Abstract
Selected Issues
MODERNIZING THE MONETARY POLICY FRAMEWORK IN COMOROS1
The Comorian monetary policy framework is currently the subject of detailed modernization proposals. IMF technical assistance missions have helped to define an Action Plan which the central bank intends to implement soon. This paper sets out how the modernization plans will address the problem of weak monetary policy transmission in the face of underlying structural excess liquidity. It outlines the constraints in the existing financial system, including the absence of a functioning interbank market and existing central bank capacity which need to be addressed before proceeding with plans to issue central bank bills. The issuance of bills while increasing sources of collateral for the banking system is unlikely to mitigate the high level of structural excess liquidity, which will require additional structural measures to improve private sector access to credit.
A. Introduction
1. Comoros operates a conventional peg arrangement within a monetary policy cooperation agreement with France. This simultaneously pegs the Comorian Franc to the Euro and anchors fiscal policy through the ceiling on statutory advances from the Banque Centrale des Comores (BCC) to the treasury based on the average of internal revenue over the previous three years.2 Central bank reserves are currently well above the requirements mandated by the monetary policy agreement with France. The authorities are planning to modernize the monetary policy framework to improve the transmission of monetary policy which is currently severely impaired by the lack of instruments to deal with a persistent underlying excess liquidity (chart). Even if it serves to bolster the stability of the financial system, there is nonetheless an ongoing concern that the persistently high degree of excess liquidity may be reducing the efficiency of monetary policy transmission and limiting credit to the private sector.
Required Deposit and Excess Deposits
Citation: IMF Staff Country Reports 2018, 190; 10.5089/9781484363775.002.A003
Sources: country authorities; and IMF staff calculations.Required Deposit and Excess Deposits
Citation: IMF Staff Country Reports 2018, 190; 10.5089/9781484363775.002.A003
Sources: country authorities; and IMF staff calculations.Required Deposit and Excess Deposits
Citation: IMF Staff Country Reports 2018, 190; 10.5089/9781484363775.002.A003
Sources: country authorities; and IMF staff calculations.2. Improving monetary policy transmission requires strategies based on TA recommendations to address structural excess liquidity. Financial institutions prefer to hold deposits at the BCC greater than the required 15 percent ratio, despite a 7 to 14 percent spread available from lending to the private sector. Approximately 13 percent of excess reserves are in foreign currency and held by nonresidents. Structural excess liquidity weakens the transmission of money supply variations (through, for example, an increase in BCC deposits) to private sector credit compared to other countries. The key issue is whether central bank bill issuance would contribute to reducing the structural excess liquidity phenomenon in a manner that would result in increased credit to the private sector.
3. The purpose of this paper is therefore twofold: to examine how the proposals for modernizing the monetary policy framework will improve the transmission of monetary policy and to assess their impact on the excess liquidity. The paper is divided into 4 sections. The first section describes in broad terms the existing monetary policy framework. The following two sections outline the various proposals for modernizing the framework and the prior conditions for successfully launching BCC bills. The final section draws some initial conclusions and makes recommendations regarding the timing and sequencing of the modernization process.
B. The Existing Monetary Policy Framework
4. A cooperation agreement between the Zone Franc countries provides for a guarantee of the CFA franc’s peg to the euro and its convertibility.3 The guaranteed convertibility is in principle unlimited, and operates through drawings on the BCC’s “operations account” at the French Treasury. The agreement and related foreign exchange regulations also provide for the obligation for the BCC to maintain at least 50 percent of its international reserves on the operations account and for its international reserves to represent at least 20 percent of its liabilities. With a fixed exchange rate and limited capital mobility, the monetary policy objective for the authorities consists of ensuring that there are adequate reserves to maintain the peg although with strict capital controls in place, there is in theory scope for an independent monetary policy.
5. The only monetary policy instrument currently effectively available to the BCC is reserve requirements. These reserves are calculated conventionally at 15 percent of customer deposits in banks and other financial institutions and are remunerated at the Eonia rate less 1.25 points. Excess bank reserves at the BCC are paid interest at Eonia less 0.125. The interest paid by the BCC for compulsory and surplus reserves is currently zero because the EONIA rate is negative. Hence a second monetary policy tool – the remuneration on obligatory and excess financial institution deposits – is effectively unavailable. Although the official texts mention a discount rate, no technical or legal description allows for the actual use of this mechanism. None of the rates applicable are in any case reviewed in line with prevailing macroeconomic conditions.
