems of the SLPMB and the question of the exchange rate of the leone following the devaluation of the pound sterling. The stabilization program, as it was implemented, involved three main elements: the fiscal policy of the Government, the reorganization of the SLPMB and changes in producer prices, and the monetary policies of the BSL.

Fiscal policy and public debt

The major emphasis of the program was placed on reducing the budgeted deficit for 1966/67 in order to restrict monetary expansion to the limits implied by the reserves targets. In the event, the actual deficit of Le 5.9 million in 1966/67 was larger than the deficit of Le 4.0 million in 1965/66, but it was sharply reduced from the original estimate of Le 19.3 million (Table 1). The deficit was further reduced to Le 1.1 million in 1967/68. For 1968/69 the Government budgeted for a deficit of Le 1.4 million but achieved an over-all surplus of approximately Le 5.0 million.

Table 1.Sierra Leone: Government Finance, 1963/64–1968/69(In millions of leones)
1963/64, Actual1964/65, Actual1965/66,1 Actual
Current revenues32.433.442.0
Indirect taxes15.519.027.7
Import duties13.316.320.6
Export duties and others2.22.77.1
Direct taxes10.47.26.7
Companies8.95.35.0
Personal1.51.91.7
Others6.57.27.6
Current expenditures28.531.136.8
Loans to public corporations
Debt service23.94.56.8
Current surplus or deficit (—)0.1–2.2–1.6
Capital receipts36.74.911.2
Internal0.21.03.6
External6.53.97.6
Capital expenditures37.57.813.6
Capital account surplus or deficit (—)–0.8–2.9–2.4
Extrabudgetary items
Over-all deficit–0.7–5.1–4.0
Financed by
IMF drawings
Sales of treasury bills to the nonbank sector
Bank borrowing (net)1.03.42.9
Use of cash balances1.1
Profits of West African Currency Board1.71.7
Floating debt
Discrepancy
Sources: Based on Estimates, Revenue and Expenditure, various issues, and data supplied by the Sierra Leonean authorities.

Fifteen months (March 1965-June 1966).

Sources: Based on Estimates, Revenue and Expenditure, various issues, and data supplied by the Sierra Leonean authorities.

Fifteen months (March 1965-June 1966).

Table 1.Sierra Leone: Government Finance, 1963/64–1968/69(In millions of leones)
1967/68
1966/67Revised

estimates

after

devaluation

effects
1968/69
BudgetProgram estimatesActualBudgetActualBudgetRevised estimates
38.339.938.041.740.737.141.750.1
24.226.124.427.225.824.425.234.0
19.620.519.421.820.518.419.825.3
4.65.65.05.45.36.05.48.7
8.98.48.010.010.410.312.212.2
6.96.76.58.48.88.210.110.0
2.01.71.51.61.62.12.12.2
5.25.45.64.54.52.44.33.9
33.832.731.632.632.128.332.330.8
1.0
6.76.76.57.98.77.98.59.4
–2.20.5–1.11.2–0.10.90.910.0
7.47.87.86.26.77.08.27.4
0.51.01.30.50.3
7.47.87.85.75.75.77.77.1
24.515.512.69.59.59.010.59.8
–17.1–7.7–4.8–3.3–2.8–2.0–2.3–2.4
–19.3–7.2–5.9–2.2–2.9–1.1–1.44.8
3.93.91.41.01.0
0.30.90.40.8
19.33.32.60.81.6–0.41.0–5.6
0.20.2
–0.8–0.6

Including debt service payments in respect of contractor-financed investment expenditures.

Including receipts and expenditures in respect of contractor-financed investments.

Including debt service payments in respect of contractor-financed investment expenditures.

Including receipts and expenditures in respect of contractor-financed investments.

The reduction in the budget deficits was achieved by both reducing expenditures and increasing revenues. In the first year of the program, the scope for raising taxes was limited in view of the existing relatively high rate of import duties (contributing nearly 50 per cent of current revenues) and the inflexibility of company taxes (contributing about 20 per cent of current revenues), a large proportion of which were derived from concession agreements with the mining companies operating in Sierra Leone. Although selective increases in import and excise duties were made in 1966/67, their net contribution to revenues was estimated at less than Le 0.5 million. The Government aimed at curtailing the expansion of current expenditures while maintaining efficient administration; it made no retrenchments but froze all personnel vacancies (except in such essential areas as hospitals) and reduced appropriations for travel and material supplies. Capital expenditures were allowed only for ongoing projects and those considered absolutely necessary.

The expenditure policy was further reinforced in 1967/68 and 1968/69 when decisions were taken to reduce operating subsidies to railways, road transport, and local authorities, to rationalize expenditures on education and health services, and to cut defense appropriations. In addition, in 1967/68 the Government introduced several tax measures, including an increase in the export tax on uncut diamonds and a revision of the company income tax law, as well as some increases in import and excise taxes. The increase in the export tax on uncut diamonds, however, was repealed in November 1967, as it was thought to have encouraged the smuggling of diamonds. The Government also renegotiated the concession agreements with the companies producing diamonds and iron ore, with the effect of increasing the yield from the taxes paid by these companies.

The fiscal situation was also affected by the devaluation of the leone in November 1967. In general, the devaluation improved somewhat the over-all budgetary situation, although this improvement was obscured by a downward adjustment of estimated import duties, unrelated to the devaluation but made at about the same time. The devaluation also provided the Government with an opportunity to reopen negotiations with other mining companies to revise the concession agreements.

