Central African Economic and Monetary Community: Selected Issues

Abstract

Central African Economic and Monetary Community: Selected Issues

Cemac—Reserves Management

This paper assesses the appropriate level of international reserves for the Economic and Monetary community of Central Africa (CEMAC) and reviews the impact of the current oil-price slump. Standard approaches to reserve adequacy recommend a reserve coverage of five months of prospective imports for a commodity-dependent monetary union. Under the current outlook for oil prices, prospects for maintaining reserve coverage at this level are challenging. Against this background, the paper offers proposals to reform the CEMAC’s reserve management framework.1

A. Introduction

1. This paper seeks to identify both short- and medium-term measures to strengthen CEMAC’s reserve management arrangements. It first discusses reserves adequacy for CEMAC and reviews foreign currency asset accumulation by its member states. It then assesses the implications of the new economic environment and, building on previous IMF advice, proposes a new reserve management framework.

B. Developments in International Reserves

2. CEMAC relies heavily on oil. It is the Community’s main export commodity—at the onset of the oil-price slump in mid-2014, the oil sector represented 29 percent of the regional GDP; 79 percent of regional exports; and 54 percent of regional government revenue. Foreign exchange earnings are strongly linked to oil-sector developments. Four of CEMAC’s member countries are large oil exporters (Equatorial Guinea, Republic of Congo, Gabon, and Chad, in declining order of share of oil exports in total exports); one is a small net oil exporter (Cameroon); and the last one (CAR) is an oil importer. Some of the salient features of CEMAC’s and its member countries’ external sector are summarized in Figure 1 and Text Table 1.

Figure 1.
Figure 1.

CEMAC: Oil Production, 1980–2030

Citation: IMF Staff Country Reports 2016, 290; 10.5089/9781475535464.002.A001

Sources: Country authorities; and IMF staff estimates.
Text Table 1.

CEMAC: Relative Size of Economies and Importance of Oil Sector, 2015

(Percent of GDP)

article image
Sources: CEMAC authorities; and IMF staff estimates.

3. Until mid-2014, the regional central bank (BEAC) accumulated substantial international reserves. Reserves grew from US$1.1 billion (8 percent of total CEMAC GDP) in 2001 to US$15.3 billion (16 percent of total CEMAC GDP) in 2014 (Figure 2). This development mirrored the surge in oil export receipts, mostly from the Republic of Congo and Equatorial Guinea, whose shares in the BEAC’s total international reserves grew from 6.4 percent and 6.6 percent in 2001 to 32.2 percent and 18.9 percent in 2014, respectively. This stemmed mainly from the surge in international oil prices, but also from rising oil production. Meanwhile, the imputed contributions of Cameroon and the CAR to the BEAC’s international reserves fell from 30.8 percent and 11.0 percent in 2001 to 20.6 percent and 1.7 percent in 2014, respectively.

Figure 2.
Figure 2.

BEAC: Gross International Reserves, 2000–151/

Citation: IMF Staff Country Reports 2016, 290; 10.5089/9781475535464.002.A001

1 CEMAC reserves are higher than the sum of reserves of individual countries because of the BEAC’s own reserves.Sources: IMF AFR Database; IMF, International Financial Statistics (IFS); and IMF staff calculations.

4. The BEAC’s reserves have declined significantly following the oil-price shock. With substantially lower foreign exchange proceeds in the wake of the oil-price slump since mid-2014, reserve coverage declined to 4.6 months by end-2015.

5. An important share of the BEAC’s foreign currency assets has been held by some member states outside CEMAC. Partial compliance with the BEAC’s reserve pooling requirement has thus been undermined, particularly by some of the of the largest oil exporters. It was estimated, based on indirect methods, that foreign currency assets held outside CEMAC may have represented up to 14 percent of the BEAC’s international reserves at end-2015 (Figure 3).2

Figure 3.
Figure 3.

CEMAC: Member States’ Reserves at the BEAC, 2007–15

(Billions of US dollars)

Citation: IMF Staff Country Reports 2016, 290; 10.5089/9781475535464.002.A001

Sources: IMF, AFR database; and IMF staff estimates.

6. The reluctance of some member states to surrender all their foreign currency assets may be motivated by a number of considerations, including

  • a desire to retain full ownership and control;

  • a desire to earn higher returns on foreign currency assets than those paid on deposits at the BEAC;

  • concerns about safeguards risks; and

  • requests by some development partners to hold counterpart funds for investment projects they finance.

