Monetary Policy

The BCEAO conducts monetary policy in the WAEMU at the regional level. Its basic near-term objectives are (1) to maintain the fixed exchange rate relationship between the CFA franc and the French franc—which means that the trend rate of inflation in the area is fundamentally determined by French inflation (Box 2); and (2) to achieve a target level of foreign assets for the BCEAO. The fixed exchange rate system implies that the independence of regional monetary policy is constrained: money growth within the region is endogenously determined, and an appropriate differential must be maintained between market interest rates in the WAEMU and in France (Figure 3). Moreover, there is no scope for national monetary policies in the member countries of the WAEMU. For this reason, IMF-supported programs in these countries currently do not include targets for either base money or the central banksď net domestic assets because these variables cannot be meaningfully defined at the national level. Even if they could be defined, they would be beyond the control of the national authorities. Of course, fiscal policy—including public debt management—remains within the purview of individual countries in the WAEMU, and IMF-supported programs typically include targets for the fiscal deficit, external borrowing by the government, and net domestic bank credit to the government. Cumulative borrowing by national governments from the BCEAO is itself constrained to no more than 20 percent of their fiscal revenue in the previous year.

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Money Market Interest Rates

Sources: BCEAO, and Bank of France.

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The BCEAO seeks to control domestic credit expansion in the region by using indirect monetary policy instruments and enforcing ceilings on central bank credit to governments. The policy instruments available to the BCEAO are the discount rate mechanism, a repurchase agreement facility (pension window), and a system of periodic auctions of central bank bills, as well as reverse auctions, introduced in July 1996.⁶ Auctions and repurchase agreements are the most frequently used instruments; the discount rate is used primarily to signal policy intentions about future movements in interest rates. Ceilings on central bank credit to governments, set at the equivalent of 20 percent of tax revenue in the preceding year and generally observed by member countries, are a powerful tool of credit policy. However, they lack flexibility because the central bank cannot change them to accommodate its near-term policy objectives.

The goal of the regional monetary program for 1998, adopted by the BCEAO last December, is to strengthen the gross foreign assets of the central bank while allowing credit to the economy to expand in line with the projected rate of growth of nominal GDP. The net foreign assets of the BCEAO are targeted to grow by nearly 10 percent during 1998 over the previous year, which should allow for continued adequate coverage of the monetary base. In line with the objectives determined in each country of the WAEMU in the context of IMF-supported programs, net bank credit to WAEMU governments is expected to decline moderately.

A source of concern for both the monetary authorities and IMF staff in recent years has been the vast pool of unused liquid resources in the banking system (see Appendix IV, Tables 16–18). These resources consist of a large stock of unremunerated excess reserves at the central bank and sizable holdings of long-term government bonds consolidated by the WAEMU and short-term BCEAO bills.⁷ At the end of 1996. the amount of liquid resources held by banks in these various forms amounted to almost 20 percent of bank deposits (Appendix IV, Table 18). This liquidity “overhang” tended to increase from 1994 to 1996, owing to the return of flight capital and the rise in export earnings that had to be repatriated and surrendered to the central bank, while the expansion of bank credit tended to lag behind the growth of nominal GDP. Credit expansion picked up strongly during 1997, and the ratio of liquid assets to deposits fell sharply, although it remained high at almost 17 percent.

The liquidity overhang seems to be related to a number of factors: (1) the high risk of bank loans to banks resulting from legal difficulties in enforcing the recovery of claims in case of default; (2) significant inefficiencies in the banking system at the regional level, which hinder the channeling of funds from very liquid banks in some member countries to banks in other countries where the demand for credit is relatively strong;⁸ (3) a lack of competition among banks, particularly at the regional level; and (4) the weakness of credit demand from a number of large borrowers, in particular in the export-oriented sector, who experienced substantial improvements in their cash flow and improved access to external credit after the 1994 devaluation.

