Roger Pownall and Brian Stuart
The balance of payments problems of many Fund members have proved to be more intractable than originally thought in the early 1980s, and it is apparent that additional and sustained efforts will be needed for these countries to achieve durable economic growth with balance of payments viability. In the past several years, the Fund has adapted its policies to support growth-oriented adjustment in the changed world environment. Changes have included the provision of concessional resources to the poorest member countries with the creation of the Structural Adjustment Facility (March 1986) and the Enhanced Structural Adjustment Facility (December 1987), and modifications to the Extended Fund Facility that would provide higher levels of Fund financing on somewhat improved and more flexible terms in support of programs of strong macroeconomic and structural adjustment.
The Compensatory and Contingency Financing Facility (CCFF), established by the Fund in August 1988, is the latest in this series of changes. It is intended to enhance the Fund’s support of member countries in their growth-oriented adjustment.
This new facility consists of several distinct elements and replaces the Compensatory Financing Facility for Export Fluctuations, established in 1963, and the Facility for Financing of Fluctuations in the Cost of Cereal Imports, established in 1981. The CCFF preserves the basic features of compensatory financing, to provide financing to members experiencing temporary export shortfalls or excesses in cereal import costs owing to factors beyond their control. In addition, contingency Fund financing is designed to help members pursuing Fund-supported adjustment programs maintain the momentum of adjustment in the face of adverse external shocks.
External variables such as the terms of trade, foreign demand, and world interest rates are among the key assumptions in determining the framework of adjustment programs. In the past, unexpected adverse changes in these external variables have sometimes made it difficult for member countries to carry through their adjustment efforts. In some cases, member countries’ authorities were able to respond quickly to adverse external shocks with additional policy actions, or sought additional financing from other sources. More generally, however, policy changes took longer to implement and, in the absence of additional financing, the adjustment effort was interrupted.
Where adverse shocks gave rise to sudden declines in export earnings or excesses in cereal import costs, additional Fund financing was available under the compensatory financing facility, but often only well after these shocks had registered their effects on the balance of payments. Moreover, it has become increasingly important, especially in the present economic environment, to ensure that Fund financing is being provided to a member taking effective measures to strengthen its external position.
A mechanism for contingent access to the Fund’s resources, related inter alia to developments in oil prices, was incorporated for the first time in the 1986 stand-by arrangement for Mexico. Subsequently, there were calls for a broader treatment of external contingencies in Fund arrangements. After a series of meetings, beginning with preliminary discussions in the context of the periodic review of the Compensatory Financing Facility in November 1987, the Fund’s Executive Board agreed on the basic features of the new CCFF.
To avoid creating an unduly rigid and complex system, many of the operational modalities for the contingency element of the new facility are to be developed in discussions with member country authorities on an experimental and case-by-case basis. There is to be a full review of the new facility before December 1, 1989.
The new facility provides members with overall access to Fund financing of up to 122 percent of their quota (that is, their subscription to the Fund)—40 percent of quota each for the compensatory and contingency elements of the new facility; 17 percent to cover excesses in cereal import costs; and the remaining tranche of 25 percent to be used, at the option of the member, to supplement any of the above three elements. The previous access levels of 83 percent of quota for financing of either export shortfalls or cereal import costs (with a combined access of 105 percent of quota for the two elements) will be maintained in cases where the member’s balance of payments difficulties do not extend beyond the effects of an export shortfall or an excess in cereal import costs. Disbursements under the CCFF will come from the Fund’s ordinary resources (the subscriptions paid to the Fund by countries to meet their quota obligations to the Fund), with a repayment period of three to five years.
The contingency element of the CCFF will cover a wide range of external shocks, and will make Fund financing available rapidly in combination with other Fund arrangements to help members adapt their economic policies. It will be activated only when disturbances, brought about by adverse external developments in the variables covered by the mechanism, exceed a minimum threshold level, generally to be set at 10 percent of quota. The amount to be financed by the Fund would be agreed between the Fund and the member country authorities, with a view to ensuring an appropriate mix of financing and adjustment. Immediately after an external shock, the Fund would normally provide a substantial proportion of the financing needed to counter the adverse effects of the deviation from past trends; as the policy adaptations take effect, this proportion would be expected to decline. Contingency financing from commercial banks and other creditors, while not required in all cases, will be encouraged in connection with Fund contingency financing. Fund resources will be disbursed only if adjustment programs continue to be adequately financed from all sources.
