Despite a long history of program engagement, the Fund has not developed guidance on program design in members of currency unions.

Abstract

Despite a long history of program engagement, the Fund has not developed guidance on program design in members of currency unions.

Characteristics of Different Currency Unions

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Case Studies: Burkina Faso, Greece, St. Kitts and Nevis, and Dominica

This background note outlines program design in four currency union cases, which present a characterization of selected issues confronted in these programs. The cases highlight that members of CUs can draw on pooled reserves, but this may affect overall reserve coverage of the union, and that liquidity needs for both governments and the banking sector have been at the core of balance of payments deficits, even if not always fully recognized as such in statistical tables.

1. Burkina Faso—the limited merits of drawing on pooled reserves

  • Burkina Faso has had a range of consecutive IMF supported programs, with arrangements approved in the 1990s, 2003, 2007, 2010, and 2014. Programs generally supported the country’s growth and poverty reduction agenda, while promoting structural reforms in a range of areas.

  • While Burkina Faso was affected by a number of shocks over this period, it continued to be a negative drag on the WAEMU region’s reserves. While WAEMU reserve coverage increased over the past decade by about 4 months of imports, Burkina Faso contributed negatively to reserve accumulation over this period, as reported in IFS statistics, losing close to 2 months of import coverage. Most losses were incurred after 2009.

  • Programs were not designed to sufficiently address national imbalances and restore external viability. While the 2003 and 2007 programs projected a positive contribution to regional level reserves, under the 2010 and 2013 programs, programmed reserve drawdown exceeded Fund, bilateral, and multilateral financing. This implied the program relied on a continued drain on regional reserves, which indeed materialized, reflecting that either policies were unlikely sufficiently tight or financing insufficient to cover ‘above the line’ balance of payments deficits. Hence, program design insufficiently took into account the coordination problem from relying on pooled reserves.

uA02fig01

WAEMU: Change in Reserve Assets

(Months of average imports , 2005–14) 1/

Citation: Policy Papers 2018, 011; 10.5089/9781498307284.007.A002

Source: IMF International Financial Statistics.1/ 2013 data for CIV, GNB, and NER.
uA02fig02

Burkina Faso: Projected Balance of Payment Financing Sources

(Billions of CFA francs)

Citation: Policy Papers 2018, 011; 10.5089/9781498307284.007.A002

Sources: IMF staff reports.

2. Greece’s 2010 SBA—the role of liquidity support to banks and the sovereign in BoP needs

  • The spillovers of the government liquidity crisis to bank liquidity were dealt with through ECB financing, but not included as below-the-line financing. The ECB provided specific sources of support (e.g. through waivers on minimum credit rating requirements on (Greek) instruments used in the monetary policy operations (collateral for refinancing), and later through full allotment auctions which implied excess liquidity creation for the Euro system as a whole in order to address impaired interbank markets and impaired monetary policy transmission). In the absence of such external liquidity provision to the domestic banking system, liquidity tightness in Greece would have required and resulted in stronger and potentially more disruptive economic adjustment (e.g. sharper import compression and/or stronger fiscal consolidation). As a substitute for adjustment, this may well have been considered a critical source of financing to the Greek program, with a reflection of such ECB support to the domestic banking system made ‘below the line.’

3. St. Kitts and Nevis’ 2011 SBA––the role of liquidity support to banks in BoP needs

  • St. Kitts and Nevis’ 2011 SBA aimed to restore fiscal sustainability and financial stability, and created a special banking reserve fund. A key program component included a debt restructuring operation to restore fiscal sustainability and in so doing also resolve bank-sovereign links. As such restructuring caused uncertainty about possible deposit flight—which could create pressures on domestic liquidity (or more likely on foreign reserves). To address this, the program financed the creation of a Banking Sector Reserve Fund (BSRF) to buffer against liquidity needs. The creation of this BSRF also required large front-loading of the Fund-supported program.

