Chapter

Main Features of the Facility

Author(s):
International Monetary Fund
Published Date:
January 1980
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The compensatory financing facility was established by the International Monetary Fund to provide additional assistance to member countries experiencing balance of payments difficulties arising from export shortfalls, provided the latter are temporary and largely attributable to circumstances beyond the member’s control. Ideally, the facility should enable a member to borrow when its export earnings and financial reserves are low and to repay when they are high, so that its import capacity is unaffected by fluctuations in export earnings caused by external events.

Additional Assistance

Assistance extended by the Fund under the compensatory financing facility is additional to other forms of Fund assistance: drawings under the facility do not affect the amounts that a member can draw under its reserve tranche or its credit tranches or under other special Fund facilities. A member can draw under the compensatory financing facility an amount not exceeding 100 per cent of its quota in the Fund, which is equivalent to four credit tranches combined. Compensatory drawings and credit tranche drawings are both financed from the Fund’s own resources, which consist mostly of the subscriptions paid by each member in accordance with its Fund quota. Charges and repurchase provisions2 are the same for compensatory drawings as for credit tranche drawings. Since April 1, 1977, the annual charge has been 4.375 per cent for the first year, rising by 0.5 percentage point a year to 6.375 per cent in the fifth and last year. Repurchases are normally made within three to five years of drawings and must be completed within five years.3

Temporary Shortfall

Because the aim of the facility is to cushion the adverse effects which could otherwise have resulted from temporary export shortfalls, assistance under the facility should be provided as soon as the existence of a shortfall can be established. For this reason, the decision setting up the facility specifies that the shortfall must relate to the most recent 12-month period for which data are available; this is referred to below as the shortfall year.4 The drawing should be made within the 6 months following the end of this 12-month period. The amount of the shortfall is measured by the discrepancy between the value of export earnings in the shortfall year and the medium-term trend value of export earnings in that year; the latter is defined for the purpose of the Fund facility as the five-year geometric average centered on the shortfall year. Since, at the time of drawing, export earnings are not known beyond the end of the shortfall year, the calculation of the shortfall requires a forecast of export earnings during the 24-month period following the end of the shortfall year.

The calculation of the shortfall, which is based on the nominal value of export earnings, can be illustrated by three numerical examples (Table 2a). In the three examples, export earnings are known for the shortfall year (called year 0) and for the two preceding years (called years—1 and—2). In the first example (first column of Table 2a), the value of export earnings increased by 10 per cent in each of the years—1 and 0, and is projected to increase also by 10 per cent in each of the years +1 and +2. The five-year geometric average centered on year 0 is 100; since it is identical to the value of export earnings in year 0, there is no shortfall. In the second example (second column), the value of export earnings is only 95 in year 0, but remains as in the first example in the four other years; the amount of the shortfall is 4, even though earnings actually increased in year 0. In the third example (third column), the value of export earnings is raised to 105 in year 0, and there is an export excess of 4. It is clear from these examples that a shortfall occurs when the growth rate of export earnings falls in the shortfall year, while an excess occurs when that rate rises.5 The existence of a shortfall does not require an absolute decline in nominal export earnings, but only a decline in their growth.

Table 2a.Calculation of Shortfall in Nominal Terms
No ShortfallShortfallExcess
Nominal value of yearly earnings(1)(2)(3)
Year −282.682.682.6
Year −190.990.990.9
Year 0100.095.0105.0
Year +1110.0110.0110.0
Year +2121.0121.0121.0
Trend value100.099.0101.0
Shortfall044

Calculations in Nominal Terms

All calculations relating to the use of the Fund’s compensatory financing facility are made in SDRs at current prices. The possibility of making calculations in real terms was considered several times by the Fund’s Executive Board, but on each occasion the Board decided that calculations should continue to be made in nominal terms. One consideration underlying the Board’s decision is that the amount of the calculated shortfall would not be modified by making calculations in real terms if the rate of inflation were constant.6 This can be illustrated from the previous example of Table 2a, by assuming a 10 per cent yearly rate of inflation, as is done in Table 2b. The real export earnings shown in Table 2b are derived from nominal export earnings in Table 2a by dividing the latter by a price index taken as unity in the shortfall year. In year 0, real and nominal values are identical as both are measured at prices of year 0. For all other years, the value of export earnings in real terms is 100, since the 10 per cent increase in nominal terms is offset by the 10 per cent rate of inflation. The real value of export earnings is always 100, except in year 0 when a disturbance occurs in that year. A shortfall occurs only when the real value of export earnings falls, but the amount of the shortfall is the same whether calculations are made in real or nominal terms (second columns of Tables 2a and 2b).

Table 2b.Calculation of Shortfall in Real Terms at Prices of Year 0 with a 10 Per Cent Yearly Rate of Inflation1
No ShortfallShortfallExcess
Nominal value of yearly earnings(1)(2)(3)
Year −2100100100
Year −1100100100
Year 010095105
Year +1100100100
Year +2100100100
Trend value10099101
Shortfall044

With a 10 per cent inflation rate, the nominal value of 90.9 in year − 1 is raised to 100, while that of 110 in year +1 is reduced to 100.

