Review of the Fund’s Income Position for FY 2020 and FY 2021–2022―Supplementary Information
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International Monetary Fund
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Publication Date:
24 Jul 2020
eISBN:
9781513551135
Language:
English
Keywords:
PP; income; lending; SDR billion; outlook factor; SDR Department; interest income; increase interest income; lending projection; implicit income; Personal income
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This paper reviews the Fund's income position for FY 2020 and FY 2021-22. It updates the April 2019 projections and proposes decisions for the current year.

Abstract

This paper reviews the Fund's income position for FY 2020 and FY 2021-22. It updates the April 2019 projections and proposes decisions for the current year.

Introduction

1. The supplement updates the projections of the Fund’s income position for FY 2020 and FY 2021–2022 in the staff paper issued to the Executive Board on April 13.1 The update incorporates additional information on developments through early April. The lending income projections for FY 2020 and FY 2021–2022 are broadly unchanged from the staff paper.2 However, a net income loss of about SDR 1 billion is now projected for FY 2020 in the GRA, compared with SDR 0.8 billion previously, mainly reflecting a higher estimated pension-related (IAS 19) loss. The endowment subaccount is also now projected to record a modest loss. The income projections for FY 2021–22 are broadly unchanged.

2. Uncertainties around the intensity and duration of the Covid-19 crisis will continue to impact the near term income outlook. Despite the close proximity of the updated projections to year end, the final income outlook for FY 2020 remains somewhat uncertain as described below. The outlook for FY 2021–22 is highly sensitive to the future path for interest rates and new demand for Fund resources, which could expand well beyond the updated projections in this supplement.

3. The supplement is structured as follows: The first section updates the FY 2020 income position for the main changes since the earlier projections, and the second section updates the income projections for the period FY 2021–22. Key tables, charts, and annexes have also been updated. An annex on the Investment Account (IA) Performance provides an update on the performance of the two IA subaccounts.

Review of the FY 2020 Income Position

4. A net loss of about SDR 1 billion is now projected for the GRA in FY 2020 compared with SDR 0.8 billion in the staff paper.3 The main factors contributing to the higher loss are discussed below.

Investment Income—Fixed-Income Subaccount (FI): Investment income from the subaccount is now projected at SDR 253 million compared with SDR 298 million in the staff paper. The updated projection reflects mainly the slightly negative portfolio returns in March due to a widening of credit spreads and mark-to-market losses on short-duration credit assets (Annex I). As before, this projection remains uncertain given recent heightened bond market volatility.

Table 1.

Projected Income and Expenditures—FY 2020

(in millions of SDRs)

article image
Source: Finance Department and Office of Budget and Planning

Consistent with the EA payout policy framework endorsed by the Executive Board in April 2018, the initiation of payouts is assumed to be delayed (until at least FY 2021).

Interest free resources reduce the Fund’s costs and therefore provide implicit returns. Since the Fund invests its reserves in the IA to earn a higher return, the interest free resources retained in the GRA are mainly attributable to the SCA-1, unremunerated reserve tranche positions not represented by gold holdings, and GRA income for the year not transferred to the IA. These resources reduce members’ reserve tranche positions and the Fund’s remuneration expense, or increase interest income if reflected in SDR holdings of the GRA, resulting in implicit income for the Fund.

Pension-related (IAS 19) expense: The updated expense projected for the year is based on actual information to April 9, and is slightly higher than the estimate in the staff paper, reflecting mainly an increase in the net actuarial remeasurement losses to SDR 2,204 million compared with a projection of SDR 2,083 million in the staff paper (Text Table). The higher remeasurement loss reflects a significant worsening in expected returns on the plan assets, which more than offsets the positive impact of a higher discount rate compared with previous estimates. More specifically:

  • The discount rate increased from a historically low rate of 2.71 percent4 to 2.97 percent, based on the latest estimate provided by the Fund’s actuaries as of April 9, erasing one quarter of the losses estimated in the staff paper. However, the rate remains 89 basis points below the level at the start of the year and continues to have a significant impact on the projected pension-related (IAS 19) loss for the year.

  • Asset performance has been very volatile during March and valuations reflect the large market declines recognized in the month offset partly by the slight recovery during early April. The remeasurement of plan assets is currently projected to be negative SDR 857 million compared with negative SDR 206 million in the staff paper (see Text Table).

  • Given ongoing financial market volatility, considerable uncertainties remain relating to the discount rate that will be used to measure the Fund’s retirement plan obligations at April 30, 2020, and to the full year asset returns on the retirement plan.