The balance of payments deficit in the program tables did not clearly include those related to the BSRF. Balance of payments needs were financed through limited reserve drawdown, IMF financing, and residual financing to be met through debt restructuring. Financing by the IMF for the BSRF was mentioned below-the-line in the balance of payments table, but was not numerically reflected as contributing to the balance of payments deficit, or to its financing. While the treatment was motivated by the precautionary nature of the BSRF and the need for clear communications about the financing needs at the time of a debt restructuring, an alternative presentation would have reflected a buildup of deposits at the non-resident ECCB (which could have been recorded above the line), and financed by the exceptional Fund financing (which may have been included below the line).

4. Dominica’s 2002 SBA—the role of ECCB support to the sovereign

  • Dominica’s 2002 SBA responded to external shocks, rising public debt and an economic downturn. Weaker macroeconomic outturns and policy slippages, however, caused the program to go off-track, and it was subsequently modified and extended, but required additional financing for 2003. Such financing included IMF and other official support, along with a US$1 million loan (0.3 percent of GDP) from the ECCB to help finance the larger fiscal balance.

  • The exceptional balance of payments “below the line” financing correctly included this fiscal support. Being a loan from a non-resident, the regional central bank, this was included in the balance of payments, presented as helping to fill the financing gap. Such treatment contrasts with the recording of advances from the regional central bank (in African monetary unions) or the treatment of similar government support from the ECCB to the government of Antigua and Barbuda in 2010 to deal with deposit outflows and bank recapitalization in one bank (Stanford Group) as domestic fiscal financing.

uA02fig03

Greece: 2010 SBA Financing Sources

(Billions of euros)

Citation: Policy Papers 2018, 011; 10.5089/9781498307284.007.A002

Sources: IMF staff reports.1/ Greek Loan Facility, EFSF.2/ Change in Target 2 balances. These were reported above the line.
uA02fig04

St. Kitts and Nevis: 2011 SBA Financing Sources

(Millions of ECCU dollars)

Citation: Policy Papers 2018, 011; 10.5089/9781498307284.007.A002

Sources: IMF staff reports.1/ Not contributing to balance of payments deficit.

A Conceptual Framework for Determining the Bop Need in a Currency Union Member

This background note lays out the treatment of balance of payments needs in the context of countries in currency unions (CU). Certain features of currency unions—including the non-resident nature of the union-level central bank (CUCB) and the interdependence created by membership in a union—affect the nature of external support and thus the balance of payments need. In particular, CUCB support provided on its “own account” to support a program is likely exceptional program financing.

1. The existence of a balance of payments need is a core requirement for the Fund to provide access to its general resources. The Articles of Agreement stipulate three forms of balance of payments needs under which the Fund can lend. These include a need because of: (i) a member’s balance of payments (i.e., where a member has or is expected to have a balance of payments deficit); (ii) a member’s reserve position (i.e., where reserves are inadequate); and (iii) developments in reserves (i.e., where, for example, a member that issues a reserve currency is facing a temporary liquidity problem). These balance of payments criteria are exclusive and alternative—no other form of need can justify a member drawing on Fund resources—but any one of them is sufficient. The need identified in program documents could be either actual or prospective identified through the baseline (for a drawing program) or potential, based on a downside scenario for an arrangement approved on a precautionary basis.2

2. Given this, program documents must clearly demonstrate the existence of a balance of payments need to substantiate the basis for the Fund to provide financing to its members. For program purposes, the presentation of balance of payments needs involves a clear separation of autonomous transactions from those designed to fill a balance of payments gap.3 This analytical presentation of the balance of payments distinguishes autonomous transactions from use of reserves and other exceptional financing (including from the Fund) to meet the balance of payments gap.4

3. Inaccurately specifying the balance of payments need may threaten a program’s viability. The purpose of a member’s Fund-supported program is to facilitate adjustment so that the country no longer needs to rely on reserve drawdown, exceptional financing, or so that the union can restore buffers to prudential levels with respect to that member by the end of the program.5 That is, it allows the member to resolve its balance of payments problem within the program period and, where relevant, the ability to (re) access capital markets within a timeframe and on a scale that would enable the member to meet its obligations due to the Fund. Hence all balance of payment flows need to be included, and the nature of these flows needs to be carefully separated between exceptional or autonomous (underlying). The failure to correctly separate exceptional from autonomous flows could result in countries being unable to exit program support even after completing their programmed policy adjustments. Overestimating exceptional inflows may similarly risk program viability by ultimately requiring harsher adjustment than expected.

