West African Economic and Monetary Union Staff Report on Common Policies of Member Countries

Discussions with Regional Institutions—Staff Report and the Executive Director’s Statement

Abstract

Discussions with Regional Institutions—Staff Report and the Executive Director’s Statement

Executive summary

Economic Policies and Crisis Response

Economy: With an average growth slowdown of 1 percent in 2009 and inflation below 2 percent, most WAEMU countries have weathered well the second crisis in three years because of limited global financial integration, favorable terms of trade, and Côte d’Ivoire’s post-conflict recovery.

Public finance: While government revenues held up well in most countries, deficits increased by an average of 2 percent of GDP in 2009, pushed by higher capital and current spending.

Monetary policy: The central bank adjusted its stance to changes in economic and liquidity conditions once the risks of second-round inflation effects of the 2007-08 food and fuel price shocks had passed. It lowered its refinancing rate and provided governments with significant direct credits and refinancing guarantees.

Key Assessments

Economic outlook: Growth is expected to return to pre-crisis levels in 2010, assuming a gradual global recovery.

Exchange rate policy: Despite eroded competitiveness and convergent but inconclusive indications of a modest exchange rate overvaluation, the Union is not at risk of external instability.

Financial sector: The financial sector weathered the crisis undamaged but is underdeveloped and not well supervised.

Challenges Going Forward

Fiscal and monetary policy stances: Key near-term challenges are to resist current spending pressure and prepare to tighten monetary policy if inflationary pressures reemerge.

Government domestic arrears: The BCEAO’s exceptional lending to governments following the SDR allocation had allowed them to reduce outstanding arrears, but more is needed to avoid arrears reemerging in WAEMU countries and strengthen fiscal discipline -including by improving regional liquidity management, better coordinating fiscal and monetary policies, and strengthening public finance management procedures.

Competitiveness: Medium-term challenges will be to boost growth, create jobs, and make a bigger dent on poverty by reducing the cost of doing business and attracting more FDI. Priority should be given to the financial sector and the integration of WAEMU country markets.

Financial stability: Member countries should continue implementing FSAP recommendations by improving compliance with prudential ratios and developing risk-based prudential and financial crisis-resolution frameworks.

Trade policy: A priority should be to promote regional integration with other ECOWAS countries while resisting pressures for more protection.

Economic Policy Responses

A. The global crisis and other recent economic developments

The shock from the global crisis was relatively mild in the WAEMU.

Zone-wide economic growth is estimated to have declined by just 1 percent in 2009, to 3 percent. This economic resilience appears related to favorable terms of trade for the region as a whole and a strong upturn in Cote d’Ivoire, the main economy of the union. In Togo, stepped-up donor support and a rebound of food production following flood damage led to a pick-up in growth. In the other WAEMU countries, lower prices and volumes of exports, in particular cotton helped slow growth, which in the case of Benin was amplified by the spillover of the crisis from Nigeria (Table 4)

Table 4.

WAEMU: Selected National Accounts and Inflation Statistics, 2005–2014

(Percent change, unless otherwise noted)

article image
Sources: IMF, African Department database; and staff estimates.

Includes HIPC.

Inflation pressures abated significantly in 2009, although a slight uptick is anticipated in 2010. Compared to 7.4 percent in 2008, annual average increase in the union’s harmonized CPI is estimated to decline to 1.1 percent in 2009 and to remain close to the target of 2 percent in 2010.

The Union’s external position has not been affected by the crisis. The pooled international reserves were maintained well above 5 months of import cover in 2009 in gross terms, in part because of several one- off factors such as the SDR allocation, representing half a month of imports, and foreign exchange proceeds from a privatization in Mali, representing a fifth of a month of imports (Table 1).

Figure 1.
Figure 1.

WAEMU and Sub-Saharan Africa: Real GDP Growth, 2000-10

(Percent change)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF, African Department database.
Figure 2.
Figure 2.

Sub-Saharan Africa and WAEMU: Consumer Prices, 2000–10

(Annual average, percent change)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF, African Department database.
Figure 3.
Figure 3.

WAEMU: Gross International Reserves, 2005-09

(Months of Imports of Goods and Services)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF, Africa Department Database.
Table 1.

WAEMU: Selected Economic and Financial Indicators, 2005–2014

article image
Sources: IMF, African Department database; World Economic Outlook; and staff estimates.

Data as of October 2009.

Gross official reserves divided by short-term domestic liabilities.

Sum of Exports and Imports to GDP.

B. Government spending on the rise across the Union

Fiscal policy was appropriately eased in 2009, but not as a result of explicit countercyclical measures.