C. Reserve Adequacy Considerations

7. Reserve projections point to immediate challenges. Using June WEO 2016 oil-price assumptions,3 the BEAC’s international reserves are forecast to decline from US$10.1 billion at-end 2015 (excluding non-repatriated assets) to US$7.9 billion at end-2016 (3.4 months of prospective imports), as a result of widening current account deficits for the region’s net oil exporters (Figure 4). In the medium-term, reserves would increase moderately to US$ 9.6 billion by 2021, in line with oil-price and production projections, but reserve coverage would still be below 4 months of prospective imports. In the event of lower-than-projected oil prices, CEMAC’s external sustainability could be under stress.

Figure 4.
Figure 4.

CEMAC: International Reserves Assets Import Cover, 2000–21

(Months of prospective imports of goods and services)

Citation: IMF Staff Country Reports 2016, 290; 10.5089/9781475535464.002.A001

Sources: WEO database; and IMF staff estimates.

8. Against this background, international reserves covering five months of regional prospective imports could be considered as the desirable (“target”) objective for CEMAC, a resource-rich currency union. This recommendation is based on the assessment made by IMF staff in the context of the 2016 regional consultation with CEMAC (see companion staff report). A five-month threshold was also considered appropriate by an ad hoc working group, set up by the BEAC in August 2012. The working group assessed the desirable reserve adequacy as the level required to cover both five months of CEMAC imports and the following year’s public external debt service.4 The working group considered that this dual benchmark was broadly met at end-2011.5

9. Under current assumptions, the BEAC’s foreign assets are not expected to reach the target objective of five months imports in the medium term. Depending on the possible repatriation of foreign currency assets currently held abroad, the margin below the objective would stretch from narrow to wide. On this basis, it does seem appropriate to focus on ensuring the target level of reserve coverage.

10. Some member states’ non-compliance with reserves pooling is a potential source of external instability. As noted earlier, some member states are not fully compliant with the foreign exchange assets surrender requirement. This practice may be sustainable when the price of oil exceeds US$100 a barrel and the consolidated union budget is close to balance, but it has turned into a major challenge since the oil-price slump. Indeed, CEMAC’s reserves would fall significantly short of what would be needed to defend the CFA franc’s exchange rate peg credibility if adverse assumptions materialized.

D. Recommendations for Pooled Reserve Management

11. The management of the BEAC’s international reserves is governed by the monetary cooperation agreements with France. It involves four principles: (i) the French Treasury’s guarantee of free convertibility of CFA francs issued by the BEAC; (ii) the fixed parity with the euro; (iii) the lack of restrictions on transfers; and (iv) the pooling of international reserves at the BEAC, 50 percent of which are required to be held in the Operations Account opened for the BEAC at the French Treasury.6

12. In view of current risks, the BEAC should define its target level of international reserves. In 2015, it already proposed several calibrations of the desirable level of international reserves. The approach was developed in line with international standards and the calibration criteria considered were the coverage in terms of number of months of imports and the coverage of the stock of external short-term debt. Three coverage levels were considered, but actual international reserves complied only with the lowest level—which the BEAC considers insufficient.

  • Maximum risk coverage—covering six months of prospective goods and services imports and 250 percent of the public external debt service.

  • Intermediate risk coverage—covering five months of prospective goods and services imports and 200 percent of the public external debt service.

  • Minimum risk coverage—covering three months of prospective goods and services imports and 100 percent of the public external debt service.

13. The institutional framework for reserve management should provide for the achievement of the target level. It could rely on the following rules:

  • Purpose—to constitute international reserves dedicated to support the peg and external stability.

  • Ownership and oversight—the BEAC is the owner and exclusive manager of international reserves.

  • Management—international reserves are either invested in the BEAC’s Operations Account at the French Treasury or managed by the BEAC with the objectives of maintaining capital preservation, appropriate liquidity, and adequate return.

  • Foreign assets surrender requirement—the BEAC must be able to verify compliance with the requirement and take corrective action if necessary, in particular when the regional external position is weak. The corrective action should bring the nonobservant country(ies) back into compliance.

