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IMF POLICY PAPER
INTERIM REVIEW OF THE ADEQUACY OF THE FUND’S PRECAUTIONARY BALANCES
December 2021
IMF staff regularly produces papers proposing new IMF policies, exploring options for reform, or reviewing existing IMF policies and operations. The following documents have been released and are included in this package:
A Press Release.
The Staff Report, prepared by IMF staff and completed on November 12, 2021 for the Executive Board’s consideration on December 13, 2021.
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International Monetary Fund
Washington, D.C.
©2021 International Monetary Fund
Press Release
PR21382
IMF Executive Board Discusses the Adequacy of the Fund’s Precautionary Balances
FOR IMMEDlATE RELEASE
WASHINGTON, DC-December 16, 2021 The Executive Board of the International Monetary Fund (IMF) concluded the Interim Review of the Adequacy of the Fund’s Precautionary Balances.1
Precautionary balances currently comprise the Fund’s general and special reserves.2. They are a key element of the IMF’s multi-layered framework for managing financial risks. Precautionary balances provide a buffer to protect the Fund against potential losses, resulting from credit, income, and other financial risks. For this reason, they also help protect the value of reserve assets represented by member countries’ positions in the Fund and underpin the exchange of assets through which the Fund provides financial assistance to countries with balance of payments needs.
This interim review of the adequacy of the Fund’s precautionary balances took place ahead of the standard two-year cycle given the need for close monitoring due to the heightened uncertainty in the global economy linked to the pandemic and the path and timing of the recovery.3
In conducting the interim review, the Executive Board applied the rules-based framework agreed in 2010. The framework uses an indicative range for precautionary balances, linked to a forward-looking measure of total IMF credit, to guide decisions on adjusting the target for precautionary balances over time. The framework also allows for judgement in setting the target, considering a broad range of factors that affect the adequacy of precautionary balances.
In the context of this interim review, the Board also took the opportunity to further discuss other issues that affect the level and accumulation of reserves, namely the First Special Contingent Account (SCA-1), after its full distribution; IFRS 9 credit impairment provisioning; the income volatility created by accounting for pensions revaluations under IAS 19. The Board also discussed the role of surcharges as part of the Fund’s risk management framework and the merits of a review of the surcharge policy.
Executive Board Assessment4
Executive Directors welcomed the opportunity to review the adequacy of the Fund’s precautionary balances ahead of the standard two-year cycle. They generally emphasized the importance of maintaining an adequate level of precautionary balances to mitigate financial risks, safeguard the strength of the Fund’s balance sheet, and protect the value of members’ reserve positions in the Fund. An adequate level of precautionary balances would thus continue to play an integral part of the Fund’s ability to lend.
Directors generally noted that overall financial risks remain elevated but have not increased significantly since the last review. In particular, credit risks are driven by a combination of historically high exposure, significant loan concentration toward the largest borrower, whose repurchases schedule is bunched in the near future, as well as a sizable share of emergency financing without ex-post conditionality in the lending portfolio.
In light of this, Directors broadly agreed to leave the medium-term target of SDR 25 billion, and the minimum floor of SDR 15 billion, unchanged at this time. Taking into account the expected new demand for Fund lending, the current target for precautionary balances of SDR 25 billion would remain within the indicative range of the forward-looking measure of average credit outstanding. Directors broadly noted that other qualitative considerations, while pointing to elevated risk, do not suggest a significant deterioration compared to the last review. A few Directors felt that raising the medium-term target would have been justified, while a few others thought that the level could be reduced if appropriate once the crisis abates. Against the backdrop of continued uncertainty about the global recovery, Directors noted that the target will need to be reassessed at the next regular review in about a year’s time. The minimum floor could be revisited after the review of the Investment Account.