Text Table. Reconciliation of Pension-Related (IAS 19) Gains/(Losses)

(in millions of SDRs)

article image
Source: Willis Towers Watson and IMF Finance Department

The asset revaluations for the year are projected to end of the year and are based on actual portfolio performance to April 9, 2020 with estimates for the remainder of the year, and the April 9 discount rate is projected to the end of the year.

Total income from plan assets comprises two components for financial reporting purposes: i) the expected income on plan assets calculated using the discount rate, and included in the pension cost and ii) a gain or loss included in remeasurement losses that is in ‘excess’ of this expected income.

FY20: estimate of CCBR salary scale assumption adjustment.

Lending Income: FY 2020 lending income is projected to be SDR 1.9 billion, slightly below the estimate in the staff paper.

  • The slight decline in lending income is attributable mainly to lower service charges as certain disbursements previously assumed to fall in FY 2020 will now be made after April 30.

  • The revised estimate for emergency financing stands at about SDR 32 billion as of April 14, up from about SDR 26 billion as of March 27. More than half of the additional financing is expected to be disbursed in the next financial year and has a minimal impact on FY 2020 lending income.

Reimbursements: Expected to remain unchanged in FY 2020 in U.S. dollar terms.

Expenses: In line with the Supplement to the FY 2021–23 Medium-Term Budget Paper (04/21/20) the FY 2020 net administrative budget outturn has been revised from full utilization of US$1,158 million to a US$10 million, or SDR 7 million, underspend (Annex III).

Investment income—Endowment Subaccount (EA): Based on updated projections for FY 2020, the EA is expected to incur a loss in SDR terms of about SDR 126 million for the year compared with a gain of SDR 167 million estimated in the staff paper. This reflects the sharp sell-off in risk assets during March that more than offset the earlier strong performance in the EA. An equivalent amount would be reflected in the special account for IA retained earnings, reducing the cumulative retained earnings of the IA (all attributed to the EA) to about SDR 970 million. As indicated in the staff paper, the income projections for the EA remain subject to considerable uncertainty given the high degree of volatility across the asset classes in which the EA is invested.

Disposition Decisions

No changes expected to the disposition decisions.

FY 2021–2022 Income Outlook

A. Summary of Key Risks

5. Key risks to Fund income and finances associated with recent developments include large new lending arrangements, as well cancellations and changes in the timing of purchases under existing arrangements; fluctuations in the annual pension-related gain or loss as determined under IAS 19; and uncertainties around the global interest rate environment and U.S. dollar/SDR exchange rate path. The risk of cancellation or rephasing of purchases under existing arrangements is expected to be mitigated by members seeking additional sources of funding as the crisis unfolds. As discussed in the staff paper, changes in actuarial assumptions that impact the annual pension-related gain or loss under IAS 19 can be substantial and have a significant impact on overall Fund income and accumulation of precautionary balances. While the broadening of non-lending income sources under the Fund’s new income model is helping mitigate income risk, the low interest rate environment is expected to diminish the contributions from investment income in the near term.

B. Key FY 2021–2022 Income Outlook Factors

6. The outlook for the Fund’s net income in FY 2021–2022 has been updated for the impact of changes in key assumptions, notably investment returns and lending income. The lending projections for FY 2021–2022 are expected to remain broadly unchanged from the staff paper, which already reflected most of the surge in demand for Fund resources in the form of emergency financing that is current in the pipeline. As explained in the staff paper, no projections are made for the pension-related (IAS19) gain or loss beyond FY 2020.5

7. Based on current projections, the income outlook for FY 2021–2022, excluding the impact of the pension-related gain or loss, is expected to remain strong. Overall net income is projected at about SDR 1.4 billion and SDR 1.8 billion for FY 2021 and FY 2022, respectively (Table 2), in line with the projections in the staff report.

Table 2.

Projected Income Sources and Uses—FY 2020–2022

(in millions of SDRs)

article image
Source: Finance Department and Office of Budget and Planning

Consistent with the EA payout policy framework endorsed by the Executive Board in April 2018, the initiation of payouts is assumed to be delayed (until at least FY 2021).

Interest free resources reduce the Fund’s costs and therefore provide implicit returns. Since the Fund invests its reserves in the IA to earn a higher return, the interest free resources retained in the GRA are mainly attributable to the SCA-1, unremunerated reserve tranche positions not represented by gold holdings, and GRA income for the year not transferred to the IA. These resources reduce members’ reserve tranche positions and the Fund’s remuneration expense, or increase interest income if reflected in SDR holdings of the GRA, resulting in implicit income for the Fund.