In many WAEMU countries, deficits were already on the rise before the global crisis. Subsidies to offset the effects of the 2007-08 food and fuel crisis, combined with other country-specific factors, such as pre-election slippage (Benin), and capital spending related to one-off revenues (Niger), led to the beginning of a fiscal expansion even before the effects of the global crisis were felt (Table 5).

Table 5.

WAEMU: Fiscal Balances, 2005–2014

(Percent of GDP)

article image
Sources: IMF, African Department database; and staff estimates.

When the crisis hit, it further weakened the fiscal position of several WAEMU countries. All member countries except Guinea Bissau and Senegal experienced a deteriorated fiscal deficit in 2009 compared to 2008. The zone-wide fiscal deficit is estimated to have risen to 3.7 percent of GDP in 2009 (including grants), from 2 percent in 2008.

Automatic stabilizers and measures targeted to supporting growth after the global crisis played a limited role in the fiscal easing. Revenues are estimated to have remained broadly stable in most WAEMU countries in 2009, despite a decline in demand for exports due to the global crisis. Expenditure overruns, largely unrelated to the crisis, weakened the fiscal position of several WAEMU countries. Government expenditures are believed to have increased from an average of 22½ percent of GDP in 2008 to 24½ percent in 2009.

Figure 4.
Figure 4.

WAEMU: Overall Fiscal Balance Including Grants, 2008–10

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF, African Department database.
Figure 5.
Figure 5.

WAEMU: Total Revenue Excluding Grants, 2008–10

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF, African Department database.
Figure 6.
Figure 6.

WAEMU: Total Expenditure, 2008–10

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF, African Department database.

C. A need to strengthen revenue capacity and rebalance expenditure to support growth

Government budgets aim at some fiscal consolidation in 2010, but risks remain.

As a region, the challenge will be to adopt a fiscal policy that supports a sustainable growth path. Medium-term country projections assume a modest fiscal retrenchment beginning in 2010. Although the aggregate retrenchment falls short of bringing the regional primary fiscal deficit back to its pre-2009 level, no member country appears to face significant increased risks to debt sustainability. However, WAEMU countries will need to seek ways to broaden and deepen the revenue base while rebalancing expenditures toward poverty reduction and investment.

There is a risk of lower than expected tax revenues starting in 2010 due to volatile commodity prices and pending tax exemptions or reductions. Cocoa prices are projected to decline by over 30 percent in 2010; and the WAEMU commission recently opened the way to tax shortfalls by allowing countries to introduce a zero VAT rate on a limited number of goods.

Some expenditure increases may be less supportive of growth—the continuous increase in the central government wage bill as a share of GDP in all countries except Côte d’Ivoire and Niger risks undermining the capacity to undertake pro-growth policies in the Union; the projected reversal of this trend will require firm regional resolve. Other projected expenditure increases may undermine the quality of spending—including the steep increase in capital spending in countries like Benin -which may spill over into 2010 and beyond.

Figure 7.
Figure 7.

WAEMU: Primary Fiscal Balance, 2005–2014

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF, African Department database.
Figure 8.
Figure 8.

WAEMU: Central Government Wage Bill, 2005–2014

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF, African Department database.
Figure 9.
Figure 9.

WAEMU: Central Government Capital Expenditure, 2005–2014

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF, African Department database.

D. Discussions on the fiscal policy stance

Staff Views

Staff advised tightening fiscal policy once the recovery is confirmed or if inflationary or external pressures return. Côte d’Ivoire, Guinea-Bissau, and Togo have not yet recovered a sustainable debt position or are still at medium risk of debt distress. Risks of pre-electoral spending pressures in many countries (Togo, Côte d’Ivoire, and Burkina Faso in 2010, Benin in 2011) and large spending programs initiated after the food and fuel price crises might lead to prolonged fiscal deficits and generous public wage concessions. This could translate into domestic price increases and a rapid deterioration of the external position of the region when the impact of several favorable factors in 2009 dissipates (terms of trade, SDR allocation, one-off privatization receipts).

Staff expressed concern that a failure to unwind the fiscal expansion in a timely manner could dampen long-term growth prospects. The additional government spending has increased the financing needs in member countries, (1) exacerbating the growing problem of payments arrears in many countries and highlighting the need to strengthen public financial management; (2) requiring levels of financing which the regional market may be unable to absorb thus crowding out private investment; and (3) increasing the risk of inflationary pressures reemerging in 2010.

Staff recommended rebalancing expenditure away from the measures to mitigate the food and fuel crisis and toward affordable social safety nets and investment. The latter could be done through regional initiatives.