The first time that contingent disbursements are made in a program period, an amount equal to 4 percent of quota will be deducted from the calculated balance of payments effect of the external shock before determining the amount of financing to be provided by the Fund; the member would be expected to cover this deductible on its own, through appropriate additional adjustment measures.
Contingency mechanisms will be attached to Fund arrangements supporting the adjustment efforts of member countries, and contingency financing will generally not exceed 70 percent of access under the associated arrangement, subject to the cumulative access limits described above. Contingency mechanisms may be associated with upper credit tranche stand-by and extended Fund facility arrangements. Contingency arrangements can also be attached to arrangements under the Structural Adjustment Facility and the Enhanced Structural Adjustment Facility (ESAF), provided that the adjustment program, as adapted following the adverse external shock, meets the monitoring requirements and other criteria for the use of Fund resources in the upper credit tranches.
Coverage. Contingency mechanisms would cover unanticipated changes in the key external variables beyond the control of the authorities that affect the member’s external current account such as export earnings, import prices, and interest rates. Variables such as tourist receipts and migrant workers’ remittances could also be covered if these are important elements in the member’s current account. Import volumes and capital movements would not be covered, given the difficulty in determining if movements in these variables are beyond the control of the authorities of the member countries. Natural disasters would continue to be covered by possible Fund emergency assistance but not by contingency financing.
Calculation of Fund financing. Contingencies will be monitored on the basis of the net sum of deviations from projections in the underlying program (i.e., the baseline projection). For example, if export and import prices are covered, the net sum of deviations would be the sum of unexpected movements in export and import prices multiplied by the export and import volumes specified in the program.
Fund financing would be calculated by multiplying the net sum of deviations (less the deductible of 4 percent of quota for the first purchase in the baseline period) by the proportion of the deviation to be financed. For example, with a threshold of 10 percent of quota, a financing proportion of 80 percent, and a net deviation of 14 percent of quota, financing of 8 percent of quota could be made available. Fund financing of deviations in interest costs is subject to a sublimit of 35 percent of quota to avoid possible adverse implications for the Fund’s liquidity from changes in interest costs. This sublimit is also aimed at encouraging member countries to hedge or cover the interest rate risk of part of their foreign debt or otherwise reduce the variability of interest costs through existing market mechanisms.
Baseline projections for the variables covered by the mechanism will be established for a 12–18 month period, depending on the length of the associated arrangement; for multiyear arrangements, annual baselines would be specified at the beginning of each year. These projections will draw on the forecasts prepared in connection with the Fund’s World Economic Outlook exercise, supplemented as appropriate by country-specific variables. For calculating the net sum of deviations, world reference prices and interest rates will be used, again supplemented by national data as necessary. The baseline projection and the method for calculating the net sum of deviations will be agreed between the Fund and the member country’s authorities at the time the associated Fund-supported adjustment program is framed.
The contingency mechanism assures members of the circumstances in which additional Fund financing will be made available. At the outset of an arrangement containing possible contingency financing, the exogenous factors to be covered, the corresponding baseline projections, the threshold level, the method of calculating contingent deviations, and the proportion of given contingencies that could be financed will be clearly specified.
Activation. Contingency mechanisms will generally be activated by a review by the Fund’s Executive Board. If it is clear that the minimum threshold is being exceeded, the necessary policy adaptations could be agreed with the authorities. Given the lagged effects of changes in international variables—such as interest rates—on the member’s balance of payments, it should be possible in most cases to complete the review process and provide financing as the effects of the adverse shocks are beginning to be felt. In exceptional cases where the link between contingencies, additional financing needs, and the policy actions that would need to be phased in could be specified with sufficient precision at the time the Board approves the associated arrangement, the mechanism could be activated without further review by the Executive Board.
Disbursements under the contingency mechanism would take place at the time of disbursements under the associated arrangement, provided that the objectives (or performance criteria) of the underlying arrangement, after adjustment to take account of the effects of the contingencies, were met. Subsequent disbursements under the mechanism would be made, upon observance of relevant performance criteria, adjusted as appropriate.