No incremental costs are projected in managing the SDA resources in the CCR and PRG-HIPC Trusts.

See Annex II of Review of the Fund’s Income Position for FY 2020 and FY 2021–2022 (4/13/20) which illustrates the sensitivity of the FY 2021 and FY 2022 projections to changes in the key actuarial assumptions, viz.; the discount rate and asset returns, keeping other assumptions constant.

Lending Income. The lending projections incorporated in the baseline have been updated based on more recent information on requests and inquiries for financing by member countries. Based on information available as of April 14, lending income is expected to increase slightly due mainly to higher service charges following the rephasing of certain disbursements to FY 2021. Margin income is projected to increase over the medium term following the addition of new RFI arrangements; this increase is fully offset by surcharge income being lower than the earlier estimate largely reflecting the cancellation/revision of two large arrangements by members previously subject to surcharges.6

Fixed-Income Subaccount. The SDR interest rate path in FY 2021–22 is projected to be slightly lower than in the staff paper resulting in a corresponding decrease in the investment income estimate for the subaccount. The rates in FY 2021–22 reflect lower overall bond yields across SDR markets after reaching historically low levels in March.

Endowment Subaccount. The slight drop in the estimated EA payout amount in FY 2021–22 reflects the lower net asset value now projected at end FY 2020.

Interest-free resources. The lower SDR interest rate in FY 2022 lowers implicit income from interest free resources.

Reimbursements and Expenses: Expected to remain largely unchanged in U.S. dollar terms.

C. Review of the Margin for the Rate of Charge

Reserve Accumulation

8. Reserve accumulation in FY 2021 and FY 2022 is projected to be broadly in line with the staff paper. Table 3 updates the earlier estimates. Precautionary balances are now projected to decline to SDR 16.5 billion by end-FY 2020, lower than the SDR 16.7 billion estimated earlier mainly as a result of the increase in the projected pension-related (IAS 19) loss. However, reserve accumulation is projected to remain strong in the next few years, as credit outstanding is now projected to peak at SDR 96 billion in FY 2021 and to remain at high levels through at least FY 2023. As a result, the indicative medium-term target for precautionary balances of SDR 20 billion is still projected to be reached by FY 2023 (Figure 1). The outlook for subsequent years remains highly sensitive to potential new lending beyond the current surge in emergency financing.7

Table 3.

Income from the Margin and Reserve Accumulation1 (in millions of US Dollars, unless otherwise indicated)

article image
Source: Finance Department and Office of Budget and Planning

For analytical purposes, surcharges and commitments fees are considered for reserve accumulation only.

Costs related to the Fund’s “generally available facilities.”

Derived by applying the margin against average Fund credit outstanding at the average US$/SDR exchange rate.

Includes commitment fees for expired or cancelled arrangements.

Surcharges are projected on the basis of current quotas and surcharge thresholds.

Potential reserve accumulation is derived by assuming other sources of income are sufficient to cover non-intermediation costs.

Potential reserve accumulation as a percent of precautionary balances at the beginning of the financial year.

Additions to or reductions in reserves based on net income or loss for the year (including actual and projected IAS 19 gains/(losses) up to FY 2020, and excludes retained Endowment Subaccount investment income).

Precautionary balances include the Fund’s reserves and SCA-1 balance less the gold endowment of SDR 4.4 billion.

Figure 1.
Figure 1.

Projected Precautionary Balances Accumulation

(in billions of SDRs)

Citation: Policy Papers 2020, 037; 10.5089/9781513551135.007.A002

Source: Finance Department

Alignment of Fund Borrowing Costs with Market Conditions

9. Staff’s assessment of the alignment of the margin has not changed since end-February. The key indicator for this analysis (composite EMBI spread) is assessed on the basis of 5-year rolling medians, which remain broadly unchanged even with the inclusion of the recent spike in spreads in March and April.

Exceptional Circumstances Clause

10. Updated estimates suggest that the lending margin will continue to be set under the exceptional circumstances clause for the foreseeable future. Non-lending income (consisting of investment income and implicit income from interest free resources) is projected to be mostly lower over the medium term than the estimate in the staff paper, covering about 28 percent of the Fund’s non-lending administrative expenses by FY 2026 (Figure 2).

Figure 2.
Figure 2.