Directors broadly considered that with the projected increase in lending income, the pace of precautionary balances accumulation is expected to remain adequate relative to the medium-term indicative target. Even after factoring in the proposed budget augmentation, the SDR 25 billion target would be reached in early Fiscal Year 2025 under the desk survey scenario for future lending—one year earlier than projected at the 2020 review. A few Directors stressed the importance of avoiding delays in the pace of accumulation, and a few others felt that it could be strengthened. Directors asked staff to closely monitor risks.
Directors welcomed the analysis provided by staff on the role of surcharges as part of the Fund’s risk management framework and their financial implications on members. Some Directors were open to exploring temporary surcharge relief to help borrowing members free up resources to address the health and economic challenges posed by the pandemic. Some suggested reflecting on how best to implement surcharges during pandemic situations. A number of Directors did not see a need to review the policies on surcharges or change their design at this stage, given overall low total cost of borrowing from the Fund and noting the critical role of surcharge income in ensuring an adequate build-up of risk buffers. Most other Directors expressed openness to an appropriately-timed, more holistic review of surcharge policies in the context of the Fund’s income model and overall financial outlook.
Directors also broadly supported the measures proposed by staff to mitigate the volatility of precautionary balances created by the accounting treatment of pension revaluations under IAS 19. While recognizing that income volatility stemming from the pension-related gains and losses cannot be eliminated for financial reporting under International Financial Reporting Standards, the new approach for determining precautionary balances seeks to reflect their role as a long-term buffer for economic and financial risks. It aims to achieve this by replacing the accounting valuation of the net pension-related assets and liabilities with a more long-term economic measure, and taking a more prudent stance on any economic gains. The transition to the new approach would be applied prospectively, commencing in FY2022.
Directors broadly supported keeping the SCA-1 open with a zero balance for the time being. Staff should monitor the need, and opportunities, for further SCA-1 funding, and engage the Executive Board on developments as warranted. Some Directors encouraged staff to explore further options for providing funding for the SCA-1. A few Directors highlighted the importance of the burden-sharing mechanism and the timely completion of the
16th General Review of Quotas. Some Directors noted that with the SCA-1 balance depleted, a need to book a provision for credit impairment could potentially arise and emphasized that the Executive Board should be informed ex-ante.
Title Page
INTERIM REVIEW OF THE ADEQUACY OF THE FUND’S PRECAUTIONARY BALANCES
November 12,2021
EXECUTIVE SUMMARY
Precautionary balances are a key element of the Fund’s multilayered framework to mitigate financial risks. They currently consist of the balances in the general and special reserves, totaling SDR 19.3 billion as of end-July 2021, and provide buffers to absorb losses, should these arise as a result of credit, income, and other financial risks. At the last bi-annual review, completed on October 30, 2020, the Board decided to raise the indicative medium-term target for precautionary balances to SDR 25 billion and, in light of heightened pandemic-related uncertainty, called for a reassessment of the adequacy of precautionary balances before the next regular review.
Overall financial risks remain elevated but have not increased significantly since the last review. In particular, credit risks are driven by a combination of historically high exposure, significant loan concentration toward the largest borrower, whose repurchases schedule is bunched in the near future, as well as a sizable share of emergency financing without ex-post conditionality in the lending portfolio. Market-based indicators and ratings suggest that the perceived credit quality of sovereign debt issued by the Fund’s borrowers remains weak.
Staff proposes to leave the medium-term target of SDR 25 billion, and the minimum floor of SDR 15 billion, unchanged at this time. Taking into account the expected new demand for Fund lending, the current target for precautionary balances of SDR 25 billion would remain within the indicative range of the forward-looking measure of average credit outstanding. Other qualitative considerations, while pointing to elevated risk, do not suggest a significant deterioration compared to the last review. The target will need to be reassessed at the next regular review in about a year’s time.
With the projected increase in lending income, the pace of reserve accumulation is expected to remain adequate relative to the medium-term indicative target. Even after factoring in the proposed budget augmentation, the SDR 25 billion target would be reached in early Fiscal Year (FY) 2025 under the desk survey scenario—one year earlier than projected at the 2020 review.