The first three factors—high lending risk, lack of competition, and other financial market imperfections—appear to be consistent with the simultaneous occurrence until recently of excess liquidity and slow credit expansion and also with the existence of high spreads between deposit and loan rates in the region. The fourth explanation, which features the strong cash-flow position of export-oriented companies, could help to explain weak demand for bank credit in recent years. While not a cause of immediate concern in view of the sluggishness of credit expansion in the past several years, the recent surge in bank credit suggests that the central bank must stand ready to absorb any excess liquidity in the system if and when the need arises—for example, if strong demand for credit coincides with the resolution of some of the structural problems noted above. If the use of reserve requirements or auctions of central bank bills prove insufficient, additional measures—including the issuance of central bank medium-term bonds (not redeemable on demand) carrying a suitable rate of interest—might also be considered. While not ruling out this possibility, the BCEAO feels that the need for such bonds is not required in present circumstances in view of the prudence of the banksď lending policies.

Banking System

As indicated above, some of the key monetary policy issues in the WAEMU are closely related to a number of structural problems of the regionď s banking system, which need to be addressed both to increase efficiency in financial intermediation and to improve monetary control. First, competition among banks in the WAEMU appears to be insufficient in at least two ways: (1) lending rates, except for preferred customers, remain high in real terms; and (2) the lack of competition for depositors is evidenced by low deposit rates and occasional refusals by banks to accept term deposits by customers. The lack of competition is illustrated by a large gap between the costs of funds to banks and their lending rates and, therefore, by a high level of profitability of most banks in the region.⁹

Because they are so profitable at present, the banks lack incentives to modify their strategy and develop more aggressive lending policies. In addition, the unreliability of the judicial system and, in some countries, the apparent bias of legal procedures in favor of debtors represent serious obstacles to the recovery of claims and encourage some borrowers to default on their loans. Thus, the risk to banks that would result from a more aggressive lending policy should not be underestimated. However, the rapid development of small mutual savings and lending institutions during the last five years in both urban and rural areas shows that it is possible for financial institutions to lend actively while experiencing only very limited rates of nonperforming credits.

One way to improve the functioning of the regionď s banking system would be for the BCEAO to encourage the development of an active interbank market. Indications about volume, interest spreads, and accessibility suggest that the interbank market is working imperfectly; only a few of the approximately fifty banks operating in the WAEMU participate actively in the market. Insufficient information about the financial strength of participants and the absence of an efficient payment system also hamper the functioning of the interbank market. As a first step toward improving the flow of information, the BCEAO has started to provide market participants with data on interbank loans, including the volume of transactions and the weighted average rate. In addition, a reform of the payment system is currently under way and should promote the development of interbank transactions. The efficiency and competitiveness of the banking system could also be improved through the introduction of a single, zone-wide licensing agreement for banks in the WAEMU. Currently, banks are required to have a banking license and a separate capital base in each country in which they wish to operate, discouraging them from operating across borders. While supportive of a zone-wide licensing agreement, the BCEAO faces resistance from WAEMU governments, which fear that an increase in the number of banks operating in their respective countries could increase their liability in the event of bank failure.

Bank Supervision

The financial sector of the WAEMU includes 53 banks and 26 financial institutions (Appendix IV, Table 19). At most, 10 of the 53 banks are considered large—with assets of more than CFAF 100 billion (US$170 million)—and offer a wide variety of services to a broad range of customers throughout the region. The financial situation of the banking system has improved significantly in most WAEMU countries since the early 1990s as a result of restructuring operations that have raised banksďequity base and retained profits. Net profits for 1996 amounted to about CFAF 73 billion (US$140 million), compared with CFAF 12 billion (US$22 million) in 1994, and were equivalent to 25 percent of capital for all banks taken as a group (and to 35 percent of capital for the 10 largest banks). The number of banks unable to observe the minimum capital requirement ratio fell from 17 in 1994 to 13 in 1996; of these 13 banks, all except 1 were small or medium-sized. The share of nonperforming loans declined from 32 percent in 1993 to less than 20 percent in 1996.