6. At close to 6 percent of GDP, the excess reserves of the financial institutions present a challenge to the implementation of monetary policy. The risk aversion of the commercial banks has resulted in lower rates of growth of private sector credit than are needed to boost the economy’s flagging growth performance (left panel). Compared to international standards, the level of excess liquidity in Comoros is high (right panel) if not exceptionally so4; it indicates nevertheless a need to address the underlying issues in the financial sector. Moreover, in the absence of daily accounting data, the BCC is not currently equipped to make forecasts of bank liquidity which severely limits the operational scope for monetary policy.
Private Sector Credit Growth Compared Other Monetary Aggregates
Citation: IMF Staff Country Reports 2018, 190; 10.5089/9781484363775.002.A003
Sources: country authorities; and IMF staff calculations.Private Sector Credit Growth Compared Other Monetary Aggregates
Citation: IMF Staff Country Reports 2018, 190; 10.5089/9781484363775.002.A003
Sources: country authorities; and IMF staff calculations.Private Sector Credit Growth Compared Other Monetary Aggregates
Citation: IMF Staff Country Reports 2018, 190; 10.5089/9781484363775.002.A003
Sources: country authorities; and IMF staff calculations.
Excess Reserves in percent of GDP
Citation: IMF Staff Country Reports 2018, 190; 10.5089/9781484363775.002.A003
Excess Reserves in percent of GDP
Citation: IMF Staff Country Reports 2018, 190; 10.5089/9781484363775.002.A003
Excess Reserves in percent of GDP
Citation: IMF Staff Country Reports 2018, 190; 10.5089/9781484363775.002.A003
C. The Proposal to Modernize the Monetary Policy Framework
7. The purpose of the reform proposal is to improve the transmission of monetary policy. Developing financial intermediation by active management by the Central Bank of bank liquidity - volume and amount of excess liquidity – can influence the cost of credit and the attractiveness of deposits. It is the monetary policy equivalent of the trend towards enhancing the role of price signals in the economy in general. In low-income, economies, the signals given by the Central Bank are not easily transmitted for two reasons, both of which are relevant to Comoros. First, the capital market is less efficient, and in addition the excess liquidity of the system limits the sensitivity of the institutions to changes in interest rates.
8. The objective of the proposed modernization of monetary policy instruments is to provide the BCC with more effective tools to manage bank liquidity, without compromising the parity arrangement of the Comorian franc vis-a-vis the euro. In implementing the proposals, it is critical to take the local context fully into account. For example, the number of establishments subject to reserve requirements, while having grown significantly in recent years, remains quite low (8 credit institutions) and both the BCC and the financial institutions have relatively few staff. Taking account of the capacity constraints, it is likely that the modernization project will take some time to implement and it is advisable in any case that it be carried out progressively to allow sufficient time for all actors to adapt to the proposed changes.
9. The first stage of the reform involves creating the capacity for the BCC to produce bank liquidity forecasts. This is an urgent task specific to the central bank as a result of having sole access to information on the past and future evolution of autonomous factors determining bank liquidity because they are recorded in the balance sheet of the Central Bank. In this respect, the modernization plans are progressing well: the BCC has already created a forecasting unit and is preparing the legal texts for the establishment of the Monetary Policy Committee and other institutional requirements for the reform although it will take some time for bank liquidity forecasts to be developed because there is a learning process involved and daily accounting is also required.
10. The reform also aims at the introduction of an interest rate corridor defined by the rates applicable at the standing facilities of the BCC. These rates will define the limit on variations in the interest rate on short-term interbank lending organized within this corridor. The standing facilities will consist of an automatic deposit facility offering a dissuasive return: bankers should prefer to have a remunerative asset or lend to their colleagues rather than depositing their cash account with the BCC and a lending facility, also at dissuasive rates to encourage bankers to borrow from another commercial bank rather than the central bank. Thus, begins the operation of the interbank market. When an interbank loan has been made, banks will systematically inform the BCC and the data on the interest rates applicable will be a valuable indication of the state of bank liquidity as felt by the institutions involved. It is also the beginning of a short rate curve. The BCC will have to ensure the collection of the relevant data on these rates as well as their diffusion on its site.
