Central African Economic and Monetary Community: Selected Issues

Abstract

Central African Economic and Monetary Community: Selected Issues

Cemac—Institutions and Medium-Term Fiscal Framework

Although the institutional framework of the Economic and Monetary Community of Central Africa (CEMAC) appears reasonably sound, the slump in oil prices has brought to the fore coordination weaknesses, which, if not addressed, could threaten the monetary union. In particular, financing needs associated with widening fiscal and external current account deficits have raised concerns about macroeconomic stability and highlighted the need for a significant fiscal adjustment. To address these challenges, the CEMAC Commission has begun to strengthen the regional surveillance framework and has expressed interest in implementing counter-cyclical fiscal policies. This paper discusses the design and implementation issues involved in establishing a credible medium-term framework for fiscal sustainability.1

A. Institutional Setup

1. CEMAC has necessary institutional instruments to implement sound and coordinated macroeconomic policies. CEMAC’s main decision making body is the Conference of Heads of State. The Conference meets and its presidency rotates among member states annually. Its major function is to determine the main objectives of the Community. It nominates the heads of most CEMAC institutions.

2. The Commission is the main management and administrative body of CEMAC. Following the example of the European Union, the Commission is composed of Commissioners from each member state, led by a President and a Vice-President. At present, four Commissioners have been appointed for the following policy areas: economic and monetary policies; the common market; infrastructure and sustainable development; and human rights and good governance.

3. CEMAC’s regional central bank is the BEAC. The BEAC issues the common currency (the CFA franc), which is pegged to the euro, and pools foreign exchange reserves of member states. It conducts a single regional monetary policy, with the goal of preserving price stability. The inflation target and instruments are defined by the BEAC’s Monetary Policy Committee, which includes the governor, the vice-governor, a representative of each of the member states, one member appointed by France,2 and four representatives from CEMAC countries.

B. Macroeconomic Policy Coordination

4. In principle, the CEMAC Commission coordinates its members’ macroeconomic policies and addresses a number of important common challenges. Its multilateral surveillance focuses on members’ compliance with a set of “convergence” criteria. Achievements have been substantial, but more macroeconomic policy coordination needs to be strengthened.

5. Theoretical evidence suggests that fiscal and monetary policy coordination leads to better outcomes in terms of achieving price stability.3 To achieve such a coordination, a number of conditions must be met, including free movement of capital, a credible no bail-out commitment, no monetization of public debt, and sensitivity of sovereign interest rates to fiscal behavior.4 In other words, financial markets must be sufficiently developed to transmit price signals between fiscal and monetary policies. However, this is not currently the case in CEMAC, where the financial market, in particular a secondary market for government securities, is at an early stage of development.

6. In CEMAC, fiscal and monetary policies are designed and implemented by independent bodies. Although the BEAC conducts the Community’s common monetary policy, fiscal policy in member countries is designed and implemented by individual ministries of finance. As such, each country sets its own fiscal deficit target based on national priorities. In practice, once national budgets are approved, the BEAC adjusts its monetary policy to accommodate the financing needs of the aggregate fiscal deficit at the regional level, either directly in the form of “statutory advances,” or indirectly through its refinancing window for commercial banks and changes in the reserve requirement. Consequently, there is a risk that, (i) when the overall fiscal deficit at the regional level widens (as in recent years), the BEAC loses control of domestic liquidity; and (ii) higher fiscal deficits exert pressure on the external position.

7. There are rules for the BEAC’s financing of governments. Although financing of governments by the BEAC is in principle forbidden, there are some exceptions: statutory advances and refinancing of commercial banks on sovereign collateral are allowed up to 20 percent and 35 percent of the previous year’s fiscal revenue, respectively. The BEAC also monitors the overall fiscal and debt stance of member countries.

8. In addition, the CEMAC Commission monitors convergence of economic performance through a multilateral surveillance mechanism. The CEMAC Treaty specifies measures to promote compliance with the regional convergence criteria. The Council of Finance Ministers adopts the rules required for the convergence of national economic policies and their harmonization with the regional monetary policy. It also establishes the terms of their application and the timeframe for implementation. For the purposes of multilateral surveillance, the Commission issues decisions specifying the types of information required for surveillance, including statistical data and information relating to economic policy measures, and members comply on a regular basis. If a member country fails to satisfy the convergence requirements, the Commission can propose corrective measures. During the commodity super cycle of 2010–14, the tasks faced by the Commission were not challenging because economic growth was strong, inflation was low, and external imbalances were limited. As a result, policy dialogues were ex post presentations of policy measures taken by member states and were thus not useful for seriously influencing economic policy decisions of member countries. Following the oil price slump, the Commission has sought to strengthen coordination of fiscal policy.