Responsibility for bank supervision rests primarily with the regional Banking Commission, established in 1990. However, the ministries of finance of individual member countries and the BCEAO retain final authority, and their agreement is necessary for the most important decisions involving commercial banks and other financial institutions, including closure in the interest of depositors. By and large, the Banking Commission has supervised the banking system effectively. With the recent strengthening of its personnel, it has been able to inspect about half of the banks operating in the WAEMU and to carry out more frequent partial controls over banks on its “close watch” list—about one-fourth of active banks. The quality of the inspections it performs and of the reports it produces is generally considered to be high. However, in many cases, the recommendations of the Banking Commission tend to be implemented with long delays, especially when the issue is strengthening the capital base of banks considered to be financially unsound.

Governments have been actively involved in the restructuring efforts of a number of banks in financial difficulty—an involvement that is unavoidable when the banks are entirely or partly owned by the state. The political pressure to ensure full repayment of deposits when banks fail and depositors lose money explains, to a large extent, the reluctance of most governments to accept the closure of banks as a solution. Governments should seek full privatization of the banking system, which would diminish this pressure. The need to raise capital ratios to international standards should also receive prompt attention. The capital adequacy ratio currently in place in the WAEMU (4 percent) does not accurately reflect the level of risk faced by banks operating in the region, and a minimum ratio of 8 percent should be considered.

Trade Policy

The WAEMU treaty provides for the elimination of all tariff and nontariff barriers between member countries as well as for the rationalization and harmonization of trade policies vis-à-vis third countries through the elimination of nontariff barriers and the implementation of a common external tariff. Despite efforts to liberalize trade in recent years, and especially since the 1994 devaluation, import duties are generally still high in the WAEMU, especially in Burkina Faso, Côte dď lvoire, and Senegal. These high tariffs have usually been justified on the basis of the narrowness of the tax base, but they have also served in many instances to protect local industries. The move to a common external tariff thus provides an opportunity for member countries to harmonize and rationalize their individual tariff structures, further liberalize external trade, and deepen their integration with the world economy.

In its dialogue with both the national authorities and the regional Banking Commission, the IMF staff has argued that the common external tariff should involve a reduction in tariff peaks, a simplification of the tariff schedule, and a reduction in the average external duly rate to the lowest level consistent with reducing fiscal imbalances. In line with the principles of the World Trade Organization, the staff has also cautioned against the adoption of a tariff structure that would raise the tariffs in those member countries with the lowest rates, such as Benin and Togo. In view of the relatively small economic size of the WAEMU and the relatively low level of trade among its members (see Appendix I), it should be possible to reduce intraregional levels of protection substantially while liberalizing trade with the rest of the world, resulting in considerable trade creation with very little trade diversion.

On November 28, 1997, the Council of Ministers adopted a precise calendar for introducing the common external tariff. The ultimate objective is to put in place by January 1, 2000, a structure that consists of four rates: 0, 5, 10, and 20 percent (see Box 3). In the first phase of the transition (from July 1, 1998 to December 31, 1998), all import duties will be subject to an overall ceiling of 30 percent. In the second phase, starting January 1, 1999, the number of rates will be limited to four: 0, 5, 10. and a temporary maximum rate of 25 percent. On top of the tariff rates that will be in place by January 2000, there will be a statistical tax not to exceed 1 percent that, for some countries, will represent a sharp reduction from existing levels. In addition, a few products—still to be identified—could be subject to import surtaxes on a transitory basis. Safeguard measures, however, may be applied in specific circumstances to protect local industries or producers from erratic fluctuations in international prices.

With regard to the liberalization of trade within the WAEMU, the 60 percent preference margin relative to the tariff rate applicable to countries outside the union in July 1997 will be raised to 80 percent in January 1999 and to 100 percent in January 2000. These steps will eliminate by the latter date all internal tariffs on trade between member countries related to eligible industrial products—that is, those with a regional value added equal to at least 40 percent of total value added or with a regional content of at least 60 percent. All duties on agricultural products and handicrafts were eliminated in July 1996.