Authorities’ Views

The authorities share staff concerns about fiscal policy having loosened in 2009. The Council of Ministers called for an unwinding of the fiscal easing in its December 2009 communiqué. The BCEAO expressed concern about the challenges posed by a prolonged easing of the fiscal stance across the region, including the capacity of the regional market to absorb the increased financial requirements that may result and the growing problem of payment arrears. However, the WAEMU commission stressed the need to weigh macroeconomic stability considerations against the serious infrastructure bottlenecks, especially energy and transport infrastructure, that ought to be alleviated to unleash the region’s growth potential.

Staff is of the view that the BCEAO’s call for unwinding the fiscal easing is appropriate.

E. Underlying conditions affecting monetary policy

The central bank has been keen to avoid second-round inflation effects stemming from food and fuel prices

The BCEAO’s main objective is to pursue price stability, understood as keeping inflation in the WAEMU zone below 2 percent. This inflation target is in line with the ECB target, which should facilitate management of the CFA franc peg to the euro. Inflation rates in the WAEMU are more volatile than in the euro zone because the harmonized CPI basket has a larger share of food. The core inflation (excluding food and fuel) is less so. This has led to significant discrepancies between program objectives and realizations. Regional 12-month inflation rose to double-digit levels in the course of2008, then declined steadily as the pressure on food and fuel prices abated, reaching negative territory in July 2009.

BCEAO has managed its policy rate with a view to keeping inflation in check and promoting growth. In response to rising inflationary pressures fueled by the food and fuel crisis, the BCEAO increased its policy rate twice, in August 2006 and August 2008, to 4.75 percent. Once inflation eased, in June 2009 the BCEAO reduced the rate to 4.25 percent, but later and by less than the ECB, which undertook an aggressive interest rate reduction to forestall the impact of the financial crisis.

Interbank rates broadly followed the policy rate. Interbank interest rates in the WAEMU zone tracked the decline of the BCEAO policy rate, which helped maintain investment and growth. However, they remained substantially different from the euro zone rates because of limited capital mobility.

Figure 10.
Figure 10.

WAEMU and Euro Zone: Consumer Price Inflation, 2003–09

(Annual percent change)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: BCEAO
Figure 11.
Figure 11.

WAEMU and Euro Zone: Policy Interest Rates, 2003–09

(Percent, average)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF, African Department database.
Figure 12.
Figure 12.

WAEMU and Euro Zone: Interbank Interest Rates, 2003–09

(Percent, average)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF, African Department database.

F. An appropriately accommodating monetary policy stance

The BCEAO reacted proactively to the financial crisis.

Additional liquidity injected as needed

When inflation was sufficiently contained and some banks needed immediate support in the wake of the financial crisis, after December 2008 the BCEAO injected substantial amounts of liquidity through weekly auctions. The BCEAO started to scale down its liquidity injections when it switched to other instruments, in the second quarter of 2009. To respond to banks’ structural needs, the BCEAO also launched a one-month standing refinancing window at a fixed rate with no ceiling.

Reserve requirements reduced

As part of the move to unify reserve requirements across the zone, as recommended by the Fund’s FSAP, the BCEAO in June 2009 reduced the reserve requirements ratio for banks in Benin, Mali, and Niger. This reduced the average reserve requirement from 7.5 to 6 percent and the spread between the maximum and the minimum reserve requirements from 12 to 6 percentage points.

Interbank rates influenced

Since June 2009 for the first time the BCEAO has succeeded in steering the interbank interest rate within the corridor between its policy rate and the marginal rate of liquidity injections, While interbank rates have been in the corridor for only a short period of time, this may suggested better transmission of signals from the central bank to market participants.

Figure 13.
Figure 13.

WAEMU: Liquidity Injections, 2009

(Billions of CFA Francs)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: BCEAO, and IMF staff estimates.
Figure 14.
Figure 14.

WAEMU: Minimum Reserve Requirements, 2002–09

(Percent of deposits and credit)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: BCEAO, and IMF staff estimates.
Figure 15.
Figure 15.

WAEMU: Selected Policy Interest Rates, 2007–09

(Percent)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: BCEAO and IMF staff estimates.

G. Addressing the domestic arrears issue

The accumulation of government domestic arrears threatens the health of the financial sector.

According to a recent survey of member governments compiled by the central bank, the stock of government domestic arrears is estimated at CFAF 1,400 billion as of April 2009, the equivalent of 4.3 percent of WAEMU GDP and well above most SSA countries. Although all WAEMU countries except Benin run domestic arrears, Togo and Guinea-Bissau have a disproportionate share of the total.

The accumulation of arrears spans several years. Causes include lack of proper coordination of fiscal and monetary policies, weak management of liquidity on the regional financial market, and weak public financial management. The negative impact extends to private sector government suppliers, who in turn face difficulties in repaying their loan commitments to the banking sector.

Figure 16.
Figure 16.