From the early 1960’s, the development effort of the Government had relied heavily on external loans, especially medium-term suppliers’ credits. During the period 1960–65, new borrowings by the Government amounted to about Le 53 million, of which approximately half was in the form of external suppliers’ credits. The servicing of these debts has imposed a heavy burden on the budget, averaging Le 7.5 million annually during the three fiscal years 1966/67–1968/69. As an essential element in the program to restore budgetary equilibrium, the Government decided not to enter into any further credit arrangements with suppliers and to limit new public borrowing to long-term loans with terms that took account of the onerous repayment schedule in the next few years. In addition, some of the existing suppliers’ contracts on which work had not started were reviewed and canceled where it was felt that the project was not viable or the contract was too expensive. The decision to abstain from further short-term borrowing has been enforced, almost without exception, and new borrowing by the Government has been confined to long-term loans. This has had the desired effect of stretching out the debt structure of the Government to conform to available resources over the next few years.

The decision mentioned above regarding suppliers’ credits meant that development expenditures had to be reduced during the early phase of the stabilization program; in 1967/68 these expenditures were about 25 per cent below the level of the previous fiscal year. However, the stabilization efforts of the Government soon attracted larger amounts of long-term external capital assistance. In addition, the expenditure-economy and taxation measures made it possible to budget for a modest current surplus in 1968/69. As a result, the Government was in a position to achieve a 10 per cent increase in its capital expenditures in 1968/69 compared with 1967/68.

Although the over-all budget deficits were reduced, the actual outcome was somewhat different from that anticipated in the stabilization program. In all three fiscal years covered by the program, actual budget outturns were better than those envisaged in the original budget estimates.

The discrepancy between the budgeted and actual outcome in these years reflected both the difference between estimated and actual revenues, especially those from import duties, and shortfalls in expenditures. Until about the middle of 1968 the level of imports declined more than was anticipated, as agricultural exports failed to increase owing to the difficulties of the SLPMB, and diamond exports also declined (see below). This shortfall in revenues, which occurred mostly during the fiscal year 1967/68, was largely offset by a shortfall in capital and current expenditures in both 1966/67 and 1967/68. In 1968/69 exports of diamonds and agricultural commodities exceeded all expectations, and receipts from indirect taxes (mostly on foreign trade) were more than 25 per cent above the estimates during the first half of the fiscal year. At the same time, current expenditures (excluding extrabudgetary items) were running below budget estimates by approximately 15 per cent.

The shortfall in current expenditures was in direct contrast to the practice in previous years, when large supplementary appropriations were necessary. This achievement reflected the serious efforts made by the Government to rationalize its expenditures, introduce proper accounting methods, and enforce strict expenditure control.

SLPMB and producer prices

The SLPMB was a major source of deficits in the public sector, and its difficulties adversely affected exports in 1966 and 1967. The Board was established in 1949 as the sole organization to market the country’s principal agricultural products. From the early 1960’s on, it expanded its activities to cover the development of new plantations and the establishment of processing factories. Most of these ventures turned out to be uneconomic and resulted in substantial operating losses for the Board. It was difficult to assess the extent of these losses with any precision, since no reliable accounting data were available after 1962/63. By late 1966, however, the Board had accumulated large liabilities to buying agents and had no working capital to purchase produce for exports. Confidence in the Board was shaken, and there were indications that the produce was being smuggled to neighboring countries.

The policy under the stabilization program aimed at restoring the financial viability of the Board, providing maximum encouragement for producers of exports, and generating operating surpluses to contribute to public development effort.

As a first step, the management of the Board was reorganized and proper internal financial control was instituted. The Board’s activities were confined to the marketing of crops, and the nonviable plantations, which were estimated to involve the Board in a financial loss of nearly Le 1.0 million annually, were closed down and handed back to local chiefs. The remaining viable plantations were transferred to the Government, which hoped to interest overseas investors in their development.

These measures were followed by a review of the trading operations of the Board. This review revealed that the Board would continue to incur losses on the basis of the existing schedule of producer prices. Hence a reduction in producer prices became necessary. In June 1967 the Government announced reductions of between 17 per cent and 27 per cent in the producer prices of palm kernels, coffee, and cocoa (Table 2); these products represent nearly 90 per cent of the value of total production handled by the Board. In addition, benniseed, on which the Board had incurred sustained losses, was taken off the purchase schedule; ginger had been removed from the schedule in April 1967.

Table 2.Sierra Leone: Producer Prices, 1966/67–1967/68(In leones per ton)
Palm KernelsCoffeeCocoa (Grade I)Piassava
1966/6763.62268.80268.8084.00
1967/68 (June)46.00224.00200.0084.00
1967/68 (November)54.20. . .224.0084.00
1967/68 (December)61.43231.20257.6092.40
Prices in Liberia (December 1967)83.31336.00298.59. . .
Sources: The Sierra Leone Gazette, various issues, and data supplied by the SLPMB.
Sources: The Sierra Leone Gazette, various issues, and data supplied by the SLPMB.

The reduction in producer prices was in one sense counter to the policy of providing maximum encouragement to producers. However, it was felt that higher prices could hardly provide the necessary incentive if the Board was unable to pay producers the prices officially posted. The authorities considered that in the circumstances priority should be given to ensuring the regularity of cash payments and to liquidating the Board’s short-term liabilities to buying agents.

