A. Existing Variables

GDP

13. It is generally agreed that GDP is the most important quota variable. GDP provides a comprehensive measure of economic size, and is a widely reported and used measure that is available on a timely basis for the vast majority of the membership. Market GDP has been viewed as the single most relevant indicator of a member’s ability to contribute to the Fund’s finances, though it is clearly not the only such measure, and is also relevant to a member’s potential demand for Fund resources. As noted, PPP GDP was viewed as a relevant measure of members’ weight in the global economy from the perspective of the Fund’s non-financial activities.⁵ The GDP variable also captures dynamism. The more rapid growth of EMDCs in recent years has already been reflected in an increase in their aggregate share in the GDP blend variable from 32.7 percent at the time of the 2008 reform (data through 2005) to 39.8 percent in the latest update (data through 2009). Based on the latest WEO forecasts, this share is projected to increase further to about 43 percent by the 15^th Review and just under 50 percent by 2014-16 (Figure 3).

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Projected GDP Blend Shares for EMDCs

Citation: Policy Papers 2011, 063; 10.5089/9781498338585.007.A001

Source: IFS and WEO projections

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14. Two main issues have been raised regarding the role of GDP in the formula. One relates to its weight in the formula, where some have argued that GDP should have a higher weight, including that it should be the only variable. In the 14^th Review, the effective weight of GDP in distributing the quota increases was increased as it also played an important role in determining eligibility for the 40 percent ad hoc increase. Preliminary staff work also suggests that market GDP has played a significant role in judgments on members’ access to Fund resources in recent exceptional access cases (Annex III). A second issue relates to the mix between market and PPP GDP in the blend variable. The 2008 agreement to use a 60/40 weight reflected a compromise, taking account of the central role of quotas in the Fund’s financial operations, for which market GDP is the most relevant indicator. However, views have continued to diverge, with some arguing that market GDP is the only relevant measure, and others arguing the PPP GDP should play a larger if not exclusive role.⁶

openness

15. Openness has been viewed as an indicator of a member’s involvement and stake in the global economy. Countries that are relatively more open to trade and financial flows may have a greater stake in promoting global economic and financial stability. Openness also may have a bearing on a member’s ability to make financial contributions to the Fund, as well as its potential need for Fund resources. The current openness measure is highly correlated with GDP, but gives a greater relative weight to countries with higher ratios of exports to GDP.⁷ Some have questioned the role of openness in the formula as currently measured (the QFRG proposed that it be excluded), and its effective weight was reduced significantly in 2008 though it remained the second most important variable with a weight of 30 percent. Among the issues raised are:

• Measuring trade on a value added basis. A longstanding issue has been the concern that the current gross measure leads to double counting of cross-border flows which can exaggerate the importance of openness. This effect tends to be magnified over time as the share of trade in global value added increases, reflecting greater vertical specialization and trade in intermediate goods. It can be a particular issue for countries with large entrepot trade activities, international financial centers, or those heavily engaged in processing imports for re-export. Moving to a value added basis could address these issues, but the lack of a reliable database with sufficient coverage has precluded such a change to date.⁸ The sixth edition of the Balance of Payments and International Investment Position Manual (BPM6) will introduce changes to the treatment of goods for processing to capture in trade flows only the explicit fees that are paid to the goods processor rather than the full value of the goods entering and leaving the processing economy, in the case where goods do not change ownership. However, it is likely to be many years before these changes can be fully implemented, and even then they will not eliminate all cases where trade is double counted (see Statistical Appendix, Box A2).

• Treatment of intra-currency union flows. Some have argued that intra-currency union flows should be excluded as they take place in a common domestic currency and may exaggerate a member’s broader integration into the global economy. It has also been argued that since trade takes place in a common currency, the existence of a currency union reduces an important source of balance of payments risk for its members. Against this, others have emphasized that greater trade integration is not limited to currency unions and the degree of integration can vary across unions. Also, the Fund has frequently been called upon to provide balance of payments support to members of currency unions. When this issue was last discussed in 2009, no euro area member had entered into a financial arrangement with the Fund, and this possibility was still considered fairly remote. However, subsequent events have made clear that even currency union members with relatively well-developed financial systems and institutional frameworks can be subject to balance of payments risks that give rise to requests for financial assistance from the Fund.