4. Thus, designing a program of members of currency unions requires a careful assessment of two issues: (i) the residency of financing institutions; and (ii) the exceptional nature of their financing. In the following, we will first elaborate on the residency of the central banking institutions (and thus whether its transactions with the member should be accounted for in the BOP). Second, we will present key criteria to help distinguish and assess when financing takes on an exceptional nature. Third, we also discuss the nature of the balance of payments need when it reflects inadequate union-level reserves.

Incorporating All Balance of Payments Flows—Residency of the CUCB

5. CUCBs are organized alongside two different models.

  • In “centralized”6 CUs (e.g., ECCU, WAEMU, CEMAC), the CUCB consists of only one legal entity, even though there may be branch offices present in member countries that assist in the operational implementation of union-level policies. However, such branches have no separate legal status, and hence no own-capital or loss-bearing capacity. CUCB transactions and those of their branches are therefore external.

  • In a “decentralized” CU (eg., EMU), in addition to the CUCB, national central banks (NCB) exist and are separate legal entities, resident in the relevant country.7 As separate legal entities, NCBs have their own balance sheets and capital, and operations by the NCB that are initiated by the NCB are domestic transactions and are backed by the NCB’s own capital (e.g., ELA). As in centralized CUs, CUCB transactions with a member country are external.

6. CUCBs are not residents of their members. The Balance of Payments Manual establishes that a union-level central bank is not resident of any of the union’s members, but is resident of the union (BPM6 Manual Appendix 3). The analytical rationale for this treatment bears close similarity to why multilateral institutions including the Fund or regional development banks are considered nonresident to all of their members—BPM6 considers an international organization, including a CUCB, to have “an economic territory in its own right.”8 In addition, by their establishment through an international agreement (typically, a Treaty), CUCBs are legal entities that are not incorporated nor registered in any specific member country. The mandate of a CUCB is to conduct monetary and exchange rate policy on behalf of each of its members. The joint responsibility of all the members for the CUCB—including through decision-making, governance, and loss-bearing capacity— indicates that the “center of predominant economic interest” lies with all its members. Hence, as CUCBs are represented and backed collectively by its members, no country in a CU can claim the CUCB as a resident.

7. As a result, “own account” flows between the CUCBs and a member country are of a cross-border nature.

  • In a “centralized” CU, “own account” liquidity operations of the CUCB to a member take place exclusively through the non-resident CUCB. Local CB branches may help channel funding from the CUCB to the member but act merely as intermediaries, as they do not have an independent balance sheet and their loss bearing falls on the union at large.

  • In “decentralized” CUs, financial flows between the CUCB (e.g. ECB) and the member similarly can have a cross-border nature. Hence, liquidity provision by the central banking system of the union to the banks of the member would have a direct balance of payments impact if liquidity demand is ultimately associated with cross-border transactions. However, operations by the NCB that are supported by the NCB’s own loss-bearing capacity (such as Emergency Liquidity Assistance in the EMU), are considered a resident-to-resident transaction and hence do not directly affect the balance of payments unless liquidity met by ELA is ultimately associated with cross-border operations.9 In the case of the EMU during the period 2010–12, TARGET2 balances proxy the extent to which NCBs rely on Eurosystem liquidity. Thus, flows underlying TARGET2 transactions should be reflected in the BOP with some considered autonomous, while others could be exceptional financing to resolve a BOP need.

Distinguishing Autonomous from Exceptional Balance of Payments Flows

8. Correctly identifying the financing gap also implies clearly distinguishing whether financing transactions are autonomous or exceptional. Private flows are almost exclusively autonomous in nature, while official bilateral flows can be exceptional if they are aimed primarily at financing a balance of payments gap. This distinction also needs to be made for financing from the CUCB. While doing so will inherently contain an element of judgement, the following principles aim to guide such distinction.