It was estimated that the Board needed about Le 4.0 million (Le 1.5 million in early 1967 and Le 2.5 million in mid-1967) of medium-term credit to repay its liabilities and to meet its working capital requirements. However, the local commercial banks did not have adequate funds at their disposal to provide such a credit, and, in view of the limitations on their own finances, the authorities turned to external sources for this credit. Accordingly, on the basis of the reorganization measures mentioned above, the authorities obtained medium-term credit and overdraft facilities of up to Le 4.0 million from a London-based commercial bank.

By November 1967 indications were appearing that the reorganization measures were having beneficial effects. The confidence of producers and buying agents was returning slowly as the Board paid off its arrears and continued to make payments for produce on a cash basis. The earlier declining trend in the Board’s purchases was reversed, and payments approximately equaled its receipts. However, the sales of produce to the Board at this time were still below those recorded in previous years. A part of the palm fruit crop apparently remained uncollected by the farmers as a reaction to the sharp reduction in prices. In addition, the differential between producer prices in Liberia and Sierra Leone, particularly for coffee and cocoa, was large enough to encourage the smuggling of produce to Liberia. World prices of palm kernels (Sierra Leone’s most important export crop) rose after the June review of producer prices, and there was a marked reduction in the administrative costs of the SLPMB following its reorganization. In these new circumstances, the Government felt that producer prices could be increased somewhat without endangering the financial viability of the Board, with the aim of discouraging smuggling and providing a further incentive to farmers to collect and sell produce to the SLPMB.2 Accordingly, in November 1967 the producer price for palm kernels was increased by 18 per cent, and that for cocoa by 12 per cent; the price for coffee was left unchanged in view of the uncertainty in the coffee market pending the outcome of the International Coffee Agreement later in that month. The producer price for piassava was also left unchanged, since it had not been reduced in June 1967. Despite these increases, producer prices for palm kernels and cocoa were still about 15 per cent and 5 per cent, respectively, below the corresponding prices prevailing before the June cut, but they were in line with those in Liberia.

Soon after these increases in producer prices, the devaluation of the leone made a further review desirable. On the one hand, since Sierra Leone’s agricultural exports were considered competitive at the predevaluation rate of exchange (see pp. 518–19), an argument could be made for taxing the windfall gain from devaluation and, hence, for not announcing further increases in producer prices. On the other hand, the devaluation of the leone had created once again a substantial differential between prices paid in Sierra Leone and in Liberia, and a failure to raise prices would have encouraged the smuggling of produce. It was also felt that the devaluation provided an opportunity to give further incentives to producers without adversely affecting the financial position of the SLPMB. Indeed, since the Board could still earn profits on produce at higher prices, a positive response from producers might result in a further improvement in the Board’s financial position. For these reasons, it was decided that producer prices for palm kernels, cocoa, and piassava should be increased by almost the full extent of devaluation. With the previous uncertainties in the coffee market removed, producer prices for coffee were increased by 30 per cent for the coming crop season.

Results have justified the reasoning behind the two-step increase in prices. In 1968 purchases of palm kernels, coffee, cocoa, and piassava were 54,000, 4,100, 6,200, and 6,200 tons, respectively, compared with corresponding purchases of 35,700, 2,900, 1,300, and 4,300 tons in 1967. The increases in purchases reflect not only the price sensitivity of producers but also probably some rechanneling of produce into official channels, following the narrowing of price differentials between Sierra Leone and Liberia. These developments produced an operating surplus for the SLPMB during the crop year 1967/68 of about Le 2.2 million. For 1968/69 the Board realized another surplus of about Le 1.5 million. Out of its 1967/68 surplus, the Board made repayments of Le 0.6 million on its outstanding bank liability of Le 2.7 million; it had reduced this liability to just over Le 1 million by the close of its 1968/69 financial year. In 1967/68 the Board also repaid over Le 0.3 million to the Government in respect of loans made in 1966 and 1967, and in 1968/69 it was able to make a contribution of Le 0.5 million to the Government’s capital budget.

Monetary policy

The aim of the authorities’ monetary policy was to limit monetary expansion to amounts consistent with the reserves policy. The reserves targets implied that monetary expansion should not exceed approximately Le 7.5 million in the fiscal year 1966/67, about Le 3.0 million in 1967/68, and about Le 2.0 million in 1968/69. It was calculated that most of this increase would be absorbed by the budgeted deficits of Le 7.2 million in 1966/67, Le 2.2 million in 1967/68, and Le 1.4 million in 1968/69. It was felt that the remainder of the monetary expansion would be sufficient to meet the requirements of the private sector for bank credit. These requirements were not expected to show a large increase, primarily because the major mining and trading companies normally provide a large part of their own working capital and because the credit needs of the public corporations were limited. The exception was the SLPMB, which, as mentioned above, arranged a loan facility of up to Le 4 million with an overseas bank. As this loan was in foreign exchange, its utilization, although adding to monetary expansion, would be offset, as regards its effect on reserves, by a capital inflow. In addition, the loan was expected to assist exports directly.