• Including a measure of financial openness. It is recognized that integration in the global capital markets is an important indicator of a member’s stake in the global economy and global financial stability, and is also relevant to its ability to contribute to the Fund’s finances and its potential need for Fund resources. However, data limitations have precluded the explicit introduction of such a measure in the formula to date. Three broad options were considered in the 2008 reform: the international investment position (IIP), investment income, and financial flows. Of these, IIP was considered the most promising but less than half of the membership reported IIP data for the relevant period as of the data cutoff date. The number has increased to 102 countries reporting IIP data for 2009 compared with 81 members reporting 2005 data at the time of the 2008 reform. Staff also examined the possibility of using investment income as a proxy for IIP, and for developing an alternative measure based on aggregate financial asset and liability flows, though the latter raised a number of difficult data issues. Staff has updated these estimates as part of the current exercise (Table 6). In general, they remain heavily dominated by advanced economies, with particularly large shares for members with important international financial centers.

Table 6.

Measures of Financial Openness

(In percent)

Source: Finance Department.

1/

Trade Openness is the average sum of current receipts and payments, excluding investment income.

2/

Assets plus liabilities; 102 members reporting in 2009.

3/

The sum of the absolute value of transactions in assets and liabilities in the financial account of the Balance of Payments for direct investment, portfolio investment, financial derivatives, and other investments.

4/

Including Korea and Singapore.

Table 6.

Measures of Financial Openness

(In percent)

				Alternative Variables
	14th General Review Quota Shares	Openness 2005-2009	Trade Openness 1/ 2005-2009	International Investment Position 2/ 2009	Investment Income 2005-2009	Financial Flows 3/ 2005-2009
Advanced economies	57.7	63.8	60.3	85.8	82.1	83.5
Major advanced economies	43.4	43.0	40.8	58.1	54.4	52.2
Of which: US	17.4	13.3	12.1	20.2	20.0	14.8
Other advanced economies	14.3	20.8	19.4	27.7	27.6	31.4
Emerging Market and Developing Countrie	42.3	36.2	39.7	14.2	17.9	16.5
Developing countries	35.1	29.2	32.1	11.4	14.3	12.9
Africa	4.4	2.5	2.7	0.6	1.1	0.7
Asia 4/	16.1	16.9	18.5	7.9	8.6	7.1
Middle East, Malta & Turkey	6.7	5.0	5.7	0.7	1.7	2.9
Western Hemisphere	7.9	4.8	5.2	2.2	2.7	2.1
Transition economies	7.2	7.0	7.6	2.7	3.7	3.6
Total	100.0	100.0	100.0	100.0	100.0	100.0
Memorandum Item:
EU 27	30.2	42.2	40.3	56.6	52.2	57.0
LICs (PRGT-eligible countries)	4.0	2.0	2.2	0.2	0.6	0.6

Source: Finance Department.

1/

Trade Openness is the average sum of current receipts and payments, excluding investment income.

2/

Assets plus liabilities; 102 members reporting in 2009.

3/

The sum of the absolute value of transactions in assets and liabilities in the financial account of the Balance of Payments for direct investment, portfolio investment, financial derivatives, and other investments.

4/

Including Korea and Singapore.

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Table 6.

Measures of Financial Openness

(In percent)

				Alternative Variables
	14th General Review Quota Shares	Openness 2005-2009	Trade Openness 1/ 2005-2009	International Investment Position 2/ 2009	Investment Income 2005-2009	Financial Flows 3/ 2005-2009
Advanced economies	57.7	63.8	60.3	85.8	82.1	83.5
Major advanced economies	43.4	43.0	40.8	58.1	54.4	52.2
Of which: US	17.4	13.3	12.1	20.2	20.0	14.8
Other advanced economies	14.3	20.8	19.4	27.7	27.6	31.4
Emerging Market and Developing Countrie	42.3	36.2	39.7	14.2	17.9	16.5
Developing countries	35.1	29.2	32.1	11.4	14.3	12.9
Africa	4.4	2.5	2.7	0.6	1.1	0.7
Asia 4/	16.1	16.9	18.5	7.9	8.6	7.1
Middle East, Malta & Turkey	6.7	5.0	5.7	0.7	1.7	2.9
Western Hemisphere	7.9	4.8	5.2	2.2	2.7	2.1
Transition economies	7.2	7.0	7.6	2.7	3.7	3.6
Total	100.0	100.0	100.0	100.0	100.0	100.0
Memorandum Item:
EU 27	30.2	42.2	40.3	56.6	52.2	57.0
LICs (PRGT-eligible countries)	4.0	2.0	2.2	0.2	0.6	0.6

Source: Finance Department.

1/

Trade Openness is the average sum of current receipts and payments, excluding investment income.

2/

Assets plus liabilities; 102 members reporting in 2009.

3/

The sum of the absolute value of transactions in assets and liabilities in the financial account of the Balance of Payments for direct investment, portfolio investment, financial derivatives, and other investments.

4/

Including Korea and Singapore.