11. The issuance of bills by the BCC is intended to meet two objectives: to absorb excess bank liquidity and to provide collateral for loans between the BCC and between banks. At the same time as the issuance of bills begins, interest payments on excess reserves will be suppressed so as to create incentives for financial institutions to purchase bills. In view of its monetary policy objective, the issuance of bills will be exclusively reserved for institutions receiving deposits and subject to reserve requirements, with a view to ensuring operational feasibility for the BCC although eventually, this faculty could be open to other financial institutions. The main steps in the process of modernizing the monetary policy framework and their current status are summarized in the Table 1 underneath.
Comoros: Implementation Steps for Modernization of the Monetary Policy Framework
Comoros: Implementation Steps for Modernization of the Monetary Policy Framework
| Actions | Objectives | Status March 2018 |
|---|---|---|
| Create a BCC Monetary Policy Committee | Take monetary policy decisions based on an assessment of national and international macroeconomic conditions, particularly as regards setting the key interest rates of the BCC. | Draft legal text prepared |
| Create a Liquidity Management Committee | Assist the Governor in decision-making processes, notably regarding the volume of adjudications. | Draft legal text prepared |
| Put in place the legal and regulatory framework for BCC bills | Define the characteristics of bills and the conditions for issuance and subscription. | Draft legal text prepared |
| Put in place the legal and regulatory framework for purchase and sale of CBB bills: repurchase agreements and framework contract for banks and other financial establishments | Allows holders of bills to sell at any given time. | Draft legal text prepared |
| Create a standing loan facility at fixed interest rates relative to the rate on CBB bills | Facilitates the absorption of liquidity shocks at the level of individual financial institutions, enabling them to meet reserve requirement obligations. | Legal text to be drafted |
Comoros: Implementation Steps for Modernization of the Monetary Policy Framework
| Actions | Objectives | Status March 2018 |
|---|---|---|
| Create a BCC Monetary Policy Committee | Take monetary policy decisions based on an assessment of national and international macroeconomic conditions, particularly as regards setting the key interest rates of the BCC. | Draft legal text prepared |
| Create a Liquidity Management Committee | Assist the Governor in decision-making processes, notably regarding the volume of adjudications. | Draft legal text prepared |
| Put in place the legal and regulatory framework for BCC bills | Define the characteristics of bills and the conditions for issuance and subscription. | Draft legal text prepared |
| Put in place the legal and regulatory framework for purchase and sale of CBB bills: repurchase agreements and framework contract for banks and other financial establishments | Allows holders of bills to sell at any given time. | Draft legal text prepared |
| Create a standing loan facility at fixed interest rates relative to the rate on CBB bills | Facilitates the absorption of liquidity shocks at the level of individual financial institutions, enabling them to meet reserve requirement obligations. | Legal text to be drafted |
12. The reform proposals will therefore fundamentally change the operation of the monetary policy framework and the transmission of monetary policy. To summarize, the change is intended to operate in 4 main ways.
The system will now be anchored on the monetary policy rate decided by the monetary policy committee. In principle the policy rate will be indexed to the money market rate of the anchor zone.
The structure of interest rates will be determined by the interest rate corridor.
Interest rates on private sector credit and deposits will reflect rates prevailing in the interbank market.
The BCC will aim to manage liquidity through issuance of bills and in so doing create an importance source of collateral for the banking system.
D. Sequencing Reforms and Preconditions for BCC Bill Issuance
13. Before deciding to proceed with bill issuance, there are a number of preconditions to be met and the monetary authorities should therefore ensure that reforms are undertaken in the appropriate sequence. Key requirements in this regard are the following.
a sound and competitive financial system is in place including an effective electronic payments system and interbank market;
the central bank has a sufficient degree of institutional autonomy and operational capacity; and
the central bank has sufficient liquidity forecasting capacity.
14. Each of the requirements mentioned above poses challenges in the Comorian context. First, the financial system is currently under considerable stress with high levels of non-performing loans and considerable excess liquidity. Currently, the National Payment System does not have the necessary infrastructure to facilitate electronic funds transfers between credit institutions and other financial institutions, or to facilitate electronic payments—a prerequisite for a functioning interbank market—at the end-user (retail) level. Second, an efficient accounting and auditing system is also a requirement for ensuring that transactions are recorded appropriately and accurately, which is crucial for providing credible and timely information that allows markets to make sound decisions. In addition, more specific to monetary policy implementation, weak payment systems or central bank accounting frameworks can greatly complicate the implementation of a liquidity management and forecasting framework and, ultimately, jeopardize the central bank’s ability to control its balance sheet. Finally, weaknesses in the functioning of the judicial system are also a source of uncertainty, in particular regarding the use of collateral. All of these deficiencies need be addressed for financial intermediation to expand.
