Public Information Notice No. 06/53

WAEMU: IMF Executive Board Concludes 2005 Regional Consultation with the West African Economic and Monetary Union (WAEMU)

May 11, 2006

On March 24, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with WAEMU.¹

Background

Over the past two years the WAEMU faced a challenging policy environment which slowed growth and regional integration. The main external sector developments included the real appreciation of the CFA franc, and falling prices for the region's core commodity exports. Domestic problems ranged from a food crisis in several member countries to weak fiscal performance, socio-political crises, and financial sector problems. In the face of these macroeconomic and structural challenges, there was little progress in the implementation of regional policies. The "second convergence horizon" ended in 2005, with only limited progress in compliance with the convergence criteria. The WAEMU area remains insufficiently integrated, with trade and financial flows limited by formal and informal barriers.

Growth in 2004 and 2005 was moderate. Export prices for key commodities, most notably cotton, fell, while oil import costs rose. Côte d'Ivoire, the region's leading economy, continued to suffer from political instability, and the adverse spillover effects continued to affect the rest of the region. Against this background, region-wide growth in 2004 reached only 3.2 percent and about 4 percent in 2005. Per capita growth was positive, but below the sub-Saharan African (SSA) average.

Inflation in 2004 was less than one percent (on a period average basis), reflecting mainly a successful agricultural campaign in almost all countries, and the strength of the CFA franc. Inflation picked up in 2005, estimated to have increased to 4.5 percent following renewed oil price increases, food shortages in several countries, and a pick-up in domestic demand. Differences in agricultural output and the after-effects of the locust infestation in at least one country contributed to differing inflation across countries. In the context of excess liquidity, banks in some member countries were able to significantly increase lending. Domestic credit in Benin, Burkina Faso, and Niger increased at more than 20 percent, which also contributed to higher inflation.

Fiscal positions continued to weaken, but much of the additional deficits reflect poverty related spending; half of the additional deficits were matched by additional grants. Since 2001 overall fiscal balances in almost all member countries have been deteriorating, with the primary fiscal deficit for the zone reaching about 4 percent in 2005. While there has been some increase in the share of capital expenditures, fiscal flexibility in the region remains limited by the high share of current expenditures, in particular wages. Efforts to raise revenues have been hampered by problems in the tax administration: average revenue in 2004 represented only 16.2 percent of GDP, and was significantly lower in some member countries. Even the rates for better performing members have been below those of most other sub-Saharan countries.

External sector developments in 2004-2005 were mixed. From 2001 to end 2005, the CFA franc has appreciated—along with the euro to which it is pegged—by over 25 percent in nominal terms vis-à-vis the U.S. dollar. However, at least some of the exchange-rate based competitiveness gains from the 1994 devaluation persist as the region-wide real effective exchange rate now stands at 76 percent of its pre-devaluation level. With exports dominated by a limited range of primary commodities, WAEMU is vulnerable to terms of trade changes. Since 2000, the terms of trade have deteriorated by more than 20 percent. However, the terms of trade impact of the 2004-2005 oil price increase was softened by Côte d'Ivoire's oil exports, which amount to half of the zone's oil imports.

Macroeconomic prospects are positive but subject to risks. Price projections for the region's main export commodities are stable or point to an increasing trend. Stabilized export receipts should contribute to improving fiscal and external current accounts. Five WAEMU member countries are benefiting from the Multilateral Debt Relief Initiative (MDRI). Related flows, as well as any scaling up of aid under the G8 debt initiative, will also have a positive impact on regional growth. Given Côte d'Ivoire's importance in the regional economy, the prospects for faster regional expansion critically hinge on improved socio-economic conditions in this country. Other important risks for the region's outlook include possible further exchange-rate and oil-price induced shocks. Finally, domestic financial sector weaknesses, if not addressed at an early stage, pose a risk to financial soundness and fiscal sustainability.