The common tariff structure to be put in place over the next two years will need to be based on a detailed classification of imports to be adopted by July 1, 1998.¹⁰ In discussions with WAEMU representatives and national authorities, the IMF staff noted that the categorization of products that was under consideration was biased toward the protection of local industries in that it allowed products identified as “sensitive” to be shifted into categories that afforded the maximum allowable tariff rate. Accordingly, the staff recommended, with support from the World Bank, the adoption of a categorization of goods similar to the one established by the United Nations, which is strictly based on the level of processing of the goods (that is, primary, capital, and consumption goods). The staff also argued that the use of any exceptional surtax should be temporary and truly exceptional (that is, limited to a very small number of tariff lines).

The lower duties implied by the common external tariff could substantially reduce fiscal revenue in a number of WAEMU countries where import duty rates are currently high. Several of the countries that are most likely to be affected have requested technical assistance from the IMF to quantify the potential impact of the common external tariff and help them find ways to offset the expected losses. A recent IMF technical assistance mission to Burkina Faso estimated the revenue loss associated with the introduction of the common external tariff at 0.9 percent of GDP by the year 2000. This estimate assumes the implementation of certain compensatory fiscal measures, including an increase in excise taxes on petroleum products. A similar study for Senegal has shown that the fiscal cost, exclusive of compensatory measures, would be equivalent to 1 percent of GDP during 1998–99 and 1.6 percent in 2000. Simulations performed by the customs administration in Côte d’lvoire indicate that revenue shortfalls would be very limited in that country, provided that exemptions are virtually eliminated. In discussions with both regional and national authorities, the IMF staff has stressed that countries must offset revenue losses as much as possible by introducing compensatory revenue measures and, in particular, by eliminating exemptions on import duties and other taxes. At the same time, the staff has indicated that, if countries make such efforts, and if they are implementing an otherwise strong reform program, the IMF would lake into consideration any temporary, residual effect of tariff reduction on fiscal revenue in identifying the financing of the program.

Box 3.

WAEMU: New Tariff Structure

	From July 1.1998	From January t, 1999	From January 1,2000
External tariff
Category I	Current rate	0	0
Category II	Current rate	Maximum S%	5%
Category III	Current rate	Maximum 10%	10%
Category IV	Maximum 30%	Maximum 25%	20%
Regional tax 1	O.5%	0.5%	0.5%
Statistical tax	Current rate 2 or less	Current rate 2 or less	Maximum 1%
Intra-WAEMU tariff
Local agricultural products	0	0	0
Approved industrial
products of origin 3	60% preference 4	80% preference 4	100% preference
Non approved industrial
products of origin	-5 percentage points	-5 percentage points	…
Other products	No preference	No preference	…

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	From July 1.1998	From January t, 1999	From January 1,2000
External tariff
Category I	Current rate	0	0
Category II	Current rate	Maximum S%	5%
Category III	Current rate	Maximum 10%	10%
Category IV	Maximum 30%	Maximum 25%	20%
Regional tax 1	O.5%	0.5%	0.5%
Statistical tax	Current rate 2 or less	Current rate 2 or less	Maximum 1%
Intra-WAEMU tariff
Local agricultural products	0	0	0
Approved industrial
products of origin 3	60% preference 4	80% preference 4	100% preference
Non approved industrial
products of origin	-5 percentage points	-5 percentage points	…
Other products	No preference	No preference	…

¹ Levied on all imported goods to assist in meeting the budgetary cost of regional institutions and to finance structural regional funds and the revenue shortfall resulting from the regional preference margin. ² Rates currently vary from I percent to 6 percent. ³ Products with a minimum local content of 40 percent. ⁴ Over external tariff rate

In parallel with adopting the common external tariff, WAEMU members are working together to harmonize indirect taxation. In this regard, the regional Banking Commission is developing proposals for a value-added tax, excises, and a tax on petroleum products, for which the IMF is providing technical assistance. In December 1997, the Council of Ministers considered a general framework for harmonizing indirect taxation and will address recommendations to member countries before the end of 1998, with the objective of achieving effective harmonization by 2000.