C. CEMAC’s Fiscal Surveillance Framework

9. CEMAC’s fiscal surveillance framework combines a budget balance rule with a debt rule (Table 1 and Annex I). Three of the four primary convergence criteria are of a fiscal nature: (i) central government basic fiscal balance, defined as total revenue (net of grants) minus total expenditure, excluding foreign-financed capital spending is required to be in balance or surplus; (ii) the debt rule requires central government total debt to be kept below 70 percent of GDP; and (iii) governments should not accumulate arrears. Secondary criteria include a number of fiscal targets, but they are less directly aimed at the stability of the monetary union. Since 2002, the basic fiscal balance has been used as the main indicator to track fiscal convergence. In 2008, the CEMAC Commission introduced two supplementary criteria: (i) the basic structural balance, based on oil revenue calculated using a 3-year moving average; and (ii) the non-oil basic balance (as a percent of non-oil GDP). Both indicators should be in balance or surplus.

Table 1.

CEMAC: Fiscal Benchmarks for Multilateral Surveillance, 2001–16

(Units as specified)

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Source: CEMAC commission.

10. The basic fiscal balance rule has some significant limitations.5 Although the basic balance rule is a useful measure of fiscal effort by country authorities, it does not provide a strong anchor to assess the fiscal stance and ensure long-term fiscal sustainability. The exclusion of the foreign-financed capital expenditure raises two issues. First, it excludes a substantial source of debt accumulation. Second, it discriminates among sources of financing, to the detriment of regional financing, which in CEMAC needs to be developed.6 The non-oil basic balance supplementary indicator suffers from similar weaknesses. The structural basic balance, though an interesting innovation, also suffers from the weaknesses associated with the basic balance.

11. Compliance with the basic fiscal balance rule has been uneven, raising issues about its relevance and credibility (Table 2). During the commodity super cycle, the Republic of the Congo ran large basic balance surpluses, peaking at 19 percent of GDP in 2011. Gabon also had surpluses through 2015, peaking at 5.8 percent of GDP in 2010. However, most countries repeatedly missed the target. This begs the question of whether policies were inadequate or if the criterion itself needs to be reconsidered. With economic growth depressed, public debt surging (Table 3), sovereign risk premium rising, and international reserves declining sharply (Figure 1), country authorities are pressed to rein in fiscal deficits. In January 2016, the Council of Ministers adopted a new set of convergence criteria to enter into force in January 2017 (Table 1). These include a floor on the overall budget balance and an oil revenue savings rule, but retain the non-accumulation of arrears and maintain the ceiling on total debt-to-GDP ratio at 70 percent.

Table 2.

CEMAC: Basic Balance

(Percent of GDP)1/

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Source: IMF staff estimates and projections.

Overall budget balance excluding grants and foreign-financed investments.

Table 3.

CEMAC: Public Debt, 2010–16

(Percent of GDP)

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Source: IMF staff estimates.
Figure 1.
Figure 1.

CEMAC: International Reserves, 2010–16

(Units as specified)

Citation: IMF Staff Country Reports 2016, 290; 10.5089/9781475535464.002.A003

Sources: BEAC; and IMF staff estimates and projections.

12. Although unadjusted budget balance rules may be useful in the short term, they tend to be procyclical. Such rules do not reflect revenue and expenditure changes driven by cyclical factors. They are too rigid to allow deficits in recessions, counterbalanced by surpluses in boom times. Although these rules may help anchor fiscal policy in the short-term, there are many reasons why they may not guarantee long-term fiscal sustainability. First, the experience of the European Union’s deficit of 3 percent of GDP under the Stability and Growth Pact and the occasional U.S. proposals for a Budget Balance Amendment (i.e., zero deficit) show that an unadjusted budget balance target that might have been a reasonable goal ex ante, becomes unreasonable after an unexpected shock. Second, procyclical policies have the undesirable macroeconomic consequence of amplifying and possibly extending boom and bust features of business cycles. They also frequently entail significant social costs—for example, adhering to a strict unadjusted budget balance rule could result in cuts in social programs at a time of rising unemployment and poverty. They could also carry efficiency costs, such as deferment or cancellation of investments, or cuts in maintenance programs during recessions. Furthermore, given that pro-cyclicality tends to be stronger during booms than recessions in CEMAC, budget balance rules exert a ratchet effect on public debt, with attendant risks for longer-term sustainability.