Under its statutes the BSL is limited in the amount of credit that it may provide to the Government. Given these limits, it was not possible for the BSL to finance fully the estimated budget deficits, and the BSL therefore looked to commercial banks for financing at least a part of the deficits. With this end in view, the legal liquidity ratio3 of the commercial banks was raised from 15 per cent to 30 per cent over the period November 1966 to January 1967. At that time, the actual average liquidity ratio of commercial banks was approximately 25 per cent. It was anticipated that this step would result in the commercial banks providing at least Le 1.0 million to the Government during the fiscal year 1966/67. In addition, the counterpart of the drawings of Le 3.9 million in 1966/67, and of Le 1.4 million in 1967/68, under the stand-by arrangement approved by the Fund, were made available to the Government to support the budget. The balance of the deficits in these years was to be met by credit from the BSL. In 1968/69 a proportion of budget deficit of Le 1.4 million was to be met by net credit from the banking system and the remainder from sales of government securities outside the banking system. The counterpart of the drawings on the Fund was sterilized in an account with the BSL.

Actual net credit expansion from the banking system to the Government was less than anticipated in the program: Le 2.6 million instead of Le 3.3 million in 1966/67 and a reduction of Le 0.4 million instead of the anticipated increase of Le 0.8 million in 1967/68 (Table 3). The difference occurred primarily because the authorities sold treasury bills worth Le 0.9 million to the nonbanking sector in 1967/68. The composition of credit expansion to the Government was also somewhat different in that credit from the commercial banks was higher, and from the BSL lower, than originally estimated. Part of this increase reflected the need for commercial banks to increase their liquid assets, which took the form of increased holdings of treasury bills, as their deposits expanded with the growth in export earnings, particularly during 1968. In addition, it appears that the commercial banks found government securities bearing an interest rate of 6 per cent more attractive than other alternatives open to them. Demand for credit from the private sector was depressed throughout 1967 and the early part of 1968, and the banks chose to hold treasury bills in amounts that brought their liquid assets to a level in excess of the legal minimum of 30 per cent.

Table 3.Sierra Leone: Monetary Survey, 1961–68(In millions of leones)
19611962196319641965
Foreign assets (net)13.5213.598.8311.318.75
Bank of Sierra Leone/WACB113.9314.4114.6316.6614.23
Commercial banks–0.41–0.82–5.80–5.35–5.48
Domestic credit11.0214.3819.4818.3919.59
Government (net) Of which4.004.405.502.794.24
Bank of Sierra Leone4.004.405.503.194.28
Commercial banks0.400.04
Private sector7.029.9813.9815.3415.20
Public corporations0.260.15
Other assets (net)–1.14–2.33–2.61–1.451.14
Money19.4120.9820.2221.3221.62
Currency in circulation12.6413.0812.9213.4314.19
Demand deposits6.777.907.307.897.48
Quasi-money3.994.665.486.937.86
Post Office savings deposits3.303.283.203.183.10
Nonbanking foreign assets16.3613.1615.5412.493.39
Government8.374.817.054.351.22
Other official institutions7.037.397.537.181.21
IMF position (net)0.960.960.960.960.96
Sources: Based on Bank of Sierra Leone, Economic Review, various issues, and data supplied by the Bank of Sierra Leone.
Sources: Based on Bank of Sierra Leone, Economic Review, various issues, and data supplied by the Bank of Sierra Leone.
Table 3.Sierra Leone: Monetary Survey, 1961–68(In millions of leones)
196619671968
IIIIIIIVIIIIIIIVIIIIIIIV
6.508.867.537.488.077.815.846.709.8015.5315.1519.23
12.5213.0911.9413.1612.9912.2211.6313.2515.6817.5318.8422.90
–6.02–4.23–4.41–5.68–4.922–4.412–5.792–6.552–5.882–2.002–3.692–3.672
22.7921.4822.8823.2924.4324.1425.1124.1823.4522.9322.9721.09
6.296.007.657.658.338.558.277.136.368.127.274.61
6.425.895.326.466.896.645.624.894.775.102.560.84
0.130.112.331.191.441.912.652.241.533.024.715.45
15.7615.3415.1515.5814.5014.3914.0414.2514.3913.2114.1014.92
0.740.140.080.061.6021.2022.8022.8022.7021.6021.6021.562
1.751.050.400.060.950.370.350.611.201.000.50–1.27
22.8222.9521.6321.8923.9022.9622.2822.3925.1628.9427.7227.47
15.4715.5514.4514.4816.0415.3214.1614.3716.6318.5418.0517.85
7.357.407.187.417.867.648.128.028.5310.409.679.62
8.228.449.188.949.559.369.029.109.2910.5210.9011.58
3.023.002.922.812.762.712.632.602.602.582.58
3.634.033.552.141.25–0.88–1.53–3.00–2.73–2.26–1.83
0.850.720.440.611.110.500.080.080.010.340.31
1.211.741.470.960.990.911.180.741.081.221.68
1.571.571.640.57–0.85–2.29–2.79–3.82–3.82–3.82–3.82–3.82

West African Currency Board.

Including external loans to the SLPMB by the London head office of a local bank.

West African Currency Board.

Including external loans to the SLPMB by the London head office of a local bank.

The raising of the liquidity ratio of commercial banks, apart from providing credit to the Government, had another intention. All of the commercial banks operating in Sierra Leone are branches of foreign banks, and, as a general practice, they invest their excess liquid funds abroad. By raising their liquidity ratio, the BSL hoped to eliminate their prevailing excess liquidity and, at the same time, to conserve its own foreign exchange resources.