  • Duration. Autonomous transactions are likely to reflect regularly used liquidity operations, e.g. in response to temporary shortfalls of liquidity that are expected to be reversed relatively quickly. Exceptional support likely involves covering sustained or persistent shortfalls. The underlying cause of such needs could be resident flight (indicated by persistent deposit withdrawals) or a loss of market access and inability to rollover debt (by either the public or private sector). In such cases, central bank support to the financial system (and where relevant, sovereign) should be considered exceptional. Some examples:

    • Persistent reliance by one or a few countries in the EMU on Eurosystem liquidity facilities at the time where other EMU members persistently register surplus liquidity.

    • Persistent or rising overdraft balances of some CEMAC countries from BEAC.

  • Common application. Autonomous transactions are likely to reflect those policies of liquidity provision that are applied uniformly to all members of the CU. However, specific exceptions made to accommodate one or selected members of the CU would typically be considered exceptional sources of liquidity provision. Examples include:

    • The loan granted by the ECCU to Dominica in the context of its 2002 SBA program (Background Note II).

    • The ECCB and CEMAC frameworks allow for credit allowances to governments up to a ceiling in relation to their revenues and by CU wide reserve coverage of liabilities. This financing could also be considered exceptional balance of payments support if it exceeds normal benchmarks.10

    • ECB financing provided via discretion in applying union-wide policies (e.g. collateral requirements of Greek debt) could be considered exceptional.

  • Intent of the liquidity provision. Autonomous transactions are likely those that result from regular market functioning and operations. However, liquidity provision in response to emergency situations may reflect the character of exceptional lender of last resort financing. Examples:

    • The ECB response to the fragmentation of financial markets in the EMU, the latter of which hampered monetary policy transmission and which was reflected in some agents (e.g. banks) effectively being cut off from normal market-pricing mechanisms. As such, the intent of the full-allotment fixed rate auctions was to provide liquidity to banks in those members where market forces no longer could provide such liquidity, and where liquidity provision was needed. This, together with the expansion of the collateral base and the provision of long-term financing, facilitated provision of liquidity for banking transactions that are settled in TARGET2 accounts. The provision of ECB liquidity under the facilities noted above during 2010–12 was exceptional and thus gives rise to below the line funding. 11

    • The ECCB can only provide liquidity support to banks if the absence of this support would result in financial disruption for the member. Thus, such support is not expected under normal circumstances and any change in net liabilities of residents vis-à-vis the ECCB arising from such transaction would be considered as exceptional financing.

Reflecting Balance of Payments Problems Stemming from a Member’s External Viability Issues

9. A balance of payments problem can arise if the member needs additional buffers, either for self-insurance or to address external viability risks.

  • A balance of payments problem can arise from the need to address external viability risks, and this needs to be transparently reflected in program documents. Focusing only on the balance of payments deficit of an individual currency union member may leave the CU as a whole short of adequate reserve coverage and may jeopardize the prospects of member programs successfully restoring external viability. The jeopardy would arise from the union having insufficient reserves to defend the peg or prevent disorderly movements in the currency. This implies that more adjustment may be needed in the members with a Fund arrangement to restore the viability of the union, and hence the external viability of the borrowing member. The individual member country contributions to addressing union-level viability concerns (in addition to their own balance of payments deficits) should be reflected in Fund documents . Regional reserve coverage (in US$ billion or other denominating reserve currency and in percent of relevant metrics) should be reported as a memorandum item in the medium-term balance of payments table.

  • Other buffers. The member may need to mitigate against risks such as the need for further resources to recapitalize banks or deal with other liquidity pressures (e.g., programs in Ireland, Cyprus, and St. Kitts and Nevis). These buffers should be clearly accounted for in the tables under exceptional financing.

1

As defined in the Balance of Payments and International Investment Position Manual, Sixth Edition (BPM6), Appendix 3.

2

With respect to concessional financing from the PRGT, the above analysis of a balance of payments need applies to the Standby Credit Facility and Rapid Credit Facility. However, regarding the Extended Credit Facility, members may receive financing under this facility if they have a “protracted balance of payments problem” at the time of approval of the arrangement (Section II, paragraph 1(b)(2) of the PRGT Instrument) and a member can have a protracted balance of payments problem even if it does not have a balance of payments need as defined under the Articles of Agreement. In determining whether a protracted balance of payments problem exists, the Fund examines the components of the balance of payments rather than the overall balance of payments position along with other indicators. (for more details see Staff Guidance Note on the Use of Fund Resources for Budget Support, EBS/10/44, 3/24/2010) Since the distinction between “balance of payments need” and “balance of payments problem” is not germane to the discussion in this paper, the terms are used interchangeably in this paper.

