Review of the Compensatory Financing Facility
February 18, 2004
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IMF Concludes Review of the Compensatory Financing Facility
On March 31, 2004, the Executive Board of the International Monetary Fund (IMF) concluded its review of the Compensatory Financing Facility (CFF).
The Compensatory Financing Facility was established in 1963 to help member countries cope with temporary export shortfalls caused by exogenous shocks. The facility has been modified several times, including by broadening its coverage to include shocks affecting cereal imports. At the time of the most recent review in 2000, the Executive Board decided to simplify the structure of the CFF, and that that CFF financing would need to made in parallel with a Fund-supported adjustment program when preexisting balance of payments weaknesses needed to be addressed. The CFF has not been used since the modifications introduced in 2000. The staff paper suggests some reasons for this, and considers the role of the CFF in the Fund's array of lending facilities. A further consideration of mechanisms to deal with shocks affecting low income countries is contained in the ongoing review of the role of the Fund in low-income countries [reference] that was undertaken in parallel with the present review of the CFF.
Executive Board Assessment
Executive Directors welcomed the opportunity to review the Compensatory Financing Facility (CFF), in parallel with the paper on instruments and financing options for low-income countries. The review took place against the background that the CFF has not been used since 1999. In their discussion, Directors reflected on whether the lack of use of the CFF suggested that there is less need for the facility today, particularly in light of the evolution of other financing options, or that the reforms to the CFF introduced at the time of its previous review in 2000 had reduced demand for the facility.
Directors considered a number of premises on which the usefulness of the CFF rests: (i) that temporary shocks are common, and the appropriate response to such shocks consists of upfront financing rather than adjustment; (ii) that members have little or no access to alternative sources of financing to cushion a temporary balance of payments shock; and (iii) that other Fund facilities are not suitable for dealing with CFF-type shocks.
On the time profile of balance of payments shocks, many Directors agreed that, especially with regard to commodity prices, it is typically hard to distinguish ex ante between their temporary and persistent components. They also pointed to empirical evidence suggesting a significant downward trend and increased volatility of commodity prices over time, as well as a substantial persistence of negative commodity price shocks. In their view, these factors indicate that upfront compensatory financing entails the risk that needed adjustment could be postponed. A few Directors, however, noted that commodity price slumps have a transitory component, and that adjustment measures could be readily adopted should a shock turn out to be more persistent than expected. They pointed to a number of relevant shocks that had emerged since the previous review of the CFF and that could be reasonably viewed as being of a temporary nature.
Most Directors noted that, with the size of private capital flows having increased substantially since the inception of the CFF, the usefulness of the facility in coping with shocks has diminished for middle-income members. Indeed, members with access to private capital markets could reasonably be expected to retain such access in the face of shocks that are widely expected to be temporary if their underlying balance of payments position remains strong. On the other hand, a few Directors observed that capital markets suffer from imperfections and tend to behave procyclically. Directors also acknowledged that low-income members enjoy access to capital market financing to a much smaller degree, and that official financing is often not large or flexible enough to deal with temporary shocks. At the same time, they noted that the CFF is typically not an attractive option for low-income members in the face of such shocks, mainly on account of its non-concessional nature.
Directors explored the usefulness of other Fund facilities in dealing with CFF-type shocks. In this regard as well, Directors pointed to a fundamental asymmetry between middle- and low-income members. Regarding the former, many Directors considered that stand-by or extended arrangements could provide sufficient resources in a timely fashion to deal with shocks for which the CFF had been envisaged; and these arrangements are sufficiently flexible to incorporate appropriately tailored conditionality. A few Directors, however, believed that in practice conditionality is often applied in an inflexible manner, or that these arrangements require substantial time to negotiate and approve. They therefore believed the CFF remains a useful option to deal with temporary shocks.
Directors agreed that, for low-income members without an active Poverty Reduction and Growth Facility arrangement, stand-by or extended arrangements are often ill-suited due to their non-concessional nature, and the CFF itself (or emergency assistance for natural disasters, where applicable) suffered from the same shortcoming. For such countries, Directors considered the possibility of subsidizing the rate of charge for stand-by or CFF resources, but viewed such an option as a sub-optimal way to allocate scarce concessional resources. Many Directors believed that a short-term "window" under the PRGF Trust Fund would be a better way to help PRGF-eligible countries that do not have an active PRGF arrangement deal with temporary shocks. Several Directors, however, did not support this approach, expressing concerns that such a facility would erode PRGF program design. For countries with an active PRGF arrangement, Directors generally supported the use of augmented access to PRGF resources to accommodate temporary shocks. Overall, Directors were in favor of developing the PRGF instrument, as currently being considered in the context of the discussions on the role of the IMF in low-income countries, so that it could also serve the purposes of the CFF in low-income countries.
Directors also explored the possibility of other changes to the CFF. A number of Directors argued in favor of broadening the coverage of the facility's import element by including other basic food items beyond cereals. Many, however, acknowledged that data shortages would limit the usefulness of such an option. Some Directors favored providing a greater degree of automaticity for CFF purchases by relaxing the requirements of a satisfactory underlying balance of payments position for "stand-alone" CFF purchases. Many Directors, however, considered that the strengthened requirements introduced at the time of the previous review of the facility are consistent with the Fund's mandate to support orderly balance of payments adjustment with appropriate safeguards to Fund resources, and should be retained.
On balance, many Directors argued that there is a strong case for eliminating the CFF. This would contribute to a further streamlining of the structure of the Fund's facilities. For middle-income members, other sources of Fund and non-Fund financing could be relied upon to cope adequately with temporary balance of payments shocks, while for low-income members the envisaged new financing instruments constituted a superior response to shocks of this type. Most of these Directors, however, were willing to retain the CFF in its current form until the next review, both to give the facility extra time to prove its usefulness and in recognition that it would take some time to develop and gauge the usefulness of the new financing instruments currently being considered for low-income countries. They suggested that, in the absence of a clear demand for the CFF by the time of the next review, the facility should be eliminated. Many other Directors were of the view that the CFF provides a useful element in the mix of financing options to the membership. Most of these Directors supported keeping the CFF as it is, while the others considered that demand for the facility would pick up with appropriate modifications. Directors agreed that the CFF should be reviewed again in three years.
IMF EXTERNAL RELATIONS DEPARTMENT