With a 10 per cent inflation rate, the nominal value of 90.9 in year − 1 is raised to 100, while that of 110 in year +1 is reduced to 100.

Conducting calculations in real rather than in nominal terms would, nevertheless, affect the amount of the shortfall because the rate of inflation would not remain constant. It would increase the amount of the shortfall if the rate of inflation in the shortfall year was above average, but would reduce it if that rate was below average. As the latter would tend to offset the former, the sum of the shortfalls calculated for a large number of consecutive years would remain about the same whether calculations were made in nominal or in real terms; the distribution of shortfalls from year to year would, however, be changed.

If changes in the price indices used for calculating export earnings in real terms reflected accurately the changes in the average price paid by the country for its imports, variations in real export earnings would represent accurately variations in the purchasing power of export receipts in terms of imports. Accurate indices of average import unit values are not, however, available for all countries, and, when they are, their values are released later than those of nominal export earnings. Since it would not be possible to derive real export earnings from the average import unit value of the country concerned in all cases, a solution would be to use a common price deflator for all countries. However, for countries having an import pattern which did not reflect the weights used in the common deflator, the calculation in real terms might not result in a better timing of the purchase than the calculation in nominal terms.

Shortfall Beyond Member’s Control

If the shortfall resulted essentially from circumstances beyond the member’s control, a solution to the member’s balance of payments difficulties might not require changes in its economic and financial policies. In such instances, the member could draw under the facility without having to present a financial program that the Fund could support with the use of its resources.

The circumstances which may lead a member to draw under the facility may be illustrated by a few examples. Consider a country which derives most of its export earnings from copper. When the world price of copper falls because of a recession in the industrial countries, the country’s export receipts also fall and remain low until copper prices recover. Consider another country depending almost entirely on exports of groundnuts and groundnut products. When groundnut production falls sharply because of a drought, the volume of its exports also falls. If the country accounts for only a small part of world exportable supplies of fats and oils, the decline in the volume of its exports is not offset by a proportional increase in export unit value and its export earnings from groundnuts fall. In these two examples, the country would be able to maintain smooth growth of its capacity to import, if it could borrow when its export earnings are low and repay when they are high. In both cases, because the export shortfall is presumed to be temporary and not attributable to inappropriate policies, the member could draw expeditiously under the facility without having to negotiate a financial program.

Shortfalls in export earnings do not always result from a decline in world prices or from natural causes such as droughts or floods. They may result from a decline in the volume of exports caused by inappropriate exchange rate or price policies or by other forms of export disincentives. They may also result from a reduction in exportable supplies caused by excessive domestic demand in an overheated economy. In these instances, a solution to the member’s balance of payments difficulties would normally require policy changes, and the member should formulate a financial program that could be supported by credit tranche drawings, with the conditionality attached to such drawings.

Cooperation

When the shortfall results mainly from a decline in the volume of exports, it is not always easy to determine whether it is due mainly to circumstances beyond the member’s control or to inappropriate policies which need to be corrected. The member is generally given the benefit of the doubt in borderline cases, especially if it has been cooperating with the Fund in order to find appropriate solutions to its balance of payments difficulties. The decision establishing the facility specifies that a stricter test of cooperation should be applied when the drawing raises the member’s outstanding drawings under the facility above 50 per cent of the member’s quota.7

Need

As with any other drawing from the Fund, a member can draw under the compensatory financing facility only if it has a need to do so in terms of its balance of payments or reserve position or because of developments in its reserves. A large shortfall in export earnings generally results in an overall balance of payments deficit, which is financed partly from reserves. This is not, however, always true because the fall in export earnings may be offset by movements in other items of the balance of payments.8 For example, a decline in export earnings by a country importing raw materials and exporting manufactured products would normally be associated with a reduction in the volume of raw material imports. This would cushion the effect of the decline in export earnings on the trade balance. Moreover, the impact on the trade balance could be offset by a higher net inflow of capital.

If international reserves exceeded their normal level before the export shortfall occurred, or if they could easily be restored to their normal level by borrowing from abroad, the import capacity of the country might not be adversely affected by the export shortfall even if the member was unable or unwilling to draw under the facility. However, if reserves were already low, and if the country had no easy access to capital markets, the authorities could be constrained to restrict imports and/or to accumulate payments arrears if the country did not have access to the facility. Such measures would not only adversely affect the economic development of the country concerned but would also aggravate any balance of payments difficulties being experienced by its trading partners. The availability of compensatory financing helps to avoid such a sequence of events.

Since its establishment in 1963, the compensatory financing facility has been intended to be of special benefit to primary exporting countries, which are subject to wide fluctuations in export earnings, and to developing countries which do not have easy access to capital markets. The facility is open to all members as the Fund cannot discriminate among its members, but no industrial country9 has so far requested assistance under the facility, although some are large exporters of primary commodities.

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