D. The Pro-Cyclicality of Fiscal Policy

13. Pro-cyclicality of fiscal policy is especially pronounced in the five CEMAC countries where income from the oil sector dominates the business cycle. In CEMAC, oil accounted for approximately 29 percent of GDP and 54 percent of fiscal revenue in 2014 (Table 4). This explains the sensitivity of economies and budgets to oil prices. Table 5 depicts each member country’s correlation between total real government expenditure and GDP. They are all approaching +1, denoting a strongly pro-cyclical policy. The interesting observation is that most countries show pro-cyclical spending, with Cameroon, the largest economy and which depends less on oil, showing a correlation of 1.

Table 4.

CEMAC: Oil Sector Indicators, 2014

(Units as specified)

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Source: CEMAC authorities’ data; and IMF staff estimates.
Table 5.

CEMAC: Cyclical Correlation of Real Government Spending and Real GDP, 1990–20151/

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Sources: CEMAC authorities; and IMF staff estimates.

14. A major reason for pro-cyclical spending in the CEMAC is that when government receipts from taxes or royalties rise in oil booms, governments tend to increase spending. Two large budget items that account for much of the increased spending during the commodity boom are investment projects and subsidies and transfers. Investment in infrastructure can have long-term pay-off if it is well designed and executed in a cost-effective manner. Conversely, general consumption subsidies and transfers, which are not targeted at the poor in society, have no lasting developmental impact. There have also been instances in CEMAC when oil windfalls have been spent on higher public sector wages. Subsidies and wage bill increases are difficult to reverse when oil prices decline.

15. Pro-cyclicality of fiscal policy can lead to “disease.” An example is “Dutch Disease,” defined as a boom in spending on non-traded goods and services that arises in response to a rise in the world price of a natural resource, such as oil. One interpretation, particularly relevant if the complete cycle is not adequately foreseen, is that the process is reversed when the world price of oil declines. A second interpretation is that, even if the perceived longevity of the increase in the world price of oil turns out to be accurate, the crowding out of non-commodity exports is undesirable.7 Perhaps this explains why large oil exports have stymied economic diversification in CEMAC.

16. How can fiscal policy be made more countercyclical, or at least less pro-cyclical? It takes a long-term perspective to frame policies in terms of the complete business cycle: less government expansion during booms, counterbalanced by more spending during busts. This is necessary in CEMAC, where there has been evidence of overspending oil revenue during boom periods and of cut-off of funds when the market goes bust. In a context where short-term political pressures are strong, CEMAC needs strong Community institutions, which can help governments achieve countercyclical fiscal policies in the long run. CEMAC needs to set up fiscal rules ex ante, which are more likely to deliver the right results ex post.

E. Making Fiscal Policy More Countercyclical

17. Given CEMAC’s exposure to symmetric shocks (from oil prices), adopting cyclically adjusted rules might be a sensible option to strengthen the fiscal surveillance framework. If well-designed and effectively implemented, these rules can help reduce time-inconsistent policies, strengthen the credibility of governments’ commitment to fiscal responsibility, and facilitate countercyclical fiscal management.

F. Adopting Adjusted (Structural) Budget-Balance Rules

18. An appropriate fiscal framework should address the need for short-term consolidation while ensuring long-term sustainability. Given CEMAC member countries’ high dependence on oil, the design of the fiscal rule needs to internalize the likelihood of macro-volatility stemming from volatility in international prices. A structural budget-balance rule, complemented by a debt rule, could accommodate CEMAC’s business cycle fluctuations and macro-vulnerabilities, while providing a credible medium-term anchor for fiscal sustainability.

19. Structural budget-balance rules filter the impact of cyclical movements on fiscal variables. The structural budget-balance rule aims at approximating the budget balance that would prevail if the economy was operating at its full potential. As such, it constrains discretion in fiscal policy, signals commitment to fiscal sustainability, and avoids pro-cyclicality by enabling automatic stabilizers to work. It ensures that the fiscal dividends of an economic recovery are used to strengthen budget positions, thereby creating room for adequate fiscal policy responses to future shocks.