WAEMU: Domestic Arrears Stock by Country, 2009

(Billions of CFA Francs)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: BCEAO and IMF staff estimates.

The authorities’ action plan will inject a large amount of liquidity in the banking system.

The WAEMU took exceptional steps in September 2009 to help governments reduce arrears and their negative impact on private sector and commercial bank balance sheets:

  • ✓ Reversing a 2003 decision to suspend central bank direct financing of member governments, the WAEMU countries agreed that the BCEAO would lend them the domestic currency equivalent of the Fund’s general SDR allocation for 10 years at 3 percent interest. These loans amount to the equivalent of 1.5 percent of WAEMU GDP. Under the regional central bank statutes, the Fund’s SDR allocations are not passed on to WAEMU member’s treasuries but added to the pooled reserves of the BCEAO.

  • ✓ In addition, the central bank made eligible for refinancing an equal amount of government bonds with a maturity of seven years that would be issued for arrears clearance.

  • ✓ During the last quarter of 2009, government bonds for the equivalent of0.6 percent of GDP were issued under this initiative.

  • ✓ The BCEAO is also considering refinancing government paper used as a counterpart for specific country arrears clearance operations, including to commercial banks.

H. Discussions on the monetary policy stance and domestic arrears

Staff Views

The mission expressed concern about the macroeconomic impact of the exceptional measures taken in late 2009 to address the arrears. Significant liquidity injections and refinancing of government paper by the BCEAO may harbor inflationary potential, especially if there is no return to fiscal discipline, and weaken the Union’s external position.

There is a risk governments may use direct BCEAO financing for current expenditure that leads to a more expansionary fiscal stance or for purposes other than reducing domestic arrears, such as to substitute for other types of financing.

While implementation of the recently adopted action plan to reduce government domestic arrears will improve the liquidity of the private sector and commercial bank balance sheets, it does not guarantee an effective and durable reduction in domestic claims on government. To ensure that arrears do not reemerge, the WAEMU institutions should recommend that governments adopt more realistic revenue projections and step up efforts to control spending; and the BCEAO should improve liquidity management and coordination in the issuance of government papers so country treasuries can cover their liquidity needs promptly and avoid payment delays.

Authorities’ Views

The BCEAO is ready to tighten monetary policy if need be in 2010. The central bank saw little risk of inflation, despite the substantial injection of liquidity in late 2009, but underlined that it was willing to use all instruments to achieve its monetary targets for next year, to keep the inflation rate at 2.2 percent.

To limit monetary expansion, the BCEAO would reduce liquidity injections or cancel liquidity auctions, limit injection through the standing one-month facility, and, if needed, issue central bank bills.

Staff Response

The mission agreed that these short-term inflationary risks are remote but underlined the longer-term risks of accommodating larger fiscal deficits, including through the direct loans to governments backed by the general SDR allocation. Staff called for vigilance on the part of the BCEAO should governments fail to implement fiscal restraint in 2010.

Coordinating domestic policies

A. Regional liquidity management and forecasting

The WAEMU authorities have moved to better manage liquidity.

In November 2009 the Council of WAEMU Economic Ministers adopted a series of measures to improve the coordination of government bond issues on the regional market and improve its liquidity:

  • ☐ The BCEAO will collect annual government issuance plans and discuss with national treasuries a schedule that ensures that governments can access regional financial markets when they most need to during their budget implementation cycle.

  • ☐ A review mechanism will be launched in the first quarter of 2010 to share experience with bond issuance among member countries.

The BCEAO has improved its liquidity forecasting at the regional level. It hasmoved from liquidity projections based on commercial banks 'cash flow forecasts to a systematic liquidity projection exercise, based on the central bank’s projections of the autonomous factors of liquidity, including WAEMU Treasuries needs.

Figure 17.
Figure 17.

WAEMU: Emissions of Government Paper, 2009

(Billions of CFA Francs)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: BCEAO, and IMF staff estimates.
Figure 18.
Figure 18.

WAEMU: Savings Investment Balance, 2009

(Percent fo GDP)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF, African Department database.

B. Public financial management

Weak expenditure execution and expost controls facilitated accumulation of arrears

Inadequate budget procedures and institutions contributed to domestic arrears. Weak rules and controls for budget execution eased recourse to unfunded spending commitments and extra- budgetary expenditures, directly contributing to the steep increase in domestic arrears in several countries. Parliaments and Government Accounting Offices do not have the independence and the means for proper budget oversight.

Although several WAEMU countries have improved their budget preparation and approval process, their medium-term planning is rarely effective. Several WAEMU countries are considered to have stronger than average budget planning and negotiation capacity compared to the average SSA country (see Dabla-Norris, et al., 2010). However, capacity to plan fiscal policy over the medium term is low; effective medium-term budget frameworks would improve annual budget projections and reduce the risks of unfinanced spending.