The net foreign liabilities of the commercial banks increased from Le 4.2 million in June 1966 to Le 4.4 million in June 1967 and to Le 6.6 million in December 1967, but thereafter declined to Le 2.0 million in June 1968. Included in these figures is the medium-term external loan of the SLPMB, which was obtained through the local branch of the bank concerned. Excluding this special operation and corresponding repayments in the following months, the net liabilities of the commercial banks actually declined continuously from Le 4.2 million in June 1966 to Le 3.2 million in June 1967 and to only Le 0.4 million in June 1968. Thus, excluding the special external loan, the operations of the commercial banks resulted in a net drain on the reserves position of the BSL, despite the increase in the liquidity ratio requirement. This appears to have been possible because, simultaneously with an increase in commercial banks’ credit to the Government, credit to the private sector was reduced. In 1967 the commercial banks’ net credit to the Government rose by Le 1.1 million, while credit to the private sector declined by Le 1.3 million. Over the same period, deposits with the banks also rose by Le 0.8 million.

In November 1967 the authorities raised the bank rate, the treasury bill rate, and the interest rate on post office savings deposits by 1 per cent. This was done partly to offset the likely effect of the increase in the bank rate in the United Kingdom by encouraging both individuals and financial institutions to retain their assets in Sierra Leone, and also to provide a greater incentive for domestic savings. At the same time, the BSL expected a resumption of activity in the private sector and employed moral suasion with commercial banks to increase credit. Although provision exists for the commercial banks to use rediscount facilities with the BSL, it has been their general practice instead to bring in funds from their head offices in London to support any expansion in their credit operations. At the end of 1968 credit to the private sector rose by Le 0.7 million compared with the end of 1967. The foreign liabilities of these banks, however, were some Le 2.9 million lower than at the end of 1967. Evidently the growth of domestic deposits with the commercial banks during 1968, which amounted to about 24 per cent, enabled these banks to expand their total lending by Le 2.6 million while reducing their net foreign liabilities with their head offices.

Exchange policy

An important policy decision taken at the beginning of the program was to continue to maintain the relatively liberal exchange system. The administration of exchange control would have been difficult in Sierra Leone, given the relative ease with which diamonds and other produce could be smuggled out of the country. Exchange control could also have undermined the confidence in the currency and encouraged an outflow of capital that would have thwarted the objectives of the stabilization program.

Initially, the program had not envisaged any change in the parity of the leone. The balance of payments problems were attributed to large deficits in the public sector and to the difficulties of the SLPMB, rather than to the noncompetitiveness of Sierra Leone’s exports. Nevertheless, in November 1967, when the pound sterling was devalued by 14.3 per cent, the Government announced a corresponding devaluation of the leone, mainly to avoid a speculative outflow of capital. As mentioned above, the devaluation also provided an occasion to raise producer prices for agricultural exports by almost the full extent of the devaluation, and thereby to give additional incentive to producers of these products. In addition, insofar as the Government was able to tax some of the windfall profits of the mining companies arising from the devaluation, the devaluation helped to reduce the budgetary imbalance.

IV. Conclusion

In executing the stabilization program, the authorities of Sierra Leone used a combination of policy instruments, within a general framework of restricting over-all credit expansion to amounts consistent with the reserves targets. The fiscal deficits were gradually reduced by rationalizing government expenditures, by tapping additional sources of revenue, and by avoiding further short-term indebtedness. The deficits of the SLPMB were eliminated by implementing policies that encouraged exports of agricultural produce through official channels, and by eliminating the uneconomic activities of the Board.

The above-mentioned policies of financial reform, coupled with the continued maintenance of a liberal exchange system, helped in strengthening the balance of payments of Sierra Leone (Table 4). While imports increased by only about Le 5.0 million from 1966 to 1968, partially in response to the disinflationary policies of the Government, exports increased from Le 55.4 million to Le 78.5 million during the same period, reversing the earlier trend of declining exports. Net foreign exchange reserves of Sierra Leone, including its net Fund position, which had declined by Le 11.6 million in 1965, declined by only Le 2.6 million in 1966 and Le 5.9 million in 1967. In 1968, on the other hand, the reserves increased by Le 12.6 million; at the end of 1968 the net foreign exchange assets of the BSL were at a record Le 22.9 million.

Table 4.Sierra Leone: Balance of Payments, 1963–68(In millions of leones)
1963196419651966196719681
Goods and services–13.7–17.8–27.6–19.4–21.2–0.3
Exports f.o.b.51.763.159.455.449.078.5
Imports c.i.f.–58.1–69.8–73.9–68.2–62.6–73.0
Trade balance–6.4–6.7–14.5–12.8–13.65.5
Services (net) Of which–7.3–11.1–13.1–6.6–7.6–5.8
Investment income5.56.58.64.87.07.5
Transfers (net)1.92.02.64.31.61.4
Balance on current account–11.8–15.8–25.0–15.1–19.61.1
Capital transactions (net)11.615.412.99.314.713.2
Private Of which6.510.211.86.48.56.7
Direct investments738.811.94.64.44.4
Government25.15.21.12.86.26.5
Errors and omissions (net)–2.3–0.20.53.1–1.0–1.7
Over—all balance–2.5–0.6–11.6–2.6–5.912.6
Monetary movements2.50.611.62.65.9–12.6
Bank of Sierra Leone (net)–0.2–2.02.41.1–0.1–9.7
Commercial banks (net)5.0–0.40.10.20.9–2.9
Government–2.22.73.10.60.5
Other official entities–0.10.36.00.30.2
IMF (net)0.44.4
Sources: International Monetary Fund, Balance of Payments Yearbook, and data supplied by the Bank of Sierra Leone.