The paper also reviews policy factors discussed in recent Board meetings that affect the level and accumulation of reserves. These include the role of the First Special Contingent Account (SCA-1), after its full distribution in the context of Sudan’s arrears clearance; IFRS 9 credit impairment provisioning; the income volatility created by accounting for pensions revaluations under IAS 19; and surcharge policies.
Approved By
Bernard Lauwers (FIN)
Prepared by Finance Department
Contents
Glossary
INTRODUCTION
DEVELOPMENTS SINCE THE LAST REVIEW
A. Precautionary Balances Composition, Size and Coverage
B. Credit Risk
C. Income Risks
D. Financial Risks Related to Investments
ASSESSMENT OF THE ADEQUACY OF PRECAUTIONARY BALANCES
A. Indicative Precautionary Balances Target
B. Minimum Floor
C. The Pace of Accumulation and Analysis of Surcharges
ISSUES RELATED TO SCA-1 AND ACCOUNTING TREATMENT OF PENSIONS VALUATIONS
A Issues Related to the SCA-1 Account and IFRS 9 Credit Impairment Provisioning
B. Treatment of Pensions Net Assets/(Liability) Under IAS 19 and Impact on Precautionary Balances
ISSUES FOR DISCUSSION
BOXES
1. Evolution of Surcharges
2. Enterprise Risk Implications of Staff Proposal
FIGURES
1. Precautionary Balances Composition, Accumulation, and Coverage
2. Total Commitments and Credit Outstanding: January 1995-September 2021
3. Credit Concentration Toward Largest Borrowers and Regional Concentration
4. Scheduled Repurchases: FY 2023–27
5. Fund Borrowers: Sovereign Ratings and Spreads
6. Medium-Term Projected Operational Income and Expenses: FY 2022–26
7. Market Rates and Cost of Fund Borrowing
TABLES
1. Forward Looking Credit Measure and Calculated Range for Precautionary Balances: 2020–2023
2. Basic Information on Level and Time-Based Surcharges
3. Medium-term Projections on Surcharges Income and Precautionary Balances under Various Scenarios
4. Effect on the Precautionary Balances of a Hypothetical Loan Loss Provision
5. Pensions-related Impact on Precautionary Balances – Accounting vs. Economic Basis
ANNEXES
I. Framework for Assessing Precautionary Balances
II. Demand for New Programs
III. Burden Sharing Capacity
Glossary
| BOP | Balance of Payments |
| EA | Endowment Subaccount |
| EFF | Extended Fund Facility |
| FA | Fixed-Income Subaccount |
| FCL | Flexible Credit Line |
| FTSE | Financial Times Stock Exchange |
| FY | Fiscal Year |
| GRA | General Resources Account |
| IAS 19 | International Accounting Standards |
| IFRS9 | International Financial Reporting Standards |
| OPP | Outlook-for-Potential-Programs |
| PLL | Precautionary Liquidity Line |
| RFI | Rapid Financing Instrument |
| RSBIA | Retired Staff Benefits Investment Account |
| SBA | Stand-By Arrangements |
| SCA-1 | Special Contingent Account 1 |
| SDR | Special Drawing Rights |
| SRF | Supplemental Reserve Facility |
| SRP | Staff Retirement Plan |
| TBRE | Time Based Repurchases Expectation Policy |
| UCT | Upper-Credit Tranche |
| WEO | World Economic Outlook |
This press release summarizes the views of the Executive Board as expressed during the December 13, 2021 Executive Board discussion based on the paper entitled “Interim Review of the Adequacy of the Fund’s Precautionary Balances.”
Except the portion of the Special Reserve attributed to gold sales profits. Prior to its full disbursement in the context of the Sudan arrears clearance operation, balances in the First Special Contingent Account (SCA-1) were also included in precautionary balances.
Reviews of the adequacy of precautionary balances have been on a two-year cycle since 2002 but can be brought forward by the Executive Board if needed.
At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.IMF.orc/extanal/np/sec/misc/qualifiers.htm.