15. Successful implementation of money market operations also depends on the establishment of a sound financial relationship between the central bank and the government. International experience suggests that one of the main challenges during the transition to reliance on money market operations relates to curtailing the ability of the government to rely on the direct credit of the central bank. In the Comorian context, this issue is addressed via the limit on statutory advances to the government by the BCC. To avoid the possibility that the issuance of bills becomes a source of direct financing for the government, measures should be considered to reinforce the existing regulations regarding direct financing to define the limit on statutory advances to the Treasury are adequate for the purpose.
16. The BCC is not equipped to make forecasts of bank liquidity. The production by the BCC of bank liquidity forecasts should be developed as a priority because it involves a learning process. While the recent steps towards establishing the Liquidity Management Committee at the BCC are welcome, without progress on developing a daily accounting position, the BCC cannot analyze past developments or make forecasts of bank liquidity.
17. In terms of its impact on the transmission of monetary policy, the issuance of BCC bonds while mopping up excess liquidity in the system will represent a safe investment for commercial banks and divert credit from the private sector. The issuance of CBN bills in that sense will not address the underlying cause of excess liquidity which seems to be a function of structural factors such as the absence of adequate collateral and the ability of the judicial system to enforce contracts. Improving the transmission of the monetary policy by addressing the issue of private sector access to credit will therefore require specific reform measures to improve the legal framework governing commercial bank lending, particularly as regards enhancing the structure of loan guarantees and building on the establishment of the Risk Information Centre (see Selected Issues chapter on Financial Sector Risks and the effectiveness of Monetary Policy).
E. Conclusions
18. The purpose of the proposed modernization of the Comorian monetary policy framework is to improve the transmission of monetary policy. This can be accomplished in the following sequence. The surrounding infrastructure for the upgrade of the monetary policy framework is already in place with the establishment of the Monetary Policy Committee and the Liquidity Management Committee. The same is true for the standing facilities which will define the interest rate corridor for the operation of the interbank market. By putting in place the interbank market in this way, the transmission of monetary policy will already be improved as price signaling will be initiated in the operation of the banking system. In terms of sequencing, prior to proceeding with the issuance of BCC bills there is also a need to ensure that adequate payment systems are in place, the financial system is sound and liquidity forecasting is adequate. Further technical assistance is available on all of these areas from the IMF and the World Bank (as well as from the BCEAO and Rwanda). Addressing the underlying problem of excess liquidity however will require additional structural measures.
References
Gray, S., & Talbot, N. (2006). “Bank of England Handbooks in Central Banking No. 24 - Monetary Operations.
Gray, S., & Pongsaparn, R. (2015). Issuance of Central Bank Securities: International Experiences and Guidelines, IMF Working Paper (IMF/15/106).
Gulde, A.M., & Tsangarides, C.G. (eds., 2008). Common Currency, Uncommon Challenges.
Laurens, B., & Al. (2005). Monetary Policy Implementation at Different Stages of Market Development.
International Monetary Fund (2015). Evolving Monetary Policy Frameworks in Low Income and Other Developing Economies. Staff Report.
Prepared by Liam O’Sullivan. This chapter has benefited from comments and inputs from various departments at the BCC, and several IMF colleagues.
In 1979, Comoros signed a monetary cooperation agreement with France, making the Comoros part of the franc zone which also includes the CFA franc zone (the West African Economic and Monetary Union (WAEMU) and the Central African Economic and Monetary Union (CEMAC) where the CFA franc is used). The monetary regime is similar to that of the CFA franc zone, with the following principles (i) the French Treasury guarantees without limits the convertibility of the franc zone; (ii) the currencies are convertible at a fixed exchange into Euro (before French francs); and (iii) the zone members must pool together a minimum of 50 percent of their international reserves, corresponding to 20 percent of the monetary base of each central bank, into an operations account at the French Treasury. The exchange rate of the Comorian franc to the French franc (now euro) has differed from that for the CFA franc since 1994.
The parity, in effect since the 1994 devaluation, is KMF 493 per euro. The institutional background is described in Gulde and Tsangarides (eds., 2008).
The sharp increase in level of excess reserves in Cabo Verde and Sao Tome and Principe since 2015 is due to increasing risk aversion on the part of commercial banks in response to high levels of non-performing loans (as well as exceptional levels of migrant deposits in the case of Cabo Verde).