Provisional.

Including contractor-financed loans.

Sources: International Monetary Fund, Balance of Payments Yearbook, and data supplied by the Bank of Sierra Leone.

Provisional.

Including contractor-financed loans.

Actual changes in monetary expansion and in reserves since 1966 are indicated in Table 5 below. It will be seen from this table that in 1966/67 monetary expansion amounted to Le 7.6 million, while the loss of reserves (including drawings on the Fund) totaled Le 6.1 million—about what was anticipated in the formulation of the stabilization program. In 1967/68, however, monetary expansion was only Le 0.1 million, while reserves increased by Le 6.4 million, instead of declining as had been foreseen. In 1968, reserves continued to increase; thus the improvement in reserves came much earlier than the target date that was implied in the stabilization program.

Table 5.Sierra Leone: Monetary Expansion and Change in Reserves(In millions of leones)
1966/671967/6819671968
Monetary expansion
Domestic credit (net)1.5–1.6–2.0–1.9
Drawings on nonbank reserves1.1–0.20.8
Counterpart of external bank loans1.10.42.7–1.2
Counterpart of IMF drawings3.91.54.4
Total monetary expansion7.60.15.9
Change in reserves (—decline)
Banking–1.17.7–0.812.5
Nonbanking official–1.10.2–0.8
IMF position (net)–3.9–1.5–4.4
Total change in reserves–6.16.4–6.0
Source: Based on Table 3.
Source: Based on Table 3.

The anticipated relationship between monetary expansion and the loss of reserves appears to have persisted until about the end of 1967, when the devaluation of the leone brought about a fundamental change in the situation. Indeed, the ratio of reserve loss to credit expansion was about 80 per cent in 1966/67, though it rose to 100 per cent during the calendar year 1967. However, the higher ratio during 1967 is due mainly to the effect of the SLPMB’s large external borrowing in August 1967, which in the immediate period reflected itself fully in the increased external liabilities of the commercial banks.

Recent developments show that the pressures on the balance of payments have been relieved and that the budgetary imbalance has been eliminated. Following the devaluation and the consequent increases in prices of exports, there was a substantial increase in exports of agricultural produce and diamonds. It appears that this increase in exports, which amounted to about 56 per cent for 1968 as a whole, resulted partly from factors related only indirectly to the stabilization measures of the authorities. For example, exports of alluvial diamonds increased by about 17 per cent, largely because of a revival of confidence among dealers and diggers. In addition, the SLPMB enjoyed favorable prices for two of its principal export commodities during part of 1968. The growth in exports and the effect of this growth upon foreign and domestic trade has brought considerable benefits to the government budget and economic activity. A fairly strong financial basis now exists from which the Government may resume its development effort, and emphasis in government policies has now shifted to the identification and preparation of viable development projects in the public sector.

APPENDIX

Monetary Expansion and Reserve Changes

1. Table 6 gives data on changes in monetary expansion (ΔD)4, savings (ΔS), external reserves (ΔR), and money supply (ΔMO) for the years 1962–65. It also shows the proportion of ΔMO absorbed by the changes in real income (ΔY), velocity of circulation (ΔV=1ΔK), and prices (ΔP). These calculations were derived on the basis of the following equations.

Table 6.Analysis of Monetary Expansion in Sierra Leone, 1962–65: The Quantity Theory Approach(In millions of leones)
Absorptive Factors
Change in Net Domestic Credit (A)Use of Nonbank Reserves1 (B)Total Monetary Expansion (A + B) (C)Change in savings2 (D)Change in velocity of circulation (E)Real income growth (F)Price increase (G)Foreign reserve loss3 (H)Total (D + E +F +G + H) (I)Statistical Discrepancy (C – I) (J)Non-inflationary Absorption (D + E + F) (K)Inflationary Absorption (G + H) (L)
19623.363.206.561.840.640.680.233.136.520.043.163.36
19635.10–2.382.721.02–1.570.630.252.382.710.010.082.63
1964–1.093.051.960.270.480.400.200.571.920.041.150.77
19651.209.1010.302.264–0.330.120.517.66410.220.082.058.16
Annual average, 1962–652.143.245.381.35–0.200.460.303.435.340.041.613.73
Annual average, in per cent406010025496641003070
Sources: Based on Tables 3 and 7.

Negative sign represents increase in nonbank reserves.

Change in quasi-money plus change in Post Office savings deposits plus change in other assets (net).

Includes loss in nonbank reserves.

Excludes Le 4.0 million accounting loss of reserves representing the reduction in BSL"s share in the sterling reserves of the West African Currency Board (WACB) in respect of an earlier loan of similar amount by the WACB to the Government, which was taken over by the BSL in 1965 as a domestic claim.

Sources: Based on Tables 3 and 7.

Negative sign represents increase in nonbank reserves.

Change in quasi-money plus change in Post Office savings deposits plus change in other assets (net).

Includes loss in nonbank reserves.

Excludes Le 4.0 million accounting loss of reserves representing the reduction in BSL"s share in the sterling reserves of the West African Currency Board (WACB) in respect of an earlier loan of similar amount by the WACB to the Government, which was taken over by the BSL in 1965 as a domestic claim.