Forceful implementation of the new WAEMU PFM guidelines would prevent the reemergence of arrears.

The WAEMU commission has launched, with Fund technical assistance, an ambitious program of PFM reform in the region. In 2009 the WAEMU countries adopted six regional PFM guidelines, covering all aspects of the budget cycle; most reforms should be effective by 2016. Implementation is facilitated by a multidonor program of assistance and capacity- building for the region.

Progress on PFM reforms will depend on the design of country-specific programs with strong ownership and well-identified priorities. Peer reviews could facilitate a more effective knowledge exchange between members and help accelerate change.

Figure 20.
Figure 20.

WAEMU and Sub-Saharan Africa: Quality of Budget Implementation

(Index)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: Dabla-Norris, et. Al. Forthcoming.

C. Fiscal and monetary policies in the region and the institutional reform

Should the BCEAO enforce fiscal discipline in the Union?

The build-up of domestic arrears has put the spotlight on the intensity of fiscal pressures in WAEMU countries. Suspension of direct central bank financing of governments since 2003 and the scheduled repayment of outstanding BCEAO advances to member countries have increased governments’ domestic financing needs. At the same time, the distribution of savings and investment across countries is uneven, which provides a strong rationale for the development of a regional financial market.

The new statutes of the BCEAO, which go into effect soon, ban direct central bank financing of governments.1 Article 18 foresees that the new Monetary Policy Committee will impose a limit on the total outstanding claims of the BCEAO on governments (as a percentage of prior year fiscal revenues), which constrains commercial banks’ access to central bank refinancing of government paper. This is an indirect way to impose a financing constraint on governments.

At the same time, compliance of governments with the WAEMU fiscal convergence framework is poor. A large proportion of member countries do not meet convergence criteria, including maintenance of a basic fiscal surplus.

Fiscal policy among WAEMU countries needs to be better coordinated.

The WAEMU authorities are right to be concerned about excessive public deficits and government recourse to commercial bank financing. These may tilt the policy- mix toward tighter monetary policy (to protect the exchange rate peg) and risk crowding out the private sector.

But the regional central bank cannot by itself enforce fiscal discipline. This may distract the BCEAO from its main objective- price stability- and expose it to further risks of fiscal dominance. Furthermore, central bank ceilings on financing have been repeatedly circumvented, mainly through arrears accumulation.

Fiscal convergence in the Union is likely to remain a challenge. The multilateral framework put in place by the WAEMU treaty in 1994 to ensure fiscal discipline has not delivered. Refinements in the definition of the convergence criteria to make them less sensitive to the business cycle may help.

However, a robust process of peer review and increased budget transparency will be key to ensuring that countries adopt fiscal policies that are consistent with regional objectives.

External stability assessment

A. Exchange rate and the current account

The exchange rate is modestly overvalued in spite of a growing current account deficit.

The continued appreciation of the real effective exchange rate (REER) gives rise to a modest but growing overvaluation. The REER has appreciated by 27 percent since the 1994 CFA franc devaluation and stood at 83 percent of its pre-devaluation value at the end of 2009. The various approaches of external sustainability described in detail in Appendix II support the conclusion that the overvaluation of the exchange rate did not exceed 11.3 percent in 2008. In particular, actual REER exceeded equilibrium REER by 3.9-11.3 percent depending on whether the single-country (Johansen) and multiple- country (FMOLS) method is used. The overvaluation implied by the macroeconomic balance and external sustainability approaches ranges from 5.1 percent to 7.7 percent.

These are moderate increases relative to the 2007 assessment (0.7 percent and 9.9 percent respectively with the same methods).

WAEMU’s external current account (CA) deficit has been growing in recent years. It widened from 4.6 percent of GDP in 2002-2004 to 6.6 percent in 2009. Based on staff projections, the deficit would reach an average of 7.1 percent over the 2010-2014 period.

This exceeds both the CA norm estimated by the macroeconomic balance approach and the CA that stabilizes the net foreign assets (NFA) at the 2008 level. However, balance of payments projections over the same period suggest that the CA deficit is being financed without depletion of international reserves through increased capital inflows. The projection assumes that the WAEMU region will attract increasing inflows of net foreign direct investment (FDI).

Figure 21.
Figure 21.

WAEMU: Actual and Estimated Equilibrium REER, 1985–2009

(Index, base=2000)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMf staff estimates.
Figure 22.
Figure 22.

WAEMU: Current Account Deficit, 1990–2014

(percent of GDP)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF staff estimates.