Executive Board Assessment

Directors agreed with the thrust of the staff appraisal. They observed that the economic performance of the WAEMU in 2004/2005 had been affected by difficult external and, in some cases, internal environments in WAEMU members, contributing to only moderate economic growth, rising inflation, and a slow pace of structural reform and regional integration. Directors noted that prospects for strengthened economic performance will depend on developments in the external environment, the strength of macroeconomic and structural policy implementation, and the resolution of the socio-political difficulties in Côte d'Ivoire, the largest WAEMU member. They called on the member authorities to make progress on already agreed regional policies, particularly in the area of trade.

Directors agreed that the fixed exchange rate regime has provided a useful anchor for regional policy, and observed that the regional central bank's ability to maintain a sufficient level of international reserves adds to the credibility of the arrangement. While the real effective exchange rate appreciated over the past year, it remains broadly in line with fundamentals, although differences among members are widening. Against this background, Directors stressed that future exchange rate and terms of trade developments should be monitored carefully, and called for increased domestic price and wage flexibility to help alleviate past losses in price competitiveness. They also underscored the importance of prudent fiscal policies, including the containment of wage increases, in underpinning the exchange rate regime.

Directors observed that the damaging effects of structural and regulatory impediments to private sector activity, as outlined in international surveys on the business environment, may be more constraining to export growth than price factors. In light of this, they called for a broad-based liberalization of WAEMU members' business environments, and noted that the regional institutions could play a useful role in promoting such efforts.

Directors welcomed the regional central bank's ability to maintain a sufficient level of international reserves. The rapid credit and monetary expansion, which has contributed to increases in inflation in a number of WAEMU countries in the context of structural excess liquidity in the banking system, was, however, a source of concern. Directors considered that with increasing financial integration in the region, the use of differentiated reserve requirements will become less effective and called on the BCEAO (Central Bank of West African States) to reactivate its market-based instruments, with a view to managing liquidity at the regional level. They also noted that increasing inflationary pressures underscore the need for a more proactive stance in sterilizing the remaining excess liquidity in the system.

Directors regretted the failure of the region to reach macroeconomic convergence within the timeframe set by the second convergence horizon. They considered that this lack of success reflects both underlying economic policies as well as shortcomings in the design of the convergence criteria. Directors therefore welcomed ongoing efforts to redefine the convergence criteria to cover the relevant budgetary stance for each country more accurately, with several Directors calling for simple and transparent criteria that would contribute to an effective signaling process. Directors emphasized that a renewed commitment of members to adhere to common macroeconomic targets and to promote more integrated regional markets will also be crucial. In this context, they noted that the emergence of a regional treasury bill market—while welcome by itself—could pose risks to fiscal discipline, and therefore reinforces the importance of improved regional policy coordination. The authorities were also encouraged to promote the use of existing regional guidelines on public accounting, statistics, and budgetary processes.

Directors urged the authorities to step up their efforts to improve the soundness of the financial sector and enforce prudential regulations. In particular, they underscored the importance of preserving confidence in the regional banking system. In that context, they welcomed the actions already taken by the authorities in addressing the systemic banking problems in Togo, while stressing the need for further decisive efforts. Directors welcomed the dynamic development of the microfinance sector in the region, but called for a consistent regulatory framework and effective oversight. Several Directors supported the consideration of a regional Financial Sector Assessment Program (FSAP).

Directors called for a renewed focus on trade issues. They pointed to the need to abolish non-tariff barriers maintained within the region in violation of the common market, as well as the desirability of a pre-announced, phased reduction of external tariffs over the medium term. In this regard, Directors stressed the importance of strengthening domestic revenue mobilization in member countries to compensate any adverse impact on fiscal revenue from further trade liberalization.

Looking forward, Directors saw the key structural challenges for the WAEMU in reaching higher growth rates and in broadening the output base. In view of the limited institutional capacity of the regional institutions, they recommended that the regional authorities should focus on those regional growth-supporting policies relating to infrastructure, the facilitation of trade and energy supply improvements.

¹ The IMF holds annual regional discussions with the WAEMU region. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. 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.