20. Combining a structural budget-balance rule with a long-term debt anchor could serve CEMAC well, provided the supportive infrastructure and institutional capacity are developed. Given the trend increase in public debt, a debt rule would align the medium-term fiscal framework with an anchor (e.g., achieving a debt-to-GDP ratio of 40 percent, which is currently some individual countries’ debt target).8 Debt rules are more directly linked to fiscal sustainability than budget-balance rules, since they capture the impact of below-the-line operations that do not affect the budget balance, but increase the public debt (e.g., recognition of previously unrecognized or contingent liabilities). Debt rules also have the advantage of requiring the fiscal stance to be aligned in the event of a permanent (structural) shock.

21. However, these rules need to be formulated carefully, with “escape clauses” (Annex II). Escape clauses provide flexibility in the event of exogenous shocks in order to prevent a systematic debt buildup. They specify the circumstances under which a rules-based fiscal framework can be temporarily relaxed or put into abeyance. Such escape clauses and their possible triggers must be specified, with clear guidelines as to their interpretation and application. Although escape clauses are intended to deal with the consequences of large but temporary shocks, more permanent ones require a lasting revision of the rule’s target. It is also good practice to review, on the basis of economic fundamentals, the debt target and path every three to four years. In addition, since debt ceilings can often be avoided by granting guarantees in lieu of loans, the CEMAC Commission should appropriately include provisions for a ceiling on explicit and implicit public guarantees in its fiscal framework and rules.

G. Simulated Performance of Alternative Budget-Balance Rules

22. For illustrative purposes, we simulate the impact of two alternative budget-balance rules on public debt. These are: (i) a structural budget-balance rule assuming a gradual adjustment path, which is a steady reduction in the structural overall deficit to zero by 2020, when the output gap closes; and (ii) unadjusted budget-balance rules with constant overall deficit ceilings of 1.5 percent and 0.0 percent of GDP. The simulations are conducted for the period 2017–20 and are based on the assumptions shown in Table 6.9

Table 6.

CEMAC: Simulation Assumptions, 2016–20

(Units as specified)

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Source: Author’s assumptions.

23. Simulation results illustrate different debt dynamics and degrees of flexibility depending on the rule (Figure 2). Under the structural (adjusted) budget balance, public debt would decline to 38 percent of GDP in 2020, when the output gap closes and the overall deficit converges to zero. The unadjusted budget-balance deficit rule of 1.5 percent of GDP broadly replicates the outcome of the structural budget-balance, but the debt dynamics reverses after 2019. Finally, the unadjusted budget-balance deficit rule of zero percent of GDP requires the largest fiscal adjustment. As a result, the debt-to-GDP ratio declines to 33 percent of GDP in 2020.10 Faster adjustment comes with tradeoffs. First, a zero overall balance in 2017 would require across-the-board cuts in expenditure, which is not desirable. Second, as noted above, a faster adjustment would have a larger up-front growth cost than would a more gradual approach, because of the multiplier effect.11

Figure 2.
Figure 2.

CEMAC: Illustration of General Government Debt, 2015–20

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 290; 10.5089/9781475535464.002.A003

24. However, technical complexities associated with structural budget-balance rules raise concerns about their suitability. First, the structural balance is difficult to estimate and apply for fiscal surveillance owing to uncertainty in measuring the output gap. Incorrect estimates of potential output could lead to mistakes in assessing the magnitude of the output gap12 and thus in determining the appropriate fiscal stance (Ho and Mauro, 2015). This is because, more often than not, macroeconomic forecasts of growth fail to take into account “reversion to the mean” (Pritchett and Summers, 2014) and are plagued with widespread optimism bias (Ho and Mauro, 2014). Optimistic economic growth forecasts lead to an underestimation of the government’s debt-to-GDP ratio in the medium term. As a result, the country could end up with a higher-than-expected debt ratio. Second, data deficiencies (including lack of data on arrears) and capacity constraints make it difficult to estimate a meaningful structural budget balance. Third, the existence of off-budget funds and difficulties in measuring capital spending, when projects are implemented outside the central government, add additional complexities in evaluating the fiscal position.

H. Supporting Institutions

25. Fiscal rules per se do not guarantee successful implementation of counter-cyclical fiscal policies. It is also important to devote efforts and resources to strengthening the capacity of key institutions in charge of implementing laws and rules. First, there should be reliable data availability as well as a minimum technical forecasting capacity, which are broadly available at the economic policy unit of the CEMAC Commission. Each Ministry of Finance would have to enhance its capacity to prepare budgets based on realistic assumptions, monitor the behavior of line ministries and public enterprises, and effectively enforce corrective measures, if necessary.13 In this context, macro-fiscal units of the Commission and Ministries of Finance need to be strengthened to produce reliable data and forecasts (including a medium-term expenditure framework) and analyze sectoral linkages and business cycles. Second, budget reporting systems need to be comprehensive in terms of aggregates covered, and sufficiently developed to produce in-year and timely end-year reports. This allows monitoring of the adherence to the rule, and provide an opportunity to inform policymakers in time if policy changes are needed. Third, internal and external audit systems need to be strengthened to ensure that public resources utilization is fully accounted for. And finally, fiscal data—consistent with the budget reporting system—should be publicly released in line with a pre-announced calendar to allow external monitoring of the rule.