B. Structural competitiveness to support growth

Weak structural competitiveness, including high factor costs are a drag on productivity and growth. The cost of starting and operating a business in the Union is high. According to a survey by the WAEMU Commission, which confirms other competitiveness indicators, the three most disruptive factors of production in the Union are frequent electricity outages, inadequate transportation system, and high cost of capital.

The continued appreciation of the REER over the last few years could presage a new period of sluggish growth in the region. By the authorities’ own account, long-term growth has been disappointing, especially by comparison with SSA countries outside the currency union.

While the rest of Africa steadily increases its share of world exports, WAEMU is losing export share. Due to a combination of appreciating exchange rate and structural impediments to enhanced competitiveness, the WAEMU market share in world exports has declined by 23 percent since 1999. In contrast, the share of world exports from the rest of SSA has been on the rise.

However, recent developments in FDI paint a brighter picture for WAEMU exports. Annual FDI inflow grew from 2 percent of GDP in 2000 to 3.3 percent in 2008, and is projected to have reached the SSA average in 2009, reflecting the launch of several large mining projects that will translate into higher exports in the medium term. Authorities noted that the acceleration of FDI inflow, if sustained, could spur long-term growth.

Figure 23.
Figure 23.

WAEMU and Sub-Saharan Africa: Exports to the Rest of the World

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMf staff estimates.
Figure 24.

WAEMU: Competitiveness Indicators, 1985–2008

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMf staff estimates.
Figure 25.
Figure 25.

WAEMU: Foreign Direct Investment, 2001–2009

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF, African Department database and staff estimates.

C. Policy discussions on the exchange rate and external sustainability

Staff Views

The WAEMU REER overvaluation is modest and, given the margin of error, does not warrant any radical adjustment. However, a resumption of the appreciation of the euro (to which the WAEMU CFA franc is pegged) would further hurt the region’s competitiveness and weigh on long-term growth and export performance.

The authorities should (i) minimize inflationary pressures; (ii) improve structural competitiveness factors by lowering transportation costs, ensuring a reliable electricity supply to businesses; (iii) better enforce business-friendly WAEMU and rules policies that promote regional integration, in particular competition rules; and (iv) moving forward with structural reforms aimed at harmonizing and modernizing the financial sector.

Authorities’ Views

The authorities acknowledged that the REER appreciation is a concern to them. While they expressed reservations about some of the assumptions underlying the staff assessment, they agreed that a protracted appreciation of the CFAF could weigh on the competitiveness of the region compared to the rest of the world and on its growth performance. The authorities stressed their commitment to fighting inflation; they also emphasized that the appreciating trend of the euro against the dollar may not last.

The authorities expect that growth and investment in the region will be sustained by the implementation of the Regional Economic Plan (REP). The REP, which was launched in 2006, aims at accelerating regional growth by scaling up regional priority integration- enhancing spending by CFAF 2900 billion (9 percent of 2009 GDP), of which about CFAF 2400 million are covered by external assistance. The majority of the REP’s resources (78 percent) are programmed for infrastructure projects (road, energy and telecommunications). At end-July 2009, 40 percent of the financial resources had been secured.

Authorities also expect the business environment to improve with the intended modernization of the financial sector and the nascent enforcement of competition policies at the regional level.

Financial sector reforms

A. Opportunities for development and modernization

The union needs a stronger financial system to support investment and long-run growth.

Financial sectors are less developed in the WAEMU region than in the rest of SSA. As credit to the private sector in countries like Ghana, Kenya, and Nigeria surpassed 30 percent of GDP in 2008, the ratio of private credit to GDP continued below 20 percent in the WAEMU region.

The banking sector is underdeveloped and access to bank services is very limited. Only about 5 percent of the population have access to a bank-a low number even by sub-Saharan African standards.

As African frontier markets began attracting the attention of investors seeking higher yields across the world, the WAEMU region fell behind its peers in attracting its share of investment.

There are no secondary markets, market dealers charge high fees, and regulations do not offer adequate incentives for market development. Market capitalization is very low as a percentage of GDP, even when compared to other SSA countries—notably Kenya.

The securities market was set up to attract investment, especially international investment, in government securities and local companies. But the main issuers of securities are governments, and the main purchasers of those securities are government-controlled financial institutions.

Figure 26.
Figure 26.

Selected African Countries: Private Credit, 2000–09

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: IMF, African Department database.
Figure 27.
Figure 27.

WAEMU: Number of Bank Branches, 2008

(per millions of inhabitants)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Figure 28.
Figure 28.

Selected African Countries: Market Capitalization, 2005–09

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source: BCEAO and IMF staff estimates.

B. Financial sector soundness and supervision

Financial sectors have generally weathered the crisis well, but compliance with prudential norms is low in many countries.