Table 7.Analysis of Monetary Expansion in Sierra Leone, 1961–65: The Quantity Theory Approach(In millions of leones)
19611962196319641965
Money (MO)119.4120.9820.2221.3221.62
GDP at current price (Yc)183.00191.60199.60205.60211.80
MoneyGDP(K)0.10600.10950.10130.10370.1021
Money absorbed by change in K20.64–1.570.48–0.33
GDP at 1961 prices (Y)183.00189.40195.10199.00200.10
Money absorbed by change in Y30.680.630.400.12
Percentage change in GDP attributable to price increase (ΔP)1.11.21.02.5
Money absorbed by change in (P)40.210.250.200.53
Sources: Based on Table 3 and data supplied by the Sierra Leonean authorities.

Currency in circulation plus demand deposits.

ΔKKt-1MOt-1.

ΔYYt-1MOt-1.

ΔP MOt–1.

Sources: Based on Table 3 and data supplied by the Sierra Leonean authorities.

Currency in circulation plus demand deposits.

ΔKKt-1MOt-1.

ΔYYt-1MOt-1.

ΔP MOt–1.

Hence,

Equation (3) allocates ΔDt betwen various absorptive factors that may be classified as “noninflationary” and “inflationary,” represented, respectively, by the elements in the large parentheses in the right-hand side of the equation.

It will be seen from Table 6 that, on an average, about 70 per cent of the monetary expansion during 1962–65 was absorbed by inflationary factors and 30 per cent by noninflationary factors. Most of the inflationary absorption was in the form of reserve loss, which averaged 64 per cent of the monetary expansion; the price effect of monetary expansion was rather negligible in view of the openness of the Sierra Leonean economy.

2. The income-import approach as developed by J. J. Polak6 is based on the equation

where Y(t) is national income in period t and ΔMO(t) is the increase in the quantity of money in the same period. Since

where X(t) is export receipts (including investment income and service exports), C(t) is net capital movements, D(t) is net monetary expansion, and M(t) is import payments during period t, and since imports are expressed as a function of income,

a derived equation can be obtained

where

This means that import payments in year t depend on export receipts, net capital movements, and net domestic credit expansion in that year and in the previous years. Since the change in foreign reserves is expressed as

the reserve loss in year t can be calculated in relation to any assumed domestic credit expansion if estimates for X and C were available for that year.

The coefficients for Q (t)’s were taken directly from Table 3 of Polak’s article7 for values of the import-income ratio (m) and velocity of circulation (V). For Sierra Leone these ratios averaged 0.35 and about 10, respectively, during 1963–65 (Table 8), giving the resulting coefficients of Q(t), Q (t–l), and Q (t–2) as 0.73, 0.26, and 0.01, respectively.

Table 8.Analysis of Monetary Expansion in Sierra Leone, 1963–67: The Income-Import Approach(In millions of leones)
1963196419651966/67, Forecast11966, Actual
Exports (X)54.764.659.862.061.8
Merchandise51.763.159.456.055.4
Net investment income5.56.58.64.04.8
Other receipts8.58.09.010.011.2
Imports (M)64.073.572.672.4
Merchandise58.169.873.968.2
Drawings on project loans24.48.914.88.8
Other payments10.312.613.513.0
Change in reserves (ΔR)–2.5–0.6–11.6–2.6
Capital movements (C)36.88.31.29.08.0
Monetary expansion (ΔD)22.32.010.35.0
GDPMO(V)9.99.69.8
Average V, 1963–659.8
ImportGDP(m)0.310.380.38
Average m, 1963–650.35
Sources: Based on Tables 3, 4, and 7.

Forecasts made in the formulation of the program in September 1966.

Including use of nonbank exchange balances.

Equals M—X—ΔR.

Sources: Based on Tables 3, 4, and 7.

Forecasts made in the formulation of the program in September 1966.

Including use of nonbank exchange balances.

Equals M—X—ΔR.

Balance of payments items for Sierra Leone were divided into four categories, i.e., export receipts, import payments, change in reserves, and capital movements (Table 8). Export receipts include merchandise exports f.o.b., net investment income, and gross receipts from other services. Import payments include merchandise imports c.i.f. less imports financed by project aid and by the use of nonbank foreign exchange reserves of the Government.8 Capital movements were defined as export receipts minus import payments and change in reserves.

Since the stabilization program was worked out in terms of a fiscal year, the balance of payments estimates ought also to be reworked in the corresponding time unit. However, it was not possible to obtain accurate payments data on a fiscal year basis. Instead it was assumed that the payments outturn for the calendar year 1966 would approximate that of 1966/67, and for 1965 that of 1965/66.

The effects of monetary expansion on changes in reserves were then calculated on the basis of independent estimates for export receipts and capital inflow. For the fiscal year 1966/67, export receipts, X(t), were estimated at Le 62.0 million and capital inflow, C (t), at Le 9.0 million. On this basis a target of Le 5.5 million in reserve loss implied a maximum permissible monetary expansion, ΔDt, of about Le 7.5 million.

Programme de stabilisation du Sierra Leone

Résumé

Cet article étudie le programme de stabilisation mis en oeuvre par le Sierra Leone depuis la fin de 1966, avec l’assistance financière du Fonds Monétaire International sous la forme d’une ligne de crédit “stand-by”. Ce programme présente un intérêt particulier en raison des divers instruments de politique auxquels il fait appel pour atteindre les objectifs qu’il s’est fixés: améliorer la balance des paiements sans appliquer de restrictions au régime libéral des changes en vigueur et établir les conditions propres à une reprise de la croissance économique.

