II Modified Adjustment Strategy
- Stéphane Cossé, Johannes Mueller, Jean Le Dem, and Jean Clément
- Published Date:
- June 1996
The realignment of the CFA franc parity in terms of the French franc in January 1994 represented a key modification of the adjustment strategy followed until then to address the rapidly deteriorating economic situation of the 14 member countries of the CFA franc zone. The devaluation was aimed at restoring macroeconomic viability in these countries, while preserving the monetary cohesion of the CFA franc zone and enhancing the momentum of economic integration. A key consideration in designing the new strategy was to ensure that the devaluation would be sufficiently large and supporting policies sufficiently strong to address the loss of competitiveness experienced during 1986–93 and thus give credibility to the new exchange rate.
The design of the individual country programs had to take into account the participation of member countries in the two regional economic and monetary arrangements—the WAEMU and the CAEMC—and the need to preserve the new peg of the CFA franc to the anchor currency, into which it remains freely convertible.4 In such an environment, monetary policy can be formulated and implemented only at the regional level, geared to the defense of the parity, while national fiscal policies—including wage policy—aim at the restoration of domestic balance, and structural reforms seek to reduce market rigidities and remove impediments to growth.
With the fixed peg geared to holding down inflation, demand management policies have to be deployed to assure both internal and external balance. Therefore, the fundamental policy objective in the context of the medium-term programs of the CFA franc countries has been both to restore government savings and to generate such primary surpluses as would allow the stabilization/reduction (as the case might require) of the debt/GDP ratio, so as to increase public investment financed from domestic resources. As the domestic private sector over the past several years has been a negligible net saver in most countries and has been reluctant to hold claims on the public sector (which has translated into a lack of domestic or regional capital markets),5 public debt in the CFA franc zone is mostly foreign held. At the same time, the statutory ceiling on central bank advances to the treasuries limits the room for monetizing fiscal deficits.6 The restoration of fiscal viability is thus tantamount to the restoration of external viability, that is, the reduction of imbalances in the external current account to a level that can be financed spontaneously from abroad on a sustainable basis.
Attainment of macroeconomic viability so defined was predicated on a two-pronged strategy. First, government revenue was targeted to increase substantially through a broadening of the tax base, which was to more than compensate for a reduction of tax rates, especially on international trade. Second, government expenditure was to be curtailed, mainly through containment of the wage bill and subsidies to public enterprises. Higher government savings from these measures, combined with increased availability of foreign financing, were to allow for a recovery in public investment, the rapid elimination of external payments arrears, and the progressive reduction of domestic arrears. Sectoral allocations of government expenditure were to give priority to the development of human resources and essential infrastructure.
Fiscal objectives also had to be consistent with the ongoing efforts to harmonize and reduce external tariffs in the two subregions and with the attendant reduction in the relative contribution of international trade taxation to government revenue.7 Policies had to take into account the regional convergence criteria that were being developed in the WAEMU and, more recently, in the CAEMC, which are to serve as tools of regional surveillance.8
Structural reforms were designed to foster the conditions for sustainable growth over the medium term through the development of a competitive private sector and regional integration. The latter objective was seen, among other considerations, as a key to reducing the vulnerability of the zone to external shocks. Structural reforms centered on liberalizing domestic and international trade, including the virtual elimination of price controls and quantitative restrictions on imports, increasing flexibility in labor markets, streamlining government and reducing progressively its involvement in the productive sectors, and, where needed, restructuring the financial sector.
The medium-term macroeconomic frameworks were set out in the respective policy framework paper of all countries with programs supported by the Fund’s structural adjustment facility/enhanced structural adjustment facility (SAF/ESAF).9 In the other countries, the design of programs supported by stand-by arrangements from the Fund was also consistent with explicit medium-term frameworks. For a few stand-by arrangements, medium-term and structural policies were already elaborated in some detail (for example, for Cameroon and the Congo), and for all the programs, World Bank staff assisted the authorities in the design of policies in the Bank’s area of expertise. The medium-term scenarios reflected the extremely difficult initial positions of most countries, characterized by negative growth, large fiscal and external imbalances, high debt/GDP and debt-service ratios, and sizable domestic and external payments arrears. The baseline paths of external current account adjustment took into consideration the strength of the policy package adopted, the need for reserve reconstitution at the subregional levels, and realistic assumptions about the potential access to normal inflows of foreign aid, including debt relief.
To restore macroeconomic viability over the medium term, the programs adopted by the CFA franc countries generally aimed at achieving (1) an early stabilization of price increases, after the initial wave of corrective inflation attendant on the devaluation, at rates approximating those in the anchor country; (2) a resumption of investment and output growth based on a shift of resources to the tradable goods sector; (3) a rapid rebound in domestic savings and a significant narrowing of external current account imbalances; and (4) a strengthening of the two regional central banks’ net foreign asset position.
Inflation was projected to accelerate sharply in early 1994 as a result of the pass-through of the devaluation and of modest increases in nominal wages; but it was to decelerate rapidly starting in the second half of the year. In the short run, inflation rates were expected to vary across countries. This was partly due to differences in country characteristics, such as the degree of openness, and in the likely changes in the terms of trade, but also because of the prospective differences in the pace of adjustment—including progress in reducing trade taxes, the scope and speed of price liberalization, and the extent of competition in domestic markets. Over the medium term, inflation rates were projected to decline and converge as a result of the common exchange rate anchor, the liberalization measures, and progress toward integration.