Projected Non-Lending Operational Income and Non-Lending Expenses1

(in millions of SDR, percent)

Citation: Policy Papers 2020, 037; 10.5089/9781513551135.007.A002

Source: Finance Department and Office of Budget and Planning1 Non-lending operational income comprises investment income and implicit income from interest free resources. Baseline projection assumes 1 percent payout from the Endowment Subaccount commencing in FY 2021. Alternative projection assumes 1.5 percent payout. Non-lending expenses are net administrative expenditures less intermediation costs related to generally available facilities, PRGT and SDR Department.

11. The projected burden sharing adjustment rates for FY 2020 are slightly lower than estimated in the staff paper (Table 4). The burden sharing adjustment rate is projected to be lower in Q4 FY 2020 following the recent clearance of Somalia’s arrears, resulting in a lowering of the average rates projected for the year.

Table 4.

Burden Sharing Adjustment Rates

(in basis points, unless otherwise stated)

article image

The average rates have been calculated using the quarterly burden sharing rates and SDR interest rates. No adjustments to the rate of charge in FY 2015, FY 2016, and the first two quarters in FY 2017.

Annual average rate calculated is less than 0.5 basis points. (prior to October 2014, the minimum burden sharing adjustment rate was set at 1 basis point).

In October 2014, the minimum for the quarterly burden sharing rate adjustment of 1 basis point was reduced to 0.1 basis point.

Annex I. Investment Account (IA) Performance

This annex provides a brief update on the performance of the two IA subaccounts. The portfolio will be reviewed during the year and include a discussion of policy, governance, and investment arrangements.

Endowment Subaccount (EA)

1. Equity markets have fallen significantly since February, as the evolution of the COVID-19 outbreak brought about a sharp deterioration in the global economic outlook. The magnitude of the decline in equity prices was not unusual by comparison with previous bear markets, but the speed of decline was unprecedented. Investors’ flight to the safety of government bonds and central banks’ policy responses have supported the performance of the fixed-income investments, while the returns on equity and real estate markets were all in negative territory for the IMF’s current fiscal year to the end of March (Figure A1.).

Figure A1.1.
Figure A1.1.

EA Asset Class Returns by IMF Fiscal Year

Citation: Policy Papers 2020, 037; 10.5089/9781513551135.007.A002

*Bloomberg data through March 31, 2020.Notes: (1) Local currency index proxy; (2) Developed market (DM) corporate bonds index proxy for reference.

2. The EA strategy has performed relatively well through the recent market sell-off. The EA was established with a “conservative diversified” strategy to provide a potentially meaningful contribution to the Fund’s income while preserving the portfolio’s long-term real value. To this end, the EA’s asset allocation maintains a large exposure to fixed income with a notable allocation (20 percent) to inflation-linked bonds (US TIPs). While US TIPs have performed less well than nominal bonds given declining inflation expectations, they have outperformed equities in the recent sell-off. Comparable long-term investors such as pension funds and university endowments usually hold a larger allocation to equities or other risk assets, and would have experienced larger drawdowns and higher return volatility than the EA. The investment arrangements for the passive component of the EA have also protected portfolio performance. The passive arrangements recently adopted by the Investment Oversight Committee for the corporate bond allocation target a fixed average credit quality which is higher than the market average. As a result, the EA’s corporate bond investments have suffered fewer downgrades and performed better than a market-capitalization weighted index.

3. Given the scale of the equity market sell-off, the EA return for the fiscal year is likely to be negative (Figure A1.2). At the end of March, the subaccount’s return for the fiscal year stood at -4.11 percent, in USD terms. The EA’s annualized real return since inception is now just over 1 percent. As discussed by the Board during the 2018 Review of the IA, the EA’s long-term real return target of 3 percent has been, and remains, challenging in an environment with bond yields at historically low levels.

Figure A1.2.
Figure A1.2.

EA Returns (in percent)

Citation: Policy Papers 2020, 037; 10.5089/9781513551135.007.A002

Note: Since inception on March 18, 2014, the EA returned 3.33 percent compared to the return objective of 5.25 percent (3 percent real in USD terms).*FY2014 was a partial period of two months.

Fixed-Income Subaccount (FI)

4. Central banks’ emergency policy responses to the building crisis have driven SDR weighted government bond yields to historically low levels. Two-year SDR government bond yields are currently around 9 bps, only marginally above the SDRi floor of 5bps. The precipitous drop in yield levels was beneficial for the FI’s SDR government bond holdings. At the same time, many investors rushed to raise cash through selling short-dated credit assets, such as asset-backed securities, mortgage-backed securities, and corporate bonds. This caused a dramatic widening of credit spreads and mark-to-market losses on short-duration credit assets, although these losses are expected to be temporary in nature.