26. The Commission would need to establish a fiscal council to enhance implementation of the rules. IMF (2013b) defines a fiscal council as

  • “a permanent agency with a statutory or executive mandate to assess publicly and independently from partisan influence government’s fiscal policies, plans and performance against macroeconomic objectives related to the long-term sustainability of public finances, short- and medium-term macroeconomic stability, and other official objectives.”

A fiscal council’s key functions include: (i) contribution to the use of unbiased macroeconomic and budgetary forecasts in budget preparation (through preparing forecasts, or proposing prudent levels for key parameters); (ii) identification of sensible fiscal policy options, and possibly, formulation of recommendations; (iii) facilitation of the implementation of fiscal policy rules; and (iv) costing of new policy initiatives. The fiscal council also needs to have a legal framework that safeguards resources to conduct the required analytical tasks. Finally, the council must have strong media presence, consistent with the fact that its effectiveness hinges importantly on the reputational and electoral impact of its analysis for policymakers. Indeed, if well-designed and effective, the fiscal council, like fiscal rules, can contribute in its own right to fiscal performance. In CEMAC, establishing a fiscal council would be challenging, not least because of the lack of reliable macroeconomic data and inability to enforce public administration laws, including sharing information with the Commission.

27. CEMAC’s new convergence framework is a step in the right direction. Although the credibility of the CEMAC member countries’ commitment to fiscal rules will depend crucially on the soundness of the design, the existence of basic institutional pre-conditions for successful implementation, and the early adoption of adequate fiscal consolidation measures to achieve the rule’s targets, empirical evidence suggests that fiscal rules have typically been adopted to lock-in fiscal adjustment gains (IMF 2009). As such, CEMAC’s new convergence criterion, which targets an overall budget balance of -1.5 percent of GDP, would facilitate fiscal consolidation over the next few years and should be the priority.

I. Concluding Remarks

28. The CEMAC Commission has expressed interest in implementing countercyclical fiscal policies. The paper highlights essential features for an effective fiscal rule framework, including well-defined escape clauses to deal with exceptional events, and an independent fiscal council to monitor the rules. Given CEMAC’s exchange rate peg, susceptibility to oil price shocks, and revenue volatility, this paper argues that a structural budget-balance rule, complemented by a debt rule, could serve CEMAC well. Structural budget-balance rules have advantages, including flexibility to allow automatic stabilizer to work and constraining discretion (especially during resource price upturns). However, given the administrative, institutional, and technical shortcomings at present in CEMAC, a structural balance rule would be challenging to implement. These issues, coupled with the fact that prior consolidation makes the adoption of a fiscal rule more credible, suggest that the new unadjusted budget-balance target would facilitate fiscal consolidation over the next few years and should be the priority in the near term.

Annex I. Properties of Different Types of Fiscal Rules

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Source: IMF staff assessment.

Annex II. Escape Clauses—Country Examples

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Sources: National authorities; and IMF staff assessment.

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1

Prepared by Koffie Nassar.

2

The French Treasury guarantees the convertibility and the peg of the CFA Franc.

6

This is assuming that credit risk and potential weaknesses of domestic financial institutions are addressed.

7

This explains why, in a boom, such as the recent commodity super cycle, it is not advisable to engage in expansionary spending and monetary policy that exacerbate overheating, loss of competitiveness, and debt accumulation.

8

CEMAC’s estimated 2015 regional average debt-to-GDP ratio was about 45 percent.

9

Note that this does not incorporate, for example, impact of fiscal consolidation (multiplier) on growth.

10

Though it could be higher if multiplier impact is higher.

12

The difference between what the economy is capable of producing on a sustained noninflationary basis and what it is producing (a measure of the degree of slack in the economy).

13

Major weaknesses in commitment control and oversight mechanisms would have to be addressed.

Central African Economic and Monetary Community: Selected Issues
Author: International Monetary Fund. African Dept.