The financial sector proved to be resilient in the face of the recent global financial crisis, despite growing linkages to Nigeria’s troubled financial sector. The share of nonperforming loans is still significant but has not increased much as a result of the global financial crisis indicating that the spillover effect was minimal.

Although foreign correspondents have tightened trade financing conditions for some WAEMU banks, and there is some evidence that remittances have slowed, the return on equity of financial institutions has been unaffected. Profitability is particularly low in the banking industry in Benin. A few banks in Côte d’Ivoire, Togo, and Mali experienced difficulties, but these were unrelated to the crisis.

As noted in the 2007 FSAP, compliance with prudential requirements is low. However, the decline in compliance in 2009 appears related to a two-step increase in the minimum capital requirement. The effective implementation of the first step led to a decline in the percentage of banks complying with core capital requirements in 2009. The Banking Commission (BC) expects most banks to comply with the final step by year-end 2010, through mergers and acquisitions if necessary.

The BC faces several challenges in the near term: (i) improving compliance with prudential regulations; (ii) upgrading the legal and regulatory frameworks; (iii) establishing a good crisis resolution framework; and (iv) extending supervision to large microfinance institutions.

Figure 30
Figure 30

WAEMU: Non-performing Loans, 2008

(Percent of loans)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source:WAEMU Banking Commission and IMF staff estimates.
Figure 31.
Figure 31.

WAEMU: Return on Equity, 2008

(Percent)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source:WAEMU Banking Commission and IMF staff estimates.
Figure 32.
Figure 32.

WAEMU: Prudential Regulations, 2007–09

(percent of banks complying)

Citation: IMF Staff Country Reports 2011, 008; 10.5089/9781455213627.002.A001

Source:WAEMU Banking Commission and IMF staff estimates.

C. Discussions on soundness and development

Staff Views

The BCEAO and the BC should prepare preventive contingency plans and a bank restructuring strategy to deal with worst- case scenarios. They should also act swiftly through recapitalization or devolution once severe vulnerabilities have been identified.

Progress on implementing the FSAP recommendations is slow (Appendix III). The WAEMU and BCEAO should step up efforts to complete institutional reform and enhance its effects through divestiture of public sector holdings in banks, and alignment of the prudential framework with best practices.

The legal and regulatory framework needs upgrading to enhance the capacity of the BCEAO and the BC to conduct macroprudential and financial stability analysis. The bankruptcy legislation under consideration would give more protection to small depositors would help ease Finance Ministers’ reluctance to give full authority to the banking commission.

Requiring more stringent compliance with prudential requirements-including the minimum capital requirements-will help fortify the banking sector. In addition, the prudential framework needs to be upgraded for risk-based supervision and financial stability analysis.

Authorities’ Views

The high number of prudential violations should not lead to exaggerated perceptions of risks in the banking system. The level of compliance is low only in small banks. Larger and international banks are more compliant, and they account for a large proportion of deposits: 40 percent of financial institutions hold 80 percent of deposits.

Progress toward full restructuring of the banking sector will be accelerated with enforcement of the minimum capital requirements by year-end 2010.

Overall the Union is attracting more and more foreign banks. Today, states compete for private funds in the market and pay a differentiated risk premium. There are fewer liquidity issues than in the past. Some banks are now offering up to 8 year term-deposits. These are all signs that the market is moving in the right direction. That should help mobilize local resources for long-term investments.

The authorities feared the banking crisis in Nigeria would spill over to the WAEMU through Nigerian banks operating in the region, but so far no ill effects have been felt.

Other issues

Discussions on trade agreements

Recent developments in regional trade agreements...

The negotiation of a full Economic Partnership Agreement (EPA) between the European Union (EU) and the West Africa region (ECOWAS plus Mauritania) is underway and is expected to be conducted in two steps. The first would be finalization of an agreement on goods, which has been postponed several times. The main stumbling blocks are the length of the transition period to full EPA implementation and the level of EU access to the West African market. Second, negotiations on an EPA on services should be initiated in 2010.

The envisaged ECOWAS-wide Common External Tariff (CET) would provide a higher protection than the WAEMU CET. The WAEMU CET has four bands and a 20 percent maximum rate. The ECOWAS heads of states have recently agreed to expand the WAEMU CET to the ECOWAS region, but with the condition that a fifth band at 35 percent rate be added.

The project of an ECOWAS-wide common currency has experienced a number of setbacks. Adoption of a common currency in the West African Monetary Zone (WAMZ) is postponed until 2015 and for ECOWAS until 2020.

...could take the WAEMU backwards

Adoption of the EPA could lead to revenue losses for WAEMU countries. The revenue impact of the EPA is expected to be smoothed over the 10-15 year transition period and offset by financial compensation from the EU, the amount of which is still being discussed. The revenue impact of the ECOWAS CET is not yet known.