5. Overall, the FI investment strategy demonstrated its resiliency through this credit crisis. The strategy, which aims at generating income over the SDR interest rate while protecting the Fund’s balance sheet, has worked as intended with its two-tranche structure balancing short-duration credit exposure (Tranche 1) with longer duration buy-and-hold investments in highly-rated government bonds (Tranche 2). The mark-to-market losses from credit assets held by managers in Tranche 1 were offset by gains on longer duration government bonds in Tranche 2. In addition, the flexibility allowed in Tranche 1 enabled the managers to pursue distinct strategies which enhanced the portfolio’s diversification and enabled them to adjust risk positions to quickly changing market conditions.

6. The FI is likely to achieve an overall positive return for the fiscal year and maintain a solid margin above the SDRi (Figure A1.3). For the fiscal year through the end of March, the FI had generated a return of 1.45 percent, 69 bps greater than the average SDRi.

Figure A1.3.
Figure A1.3.

FI Returns by Tranche (in percent)

Citation: Policy Papers 2020, 037; 10.5089/9781513551135.007.A002

Note: Tranche 2 buy-and-hold investments phased-in starting March 2017.

Annex II. Assumptions Underlying the Income Projections

Assumptions Underlying the Income Projections

(in billions of SDRs, unless otherwise stated)

article image

End-March figure is unannualized.

The projected returns for the Endowment Subaccount is shown in SDR terms.

Annex III. Consolidated Medium-Term Income and Expenses

Consolidated Income and Expenses, FY 2020–30 Baseline Scenario1

article image

The current medium-term projections are conservative and assume that a premium of 50 basis points over the SDR rate is attained in the longer run.

The baseline projections assume a 1 percent payout from the gold endowment commencing in FY 2021. The illustrative scenarios for FY 2030 show a continued payout of 1 percent in a low investment return environment (Scenario B); and a higher payout of 1.5 percent in a high investment return environment (Scenario A).

Interest free resources reduce the Fund’s costs and therefore provide implicit returns. Since the Fund invests its reserves in the IA to earn a higher return, the interest free resources retained in the GRA are mainly attributable to the SCA-1, unremunerated reserve tranche positions not represented by gold holdings, and GRA income for the year not transferred to the IA. These resources reduce members’ reserve tranche positions and the Fund’s remuneration expense, or increase interest income if reflected in SDR holdings of the GRA, resulting in implicit income for the Fund.
1

Review of the Fund’s Income Position for FY 2020 and FY 2021–2022 (04/13/20).

2

Emergency financing, including augmentations and drawings under current precautionary arrangements, to member countries facing immediate financing needs is projected to be about SDR 32 billion, based on updated data through April 14 (compared with about SDR 26 billion as of March 27 in the staff paper).

3

The net loss in the GRA in FY 2020 depletes the special reserve, slowing down the overall pace of reserve accumulation and the build-up of the Fund’s precautionary balances (see Figure 1 below). It also leads to a suspension of the transfer of currencies from the GRA to the Fixed-Income subaccount, thereby lowering future contributions from the IA.

4

As of end-February 2020.

5

As indicated in the staff paper, given the degree of uncertainty, staff’s view is that explaining the outcome of the pension-related (IAS 19) adjustment relative to a zero base is more coherent than doing so relative to a projected outcome based on hypothetical assumptions.

6

The access limit for RFIs is 100 percent of quota (see Enhancing the Emergency Financing Toolkit—Responding to the Covid-19 Pandemic (04/02/20)). A level-based surcharge of 200 basis points applies to outstanding amounts above 187.5 percent of quota. An additional time-based surcharge of 100 basis points applies to outstanding amounts above 187.5 percent of quota for more than 36 months (or 51 months for the EFF).

7

The Board will have an opportunity for a fuller discussion of the adequacy of precautionary balances later in the year.

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Cover Policy Papers
Review Of The Fund’s Income Position For FY 2020 And FY 2021-2022
Author:
International Monetary Fund
Volume/Issue:
Volume 2020: Issue 037
Publisher:
International Monetary Fund
ISBN:
9781513551135
ISSN:
2663-3493
Pages:
57
DOI:
https://doi.org/10.5089/9781513551135.007
Figure 1.

Projected Precautionary Balances Accumulation

(in billions of SDRs)
Figure 2.

Projected Non-Lending Operational Income and Non-Lending Expenses1

(in millions of SDR, percent)
Figure A1.1.

EA Asset Class Returns by IMF Fiscal Year
Figure A1.2.

EA Returns (in percent)
Figure A1.3.

FI Returns by Tranche (in percent)