Symmetry provisions. The application of symmetry in adjustment financing is an important part of the contingency element. In the event of favorable external developments, a member would be expected to set aside part of the financial windfall, and so strengthen its external position. A member could add a proportion of the gain from the favorable deviation to international reserves, if its reserve position was low. Alternatively, the Fund could reduce disbursements under the associated Fund arrangement, or the member could begin repaying earlier contingency financing disbursements.
As mentioned above, the compensatory element of the new facility retains the essential features and objectives of the previous compensatory financing facility (see “Evolution of the Compensatory Financing Facility,” by Nihad Kaibni in Finance & Development, June 1986). The compensatory financing element will continue to provide timely financial support for export shortfalls (which may continue to include receipts from tourism and workers’ remittances), or excesses in the cost of cereal imports that are temporary and largely beyond a member’s control. The requirement of cooperation with the Fund in finding an appropriate solution for a member’s balance of payments difficulties and the early drawing provision, which allows a member to purchase on the basis of partly estimated data, have also been maintained. Further, as noted above, for members whose balance of payments difficulties result only from the effects of an export shortfall or excess in the cost of cereal imports, the access limits that were applied under the CFF have been retained.
Changes. The main changes that have been introduced relate to (1) access limits for members with balance of payments difficulties extending beyond the effects of an export shortfall or an excess in cereal import costs; (2) the formula used in calculating the size of the export shortfall; and (3) the introduction of a procedure to avoid overcompensation in successive purchases if the projections of export earnings underlying an earlier purchase prove to be overly optimistic.
The design of the facility, through the provision of the optional tranche of 25 percent of quota, allows the member some latitude in determining its access for either compensatory or contingency purposes. It is expected that the member will indicate how it would like the optional tranche allocated at the time the basic Fund arrangement with a contingency mechanism is approved; the member will be free to change the allocation until the time the contingency mechanism is activated. The member’s choice will depend on its particular circumstances. For example, if a decline in exports were envisaged, a member might wish to allocate the optional tranche to the compensatory element of the facility. On the other hand, if exports were projected to grow rapidly, and thus a decline in exports was seen as unlikely, the member might benefit by allocating the optional tranche to the contingency element.
Guidelines on cooperation. The use of Fund resources under the compensatory financing element is still subject to the test of the member’s cooperation with the Fund in addressing the balance of payments difficulties. The degree of cooperation required depends upon the specific circumstances of the member and the tranche in which it requests the purchase. Except as indicated below, a member is eligible to make an immediate purchase of up to 40 percent of its quota for an export shortfall if the shortfall is temporary, largely attributable to circumstances beyond the member’s control, and the member is willing to cooperate with the Fund in finding a solution to its balance of payments problems. The optional tranche would become available on completion of a review of a program supported by a Fund arrangement, or the equivalent thereof.
If a member country’s policies have been inadequate, or where its record of cooperation with the Fund in the recent past has not been satisfactory, access to the compensatory element for an export shortfall would be made in two tranches of 20 percent each. The first tranche would be available to the member on the basis of adequate prior action. Upon approval or review of an arrangement with the Fund, the member would qualify for the second tranche of 20 percent of quota (or up to 40 percent of quota if the member had not previously purchased the first tranche). Completion of a review of an arrangement with the Fund would normally be required to qualify the member to use the optional tranche for a compensatory purchase.
Determination of amount of compensation. The formula used to determine export shortfalls has remained basically unchanged since 1979. An export shortfall is measured as the deviation of exports in the shortfall year from a medium-term trend, defined as an average of export earnings (in SDRs) for five years centered on the shortfall year, and including two years of projected exports. Calculations of the trend for exports have been based on a geometric average. An examination of past CFF purchases revealed that errors in the projection of exports had resulted in a considerable incidence of overcompensation and a few cases of undercompensation. Accordingly, the formula has been amended to include a limit of 20 percent on the average growth of exports in the post-shortfall period, compared with their pre-shortfall average. This would also limit compensation in cases where export earnings grow rapidly in the shortfall year.
Another new feature relates to a compensatory purchase with a shortfall year which falls within, or overlaps with, the two-year projection period of an earlier purchase; in this case the shortfall supporting the second purchase would be adjusted by the amount by which the earlier purchase was overcompensated or undercompensated. Underlying this approach is the view that if subsequent data revealed that the original export profile had been misspecified, the problem should be corrected at the time of the second purchase.