Another potential issue related to the EPA and the ECOWAS CET is trade diversion from cheaper imports to more expensive EU or ECOWAS but non-WAEMU products. That could lead to losses for WAEMU consumers. These losses could be mitigated if only a few products are selected and for only a limited time. The WAEMU authorities are in discussions with other ECOWAS countries on defining the selection criteria.

An ECOWAS-wide currency union is a long way off. Absent substantial progress in achieving convergence in many areas, even the newly proposed schedule seems very ambitious.

Staff Appraisal

A. Economic policy stances

Economic policies should be tightened once the recovery is confirmed or if inflation pressures return.

The global financial crisis has so far had a limited negative impact on short-term growth prospects for the WAEMU, with some member countries being more affected than others. Prospects for recovery in 2010 are good, supported by the monetary and fiscal easing in 2009, a projected upturn in the region’s main trade partners.

The decline in commodity prices pushed inflation down deeply in 2009, with only a mild uptick projected in 2010, while official reserves are kept stable. There are moderate risks to the outlook, both on the external and domestic sides. A sluggish global economy could slow the recovery. In the longer term, excessively accommodative fiscal and monetary policies could fail to keep inflation below the euro zone level and further jeopardize the Union’s competitiveness.

Economic policies should be tightened once recovery is confirmed or if inflationary or external pressures return. Fiscal adjustment should come first in countries less affected by the crisis or confronted with unsustainable deficits, large domestic arrears, and financing constraints on regional markets. Following the large liquidity injection to reduce government domestic arrears in 2009, monetary expansion in 2010 should not exceed nominal GDP growth; raising interest rates to achieve this objective should not be precluded.

Efforts to improve liquidity management and coordinate issuance of T-bills and government bonds on the regional market will alleviate financing constraints facing WAEMU governments and help prevent the reemergence of domestic arrears. This and the envisaged unification of reserve requirements should help develop regional financial markets.

B. Structural and institutional reforms

Structural reforms will be critical in achieving the objectives of the Union.

Once ratified by all member countries, the reforms of the WAEMU institutions provide opportunities for modernized conduct of monetary policy. However, the BCEAO maintains a questionable and hard-to-enforce role in ensuring fiscal discipline through ceilings on its total direct and indirect financing of governments. This role goes beyond price stability, the core of the central bank mandate. In the medium term, a reassessment of the respective roles of the central bank and the WAEMU commission in ensuring fiscal coordination and convergence within the Union is warranted. Priority should also be given to PFM reforms that will foster fiscal discipline and transparency.

Given the continued REER appreciation and the exchange rate peg to the euro, the Union risks protracted constraints on exports and growth. To boost the development of WAEMU economies and make a bigger dent on poverty, reducing the cost of doing business and attracting more FDI should be given the highest priority, together with the integration of WAEMU domestic markets and developments of the financial sector. Several regional initiatives have been launched, including an ambitious program of investment in regional infrastructure, but a critical mass of reforms will be needed promptly to reduce the gap with competitors in Africa and elsewhere.

Progress in implementing the 2007 FSAP recommendations is slow and compliance with prudential ratios remains low. The Union still lacks risk-based prudential and financial crisis-resolution plans.

Efforts to negotiate a balanced EPA between the EU and WAEMU and other West African countries should continue, especially the determination of adequate financial compensations for the revenue losses from the envisaged tariff reduction on EU imports.

It is proposed that regional discussions with the WAEMU authorities remain on the standard 12-month consultation cycle.

Issues for Executive Board discussion

The policy response

  • How do Directors assess the policy stance in the WAEMU? Do Directors agree that steps toward early fiscal consolidation are warranted, provided the economic recovery is well underway?

Competitiveness and structural reform

  • How do Directors assess the region's competitiveness? Do Directors agree that the main challenge is to improve the business environment through structural reforms?

Financial sector development

  • How do Directors assess the state of the financial sector in the region? What can the region do to accelerate financial sector development and improve access to financial services while also strengthening prudential supervision?

2010 Data and statistics

West African Economic and Monetary Union

Table 2.

Sub-Saharan Africa: Cross-Group Comparison, 2005–2014

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Sources: IMF, African Department database; and staff estimates.

Central African Economic and Monetary Community (CEMAC).

Including Nigeria and South Africa.

Gross official reserves divided by (base money plus government deposits).

Table 3.

WAEMU: Main Features of WAEMU Economies in 2005 1/

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Sources: World Bank, World Development Report ; IMF, Direction of Trade Statistics ; and staff estimates.

Unless otherwise indicated.

Exports to and imports from WAEMU countries in percent of total exports and imports.

Totals may not add up to 100 because of statistical discrepancy.