14. The BEAC should have a framework that reflects fairly each member state’s contribution to the pooled reserves. It should be based on two principles: (i) the need for each member state to contribute its fair share to the regional reserves pool; and (ii) the requirement for other member states to step in, if a member state fails to meet its required contribution (principle of “solidarity”). If a member state cannot contribute for good reasons (i.e., not enough foreign assets), appropriate mechanisms should be developed to recognize the implicit liability of this member state to pooled reserves. This liability should be reflected in BEAC’s balance sheet as debt owed to the bank. Once CEMAC reaches the target level of international reserves, excess contributors should be rewarded by providing higher returns. The BEAC should envisage a mechanism for the management of pooled reserves to make them financially attractive and thus reduce the incentive of non-compliance with the surrender requirement.

15. The enforcement of the surrender requirement should be based on a finding of non-compliance even if the target level is achieved. This enforcement should be based on objective and easy to monitor indicators. For legitimacy purposes, a declaration of non-compliance should be the result of a decision by a majority of member states (or a similar rule). Enforcement of the rule should be firm to promote compliance. The severity of the remedial action should depend on the extent of the harm caused by the non-compliance and the extent to which non-compliance is deemed to be voluntary.

E. Securing Appropriate Resources to Back Reserves

16. The BEAC’s international reserves mainly stem from the surrender of foreign assets generated by oil exports, received from governments. In exchange for depositing their foreign exchange earnings, member states receive CFA francs, which are recorded as liabilities in the BEAC’s balance sheet, and as assets in member states’ balance sheets. Designing a framework, which can guarantee a sufficient level of stable resources to back international reserves, requires analyzing the rules governing the management of the member states’ accounts in domestic currency at the BEAC. Currently, these accounts are ring-fenced and are managed separately, under the guidance of the respective member states; a member state hit by a revenue shock can draw on its account at any time, without specific restrictions or rules.

17. To support the stability of international reserves, the latter need to be backed by long-term resources. Reserves stability can only be achieved if the BEAC’s long-term liabilities and equity are equivalent to the target level of international reserves. This a necessary—albeit not sufficient—condition, because an appropriate monetary policy should also avoid creating too much liquidity, which can lead to an increase in demand for foreign exchange.7 In the BEAC’s balance sheet, currency in circulation (billets et pièces en circulation), equity (fonds propres—capital et fonds de dotation, résultat and réserves) and SRD allocations (allocation de DTS) may be considered as adequate long-term resources for this purpose. At end–March 2016, these three booking entries amounted to CFAF 3,400 billion, slightly less than two-thirds of the BEAC’s total reserves.

18. To ensure the desired stable backing of international reserves, part of member states’ deposits should be transformed into long-term resources. This would enable the BEAC to fill the gap between the current amount of stable resources and the target level of reserves. Specifically, this would mean that a portion of member states’ deposits should be transformed into long-term resources (e.g., blocked deposits or incorporated into equity). In the short term, this may prove challenging for member states.

19. For reserves above the target level (“excess reserves”), there is no need for long-term resource backing. On the contrary, a more flexible scheme, potentially similar to the framework currently applied to member states’ deposits, could be envisaged. Excess reserves should receive higher remuneration than required reserves to make them financially attractive to promote full compliance with reserves surrender.

F. A Revised Investment Strategy

20. The BEAC’s current investment strategy has shown its limitations in the context of declining reserves. The BEAC created a held to maturity portfolio, when the size of reserves was growing. However, in a context of declining reserves, such a portfolio cannot easily provide sufficient liquidities when required. Indeed, the BEAC had to sell parts of its investment portfolio in 2015 to comply with its obligation to deposit 50 percent of its foreign assets in the Operations Account. Moreover, this type of portfolio represents a significant opportunity cost, as the assets cannot be sold (except in the case of sales) to replenish the Operations Account to realize marked-to-market profits; and the BEAC still holds a large amount of securities with a negative yield-to-maturity.

21. Against this background, the ministerial committee of the Monetary Union of Central Africa (UMAC) should endorse the target level of international reserves and adopt an appropriate investment strategy for them. Ministerial endorsement is important to provide political support to the target level. This strategy should buttress the CFA franc’s peg. To this end, the BEAC should ensure that the general principles of security, liquidity, and returns on assets are properly integrated into the investment strategy. The strategy should ensure at all times the availability of liquid reserves up to the target level. The strategy could involve a three-tier framework in order of diminishing liquidity:

  • Operations Account—mandatory amount deposited at the French Treasury for everyday transactions.

  • Liquidity account—used to meet all immediate cash flow requirements and avoid using the Operations Account when its deposits are just at the mandatory level of 50 percent of total international reserves.