Coordination of Macroeconomic Policies

The WAEMU treaty aims at convergence of economic policies and performance among member countries through a mechanism of multilateral surveillance. The WAMU treaty had already specified a number of common rules in the monetary area, in particular on central bank credit to governments, the minimum level of official foreign assets, and the legal framework under which commercial banks operate. Convergence is expected to be achieved through

• basic rules and quantitative criteria related to some key policy areas, such as fiscal policies, incomes policies, and external debt management;

• harmonized statistical indicators to monitor the observance of adopted norms;

• periodic reviews by the regional Banking Commission of the performance of individual countries; and

• in cases of serious divergence, a process involving consultation and coordination, and, at some point, disciplinary actions against individual countries failing to implement corrective measures. So far, however, this process remains untested.

Box 4.

WAEMU: Convergence Criteria

Article 4b of the WAEMU treaty establishes the principle of a gradual convergence of economic performance of member countries. Accordingly, convergence criteria to facilitate monitoring of progress in the context of the multilateral surveillance on economic performance have been developed in the area of public finance. The common objectives set by these criteria are as follows:

• A level of civil service wage bill not to exceed 50 percent of tax revenue (lowered to 40 percent from January 1998).

• A Level of public investment financed by domestic resources equal to at least 20 percent of tax revenue.

• A primary basic fiscal surplus equivalent to at least 15 percent of tax revenue.

• A declining or unchanged level of domestic arrears.

• A declining or unchanged level of external arrears.

For 1997, the performance of member countries in terms of these convergence criteria was estimated as follows by the regional commission:

	Wage Bill	Investment Financed by Domestic Resources	Basic Primary Balance	Change in Domestic Arrears	Change in External Arrears
	(Percent of tax revenue)			(BiMions of CFA francs)
Benin	38	7	21	-17	—
Burkina Faso	40	23	9	-6	—
Côte d’lvoire	37	22	24	-52	—
Mali	30	18	27	-7	—
Niger	57	7	-8	-21	2
Senegal	40	14	29	—	3
Togo	51	3	6	-23	-17

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	Wage Bill	Investment Financed by Domestic Resources	Basic Primary Balance	Change in Domestic Arrears	Change in External Arrears
	(Percent of tax revenue)			(BiMions of CFA francs)
Benin	38	7	21	-17	—
Burkina Faso	40	23	9	-6	—
Côte d’lvoire	37	22	24	-52	—
Mali	30	18	27	-7	—
Niger	57	7	-8	-21	2
Senegal	40	14	29	—	3
Togo	51	3	6	-23	-17

Five indicators are used to monitor the convergence of fiscal policies in the WAEMU area, all of them defined in relation to tax revenue (see Box 4 and Appendix IV, Table 20). Member countries are also expected to gradually eliminate all domestic and external payments arrears. Indicators of economic performance for 1997 suggest that all member countries except Burkina Faso, Niger, and Togo met the convergence criterion on the basic primary balance.¹¹ Only Burkina Faso and Côte ďvoire observed the criterion on domestically financed investment, while Mali is within reach of the 20 percent threshold. All countries have satisfied the criterion on the wage bill except Burkina Faso, Niger, and Togo, which are close to the target. All member countries except Niger have eliminated external payments arrears, and Benin, Burkina Faso, and Senegal have eliminated domestic payments arrears. The recent adoption by the Council of Ministers of two decisions designed to harmonize budget laws and government accounts in the WAEMU as a whole by 2000 is expected to further strengthen the basis for multilateral surveillance. IMF technical assistance in the area of fiscal convergence has been requested and is being considered.