3

For statistical reporting purposes, countries typically follow the standard presentation—the international benchmark—but this presents changes in reserve assets and closely related items (including exceptional financing) as part of the financial account, making it more difficult to analyze and present the balance of payment deficit and its financing. Therefore, the Manual also outlines an alternative analytical presentation which facilitates a distinction between reserves and related items (including exceptional financing transactions) and other transactions, by reorganizing the standard presentation, based on an analytic construct but not on precise criteria.

4

The sixth edition of the Balance of Payments Manual identifies exceptional financing (see Appendix 1), as that which “brings together financial arrangements made by the authorities (or by other sectors fostered by authorities of an economy to meet balance of payments needs”.

5

In the context of a currency union, a balance of payments need for a member could arise from a CU-wide shortfall in reserves or a member-specific shortfall in buffers aimed at addressing contingencies specific only to that member.

6

As defined in the Balance of Payments and International Investment Position Manual, Sixth Edition (BPM6), Appendix 3.

7

In the case of the EMU, the CUCB is the ECB. The ECB, together with NCBs together form the Eurosystem.

8

BPM6 Chapter 4: “The economic territory of an international organization … consists of territorial enclave(s) over which the organization has jurisdiction. These enclaves are clearly demarcated land areas or structures that the international organization owns or rents and uses, and that are formally agreed on with the government of the territory, or territories, in which the enclave(s) are physically located. Each international organization is an economic territory in its own right, covering operations from all its locations.” And “A central bank to a group of economies (including currency union central banks) is an example of an international financial organization.”

9

The moment the liquidity provided by the NCB is used in a transaction with a non-resident, (e.g the payment to another member in the currency union), this transaction will be registered in the balance of payments (e.g such payment settlement will appear as an increase in the TARGET2 balance of the corresponding non-resident NCB and a decline in the TARGET2 balance of the local NCB).

10

The ECCB has strictly maintained these principles in extending credit, with no member allowed to draw more than the credit allocation allowed under the framework. However, WEAMU and CEMAC has had instances of repeatedly breaching their framework and members can draw down on pooled reserves. This together with the moral hazard from the French guarantee on operational accounts at its treasury have meant that the framework was disregarded under normal conditions.

11

During 2010–12, “TARGET2 liabilities … increased sizably for some NCBs. This is because their banking systems have faced payment outflows in euro which have not been matched by payment inflows in euro […]. However, the money which a bank can use to conduct payments needs to be offset by a compensating inflow. In a context of impaired interbank money markets and the non-standard monetary policy measures introduced by the ECB as a result, compensation comes from central bank liquidity […]. This has been reflected in an exceptional increase in Eurosystem liquidity provision during the crisis. […] The large increase in the TARGET2 liabilities of some countries’ NCBs during the financial crisis is thus a reflection of funding tensions in those countries’ banking systems and the Eurosystem’s accommodation of the ensuring liquidity needs. Accordingly, the very high level of net cross-border payment flows reflects the extraordinary support provided by the Eurosystem to ensure the effectiveness of the single monetary policy.” ECB (2011).

Program Design in Currency Unions
Author: International Monetary Fund. Strategy, Policy, &, Review Department, International Monetary Fund. Legal Dept., International Monetary Fund. Finance Dept., and International Monetary Fund. European Dept.
  • View in gallery

    WAEMU: Change in Reserve Assets

    (Months of average imports , 2005–14) 1/

  • View in gallery

    Burkina Faso: Projected Balance of Payment Financing Sources

    (Billions of CFA francs)

  • View in gallery

    Greece: 2010 SBA Financing Sources

    (Billions of euros)

  • View in gallery

    St. Kitts and Nevis: 2011 SBA Financing Sources

    (Millions of ECCU dollars)