  • Investment account—excess reserves above the target level, used to meet less probable cash flow requirements and provide a higher return. Indeed, excess reserves could be managed with a higher return objective, at the cost of lesser liquidity and higher risk.

The three-tier structure should include a mechanism to guarantee the automatic replenishment of a more liquid account with resources from a less liquid account, consistent with the hierarchy of accounts.

22. In light of the above, the BEAC has prepared a draft proposal for a new reserve management policy. It includes three portfolios: (i) a monetary portfolio including, the Operations Account, demand accounts, and term accounts with correspondents; (ii) a trading portfolio to serve as a supplementary source of liquidity to cover immediate liquidity needs; and (iii) and investment portfolio for higher returns in exchange of lesser liquidity. The investment portfolio would be managed “passively” and consist mainly of securities held to maturity. The BEAC could use this revised strategic asset allocation framework to fulfill its policy objectives. The size of the monetary and trading portfolios should always be at least equal to the target level of reserves. The investment portfolio, which is not a liquid portfolio, should not be considered part of the international reserves available for immediate mobilization, and therefore not accounted in the target level of international reserves. This portfolio should only hold excess reserves. It should be equipped with a transfer mechanism to replenish liquid reserves, should they fall below the target level. The reserve portfolio should be benchmarked against objectives in terms of market, exchange, liquidity, and credit risks. The BEAC has already adopted strict rules for risk management and appropriate portfolio monitoring tools required to implement benchmarked portfolio management. These should prove to be useful when the new reserve management strategy is put in place.

23. Existing constraints in the BEAC’s trading room hamper reserve management reform efforts. In a context of declining reserves, the BEAC should reinstate full reserve management capacities to its trading room to ensure that international reserves are managed more dynamically to meet liquidity needs. Given that best practices do not recommend immobilizing a substantial portion of international reserves in an investment portfolio, direct and active management by the trading room is particularly important. More active reserve management would help increase the liquidity of investments and reduce the risk that forced sales of international reserves result in unnecessary losses. The BEAC should rely on its operational rules and procedures to supervise the management of reserves.

References

  • International Monetary Fund, Assessing Reserves Adequacy, IMF Policy Paper, February 2011.

  • International Monetary Fund, Assessing Reserves Adequacy—Specific Proposals, IMF Policy Paper, April 2015.

  • International Monetary Fund, Central African Economic and Monetary Community (CEMAC) Financial System Stability Assessment, April 2016.

  • Dabla-Norris, E., J. I. Kim, and K. Shorono,Optimal Precautionary Reserves for Low-Income Countries: A Cost-Benefits Analysis, IMF Working Paper 11/249, 2011.

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1

Prepared by Vincent Fleuriet and Jose Gijon.

2

Based on data from the Bank for International Settlements (BIS) on overseas deposits by CEMAC’s non-banking sector.

3

The projections are based on an average oil price of US$44 per barrel in 2016, recovering to an average of US$55 per barrel by 2021.

4

The five-month import cover corresponds to an intermediate benchmark among three considered by the working group. This benchmark takes account of the strong volatility in foreign currency assets in CEMAC. (Comité Mixte sur le Rapatriement des Avoirs en Devises des États Membres de la CEMAC, August 2012).

5

It continued to be met until end-2015.

6

The Convention for the Operations Account of October 3, 2014 provides that the BEAC must deposit on average over ten days 50 percent of its international reserves to that account, with a minimum of 40 percent. The 50 percent are calculated on the total of international reserves excluding SDRs, and long-term investment resources constituted by the Fonds de Réserve pour les Générations Futures.

7

When the BEAC injects liquidity into CEMAC economies (directly to governments or via banks), beneficiaries may use these liquidities to buy foreign exchange from the BEAC, thereby putting downward pressure on reserves. At end–March 2016, member states had CFAF 1.6 billion in their accounts at the BEAC that could be used to buy foreign exchange. Therefore, an appropriate liquidity management is critical to avoid unnecessary pressure on international reserves.

Central African Economic and Monetary Community: Selected Issues
Author: International Monetary Fund. African Dept.
  • View in gallery

    CEMAC: Oil Production, 1980–2030

  • View in gallery

    BEAC: Gross International Reserves, 2000–151/

  • View in gallery

    CEMAC: Member States’ Reserves at the BEAC, 2007–15

    (Billions of US dollars)

  • View in gallery

    CEMAC: International Reserves Assets Import Cover, 2000–21

    (Months of prospective imports of goods and services)