The new strategy sought to reverse the trend decline in output, with real GDP projected to grow on average by about 1 percent in 1994 and 4–6 percent on average over the medium term. The recovery of output was to derive from the shift in resources from low-growth protected sectors and nontraded goods activities to tradables in which countries enjoyed a comparative advantage. Agriculture, which employs most of the population, was expected to be the first to benefit from the exchange rate action because of higher producer prices for cash crops and the expected shift of domestic consumption toward domestic goods. Similarly, the sectors engaged in non-traditional exports and in the production of import substitutes were expected rapidly to utilize existing idle capacity, as well as to benefit from the cost compression efforts of previous years.
The average investment/GDP ratio was targeted to increase by about 4 percentage points to 19 percent in 1994 and by an additional 1–2 percentage points during 1995–96. At the same time, the strategy sought to narrow the resource gap—and ultimately the external current account deficit—by raising the domestic savings/GDP ratio by 5 percentage points to 18 percent in 1994 and by an additional 4 percentage points during 1995–96. The recovery in domestic savings was to derive from improvements in the public sector financial position, at the levels of both the Government and the public enterprises, and from improved profitability in the tradable goods sector. With the narrowing of the resource gap and an increase in official grants translating into smaller external current account deficits, a return of flight capital, and a higher level of external financial assistance, the net international reserve positions of the two regional central banks were expected to improve considerably in 1994 and remain strong thereafter.
Fund-Supported Programs, Creditors, and Donors
Following the devaluation, 11 programs supported by use of Fund resources were put in place before end-March 1994, and the remaining two in May and September. In countries where the design of reforms and discussions on structural policy issues, including with the World Bank, were already at an advanced stage (Benin, Burkina Faso, Côte d’Ivoire, Equatorial Guinea, Mali, and Togo), programs could be supported forthwith by ESAF arrangements. In other countries (Cameroon, the Central African Republic (the C.A.R.), Chad, the Congo, Gabon, Niger, and Senegal), Fund support was extended initially through stand-by arrangements because speed was seen as of the essence to give a firm orientation to policies and medium-term strategies were not sufficiently articulated. In all of these cases, however, the expectation was that the stand-by arrangements would be replaced by arrangements under the ESAF or the extended Fund facility (EFF) as soon as conditions permitted and the initial programs had been implemented satisfactorily.10
All together, Fund financial support under the 13 arrangements (including multiyear arrangements) that were approved in 1994 amounted to about SDR 1.0 billion, for an overall average annual access of about 40 percent of quota (Annex I, Table 51). Program reviews were completed as scheduled with the WAEMU countries (except Niger) and with Gabon. In addition, the stand-by arrangement for Senegal was replaced by a three-year ESAF arrangement in August 1994.11 With the exception of Gabon, the programs of the CAEMC countries went offtrack. Most of these countries, however, subsequently embarked on staff-monitored programs to re-establish the momentum of adjustment and pave the way for the eventual resumption of Fund financial support once policy performance had improved.
Fund and World Bank staff have cooperated closely in assisting these countries in the design of their adjustment programs, with the World Bank focusing on the structural, sectoral, social, and human resource aspects of policies. Bank disbursements of exceptional aid to the CFA franc countries in 1994 exceeded US$0.9 billion under Structural Adjustment Loans, Economic Recovery Credits, and other quick disbursing funds, as well as the Fifth Dimension (for Cameroon, Côte d’Ivoire, and Senegal). Furthermore, regional institutions, notably the African Development Bank and the European Union, as well as bilateral creditors, in particular, France, provided substantial exceptional financial assistance. The great majority of CFA franc countries also obtained rescheduling of eligible bilateral official debt and arrears under the auspices of the Paris Club in 1994, for an amount equivalent to about US$7 billion.
Given the weak foreign reserve position of the BCEAO and the BEAC at end-1993, the requirement to maintain a 20 percent foreign exchange cover of their sight liabilities imposed de facto a sizable reconstitution of the balances in the operation accounts in 1994 as an objective of policy.
This can be traced largely to the earlier forced placement of government paper with bank and nonbank financial institutions and to the accumulation of arrears to the domestic private sector.
The statutory ceiling on outstanding government borrowing from the common central banks was attained or exceeded by all countries during 1992–94.
These measures have already resulted in the implementation of a common external tariff and a preferential internal tariff in the CAEMC. Progress in that direction is under way in the WAEMU.
See Annex II.
See Section II below for the status of arrangements with the Fund.
Cameroon and the Congo became ESAF-eligible in February 1994 and May 1995, respectively. Gabon is not ESAF-eligible.
The third annual arrangements under the ESAF for Benin, Burkina Faso, and Mali were approved on May 22, 1995, May 30, 1995, and April 11, 1995, respectively; and the second annual ESAF arrangement for Côte d’Ivoire was approved on May 19, 1995. The review under the first annual ESAF arrangement for Togo was completed on May 31, 1995, and the review under the first annual ESAF arrangement for Senegal was completed on June 9, 1995. Finally, an ESAF arrangement for Chad was approved on September 1, 1995, a new stand-by arrangement for Cameroon was approved on September 25, 1995, and an extended arrangement for Gabon was approved on November 8, 1995.