Variability

16. Variability is intended to capture members’ vulnerability to balance of payments shocks and potential need for Fund financing. It featured in the original Bretton Woods formula and was modernized in 2008 to include both current receipts and net capital flows. However, questions have been frequently raised as to whether the measure adequately captures members’ potential need for Fund resources, particularly given that advanced economies hold the majority share of the variable.⁹ Staff examined in detail a range of possibilities for amending the measure of variability as part of the work for the 2008 reform, and this work was updated in 2009.¹⁰ The options considered included: scaling the existing measure of variability to GDP or the average of current receipts and net capital flows; use of a three- versus five-year trend; focusing on downside or extreme variability; and summing variability of current receipts and variability of net capital flows. In addition to the more traditional measures, staff also explored broader indicators such as volatility of GDP growth, volatility of consumption growth and measures of consumption risk sharing.

17. It has proven difficult so far to identify a measure that is clearly superior to the current approach. In the above work, the largest shifts in quota shares relative to the current measure were registered for the scaled measures of variability. However, there is little evidence that scaled variability better reflects potential need for Fund resources, and small countries tend to have the largest shares. Alternative measures based on GDP or consumption tended to give greater weight to domestic shocks, including policy slippages and domestic upheavals, and raised data issues in some cases. While these variants all have shortcomings, the experience with the recent crisis and the large shifts in shares of this variable for a number of countries resulting from the 2009 data update suggest that further analysis of whether the current measure adequately captures potential vulnerability is warranted.

Reserves

18. Reserves provide an indicator of a member’s financial strength and ability to contribute to the Fund’s finances. While reserves have long been included in the formula, a variety of views were expressed on their continued relevance in the lead-up to the 2008 reform. Many Directors continued to see a role for reserves as a relevant indicator of members’ financial strength and ability to contribute to the Fund’s finances. However, a number of others argued that the relevance of this indicator has declined over time and raised concerns about potential distortions associated with excess reserve accumulation. Reserves are seen to have become less relevant to the ability to contribute given the increasing role of international capital markets, and they are considered to be a particularly misleading indicator for countries issuing international reserve currencies. One option that was explored was the feasibility of introducing a cap on reserves, but this was considered challenging given the absence of a clear benchmark for excess reserves accumulation.¹¹ In the end, the consensus was to retain reserves in the formula with a relatively small weight.

B. Possible New Variables and Other Issues

Financial Contributions

19. A number of Directors have stressed the importance of members’ financial contributions to the Fund. Financial contributions to increase the Fund’s liquidity have long been recognized as relevant when determining quota increases both within and outside general quota reviews. While some elements of the formula capture members’ potential ability to contribute (e.g., market GDP, openness and reserves), actual financial contributions have been taken into account outside of the formula, and mainly in recognition of a proven ability to enhance Fund resources. Financial contributions have also generally been supplemental to the issue of whether a member’s quota is out of line with its relative economic position.

20. The question of whether to explicitly include a measure of members’ financial contributions (liquidity enhancing and others) in the formula was discussed in the 2008 reform and the 14^th Review.¹² A general conclusion of that work was that members’ financial contributions to the Fund come in a wide variety of forms, and difficult measurement and aggregation issues would need to be addressed if members’ actual contributions were to be captured on a more systematic basis. These include questions regarding which types of contributions should be taken into account, how different types of contributions should be aggregated, and what time periods should be considered.

Other Variables

21. A variety of other variables have been suggested in the past. These include per capita income, external debt, changes in exchange rates, and population (see QFRG report). The latter has been seen as a way of capturing members’ relative stakes in the international public goods provided by the Fund. While this issue was raised again in the 2008 reform, the case for population is in many ways similar to that for PPP GDP, and the two variables have a relatively high correlation.¹³ In past discussions, there has not been sufficiently broad support for including population in the formula on the grounds that the Fund is essentially a monetary institution, and population does not bear directly on international monetary issues.

Compression

22. As noted, a compression factor was introduced in the 2008 reform. This was seen as a way to moderate somewhat the effects of the high correlation of size-related variables that tends to favor large economies. However, some Directors argued that compression would reduce transparency and could dampen the formula’s ability to capture dynamism over time. Compression tends to reduce the shares of a relatively small number of countries with the largest calculated quota shares, and increase the shares of all other members, without changing the ranking of members. Given the differences of view, the final compromise included a relatively modest compression factor and the agreement that it would be revisited in 20 years along with the role of PPP GDP.

Country Classification

23. The country classification used for quota purposes diverges from the WEO. The country groupings used for CQS (and quota purposes generally) were derived from earlier WEO classifications. However, to ensure continuity with previous quota papers, they do not incorporate several WEO modifications that have been introduced over time. As discussed in Annex II, shifting to the WEO based classification would lead to an increase in the share of advanced countries.