Pour atteindre l’objectif de balance des paiements, le programme détermine pour les variations des réserves de change des limites devant être atteintes grâce à un ralentissement de l’expansion monétaire. Les montants d’expansion monétaire compatibles avec les limites déterminées ont été calculés en appliquant: 1) une méthode dérivée de la théorie quantitative de la monnaie, qui attribue l’expansion du crédit intérieur à des facteurs d’absorption d’ordre inflationniste et non inflationniste, et 2) une méthode revenu/importations qui, sur la base de prévisions d’exportation et de mouvements de capitaux établies indépendamment, permet de calculer les variations des réserves en fonction des variations du crédit intérieur. Pour que l’expansion monétaire ne dépasse pas les montants indiqués par ces méthodes, les pouvoirs publics ont réduit les déficits financiers du secteur public et relevé le pourcentage de couverture des banques commerciales. Ils ont également procédé à des ajustements des prix à la production des produits agricoles d’exportation et limité le montant des emprunts à court terme et à moyen terme que le secteur public pouvait contracter à l’étranger.

Les pouvoirs publics ont fait preuve d’une certaine souplesse dans l’application des éléments du programme au cours de chaque exercice et ajusté leur politique en fonction des circonstances. La dévaluation de la livre sterling, qui a été suivie dans les mêmes proportions de celle du leone, a notamment amené des modifications de certains éléments du programme. En partie du fait de la dévaluation et des mesures qui l’accompagnèrent, le redressement de la balance des paiements est intervenu plus tôt que ne l’avait prévu le programme initial. Le Sierra Leone a enregistré de la sorte un important solde positif au titre de ses paiements extérieurs en 1968.

Programa de estabilización en Sierra Leona

Resumen

Este artículo examina el programa de estabilización puesto en práctica por Sierra Leona desde finales de 1966 y que ha recibido apoyo del Fondo Monetario Internacional mediante varios acuerdos de crédito contingente. El programa es de particular interés debido a que combina diversos instrumentos de política para el logro de sus objetivos: la mejora de la balanza de pagos sin recurrir a restricciones sobre el sistema cambiario libre y el restablecimiento de una situación que permita el crecimiento económico.

El objetivo señalado para la balanza de pagos se concretó en torno a metas específicas de reservas en divisas, cuyo logro se alcanzaría limitando la expansión monetaria. La cuantía exacta de esa expansión, compatible con las metas establecidas, se calculó atendiendo a dos factores: 1) un enfoque fundado en la Teoría Cuantitativa del Dinero, que asigna la expansión del crédito interno a factores de absorción inflacionarios y no inflacionarios, y 2) un enfoque sobre el ingreso y las importaciones que, a base de estimaciones independientes de las exportaciones y de los movimientos de capital, permite calcular las variaciones en las reservas en relación con las variaciones del crédito interno. Con objeto de limitar la expansión monetaria a la cuantía que indicaron los enfoques citados, las autoridades redujeron los déficit financieros del sector público y aumentaron las reservas obligatorias de la banca comercial. Las autoridades ajustaron también los precios a los productores de productos agrícolas de exportación y pusieron en vigor ciertos límites a nuevos préstamos a corto y mediano plazo del sector público en el exterior.

Las autoridades se mantuvieron flexibles en cuanto al contenido específico del programa para cada año y ajustaron sus políticas según lo requirieron las circunstancias. En particular, la devaluación de la libra esterlina, seguida de la devaluación del leone en la misma proporción, hizo necesario introducir modificaciones en ciertos elementos del programa. Debido en parte al resultado de la devaluación y de las medidas que la acompañaron, la mejora en la balanza de pagos se produjo antes de lo que se había proyectado en el programa original. Sierra Leona registró un superávit considerable en su balanza de pagos en 1968.

Mr. Bhatia, Chief of the Central African Division of the African Department, is a graduate of Bombay University and Oxford University. He was formerly a member of the staff of the Indian Ministry of Finance and has contributed several articles to economic journals.

Mr. Szapary, economist in the African Department, received his graduate and postgraduate degrees from the University of Louvain. He worked formerly at the Commission of the European Economic Community in Brussels and is the author of Diffusion du progrès et convergence des prix, Europe-Etats-Unis, 1899–1962 (Louvain and Paris, 1966).

Mr. Quinn, economist in the African Department, received his graduate and postgraduate degrees from the Universities of Glasgow and Manchester and from Cornell University. He was the resident representative of the International Monetary Fund in Sierra Leone from 1966 until 1968.

J. J. Polak and Lorette Boissonneault, “Monetary Analysis of Income and Imports and Its Statistical Application,” Staff Papers, Vol. VII (I960), pp. 349–415.

In Sierra Leone the supply of palm kernels is price elastic in the short run, since palms grow wild and farmers have only to pick the fruit.

Comprising mainly interbank deposits, money at call, and treasury bills.

As defined on page 507 in the text.

5

A positive sign indicates a decline in reserves.

Polak and Boissonneault, op. cit., pp. 349–415.

Polak and Boissonneault, op. cit., pp. 358–59.

This was done in view of the consideration that these imports were not directly linked with domestic income.

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