## 1wauea2022002

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### Key findings on medium-term scarring from COVID-19
- The pandemic may have reduced medium-term growth by up to 1 percentage point under a scenario in which no mitigating policies are implemented.
- Analysis focuses on the change in medium-term growth over the 2021-26 horizon relative to pre-crisis estimates.
- Three main channels of scarring analyzed: i) investment in physical capital; ii) human capital accumulation; iii) total factor productivity (TFP).
- Aggregate scenario outcomes:
  - Post-pandemic scarring with no new policies: Medium-term growth loss -0.7 (percentage points).
  - Proactive scenario with policy response: Medium-term growth loss -0.2 (percentage points).
  - Cumulative potential output losses: around 3 percent in five years under no-policy scarring; less than 1 percent over the period under the proactive scenario.
- Decomposition of medium-term growth loss (exact reported values):
  - Human Capital: -0.3 (no policies) ; -0.1 (proactive).
  - Investment: -0.2 (no policies) ; -0.2 (proactive).
  - Productivity: -0.2 (no policies) ; 0.0 (proactive).
- Sensitivity bounds:
  - No proactive policies: medium-term growth could decline by between 0.3 to 1.0 percentage points.
  - Proactive scenario: decline could range from 0.1 percent to 0.4 percent under alternative assumptions.

### Framework and methodology
- Production function with human capital-adjusted labor:
  - Y_t = A_t K_t^α (h_t L_t)^{1−α}
  - Log-growth approximation: g_{Y_t} ≈ g_{A_t} + α g_{K_t} + (1−α) g_{h_t} + (1−α) g_{L_t}
- Historical data sources:
  - Penn World Table (PWT) version 10.0 for capital stock, human capital index, and parameter α (1950–2019).
  - UN labor force growth projections as reported in the ILOSTATs database.
- Three scenario comparisons:
  - Scenario (1): Pre-crisis estimate (WEO January 2020 vintage).
  - Scenario (2): Post-crisis scarring without active mitigating measures (WEO April 2021 vintage and schooling losses).
  - Scenario (3): Post-crisis proactive scenario under policies to mitigate scarring (ambitious private investment boost, rapid schooling recovery, technology adoption).

### Investment dynamics and proactive investment scenario
- WEO vintage patterns:
  - Benin: decline in average expected investment growth rate by 2.4 percentage points (relative to pre-pandemic estimates).
  - Burkina Faso: decline by 1.1 percentage point (relative to pre-pandemic estimates).
  - Senegal: decline more muted.
  - Niger and Togo: acceleration of expected investment growth across vintages.
- Public vs private investment:
  - Private investment prospects declined relative to pre-pandemic projections; public investment partially compensates only up to 2021 then falls below pre-pandemic levels thereafter.
- Proactive policy scenario for investment:
  - WAEMU countries would gradually catch up with the global average investment share, completing the process by 2030.
  - Regression of investment share on log GDP per capita (global data 1960–2019) used to estimate implied investment rates consistent with development level.
  - Estimated additional private investment needed: around 0.8 percent of WAEMU GDP relative to the April 2021 WEO starting from 2022, annually to fill the investment gap.

### Human capital impacts from school closures and policy assumptions
- School closures in 2020 used to proxy losses in years of schooling; COVID-19 related school closures were longer than one month for the majority of countries in the region (UNESCO monitoring).
- Scenario assumptions:
  - Passive scenario: growth rate of years of schooling only gradually catches up with pre-pandemic rate by 2026.
  - Proactive scenario: growth rate of years of schooling resumes pre-pandemic long-term rate starting from 2021 with active educational policies.
- Policy implication: active policies to prevent persistent educational losses (minimize drop-outs and maintain enrollment) are crucial to reduce human capital scarring.

### Productivity (TFP), informality, and digitalization
- Informality estimates (Medina and Schneider, 2020):
  - around 43 percent of official GDP across the WAEMU region during the 1990s;
  - 40 percent during the 2000s;
  - 36 percent during the 2010s.
- Empirical impulse response (sample: 64 EMDEs, 1991-2017):
  - Increase in informality calibrated to the average size during the 2009 global financial crisis associated with:
    - TFP decline of 0.9 percent on impact;
    - widening to 1.5 percent after one year; gradual receding thereafter.
- Digitalization as offset:
  - IMF (2020a) evidence: a 1 percentage point increase in internet use leads, on average, to a 0.125 percentage point increase in growth of real per capita income.
  - Proactive scenario assumes a one standard deviation increase in internet use for WAEMU, corresponding to a little under 2 percent of population increase (or two times the average yearly increase over last two decades).

### Policy implications to diminish scarring
- Support private investment to fill estimated annual gap of around 0.8 percent of WAEMU GDP (relative to April 2021 WEO) starting from 2022.
- Implement educational policies to rapidly restore years of schooling growth to pre-pandemic rates beginning in 2021.
- Foster accelerated adoption of new technologies to attenuate TFP losses.
- National and regional measures: complement private investment promotion with improvements in business environment, electricity reliability, access to finance, PFM, and digital infrastructure.

### Trade integration and productivity-enhancing reforms
- Deeper trade integration fosters productivity by increasing trade, specialization gains, market size effects, competition, diffusion of innovation, and labor-skill upgrading.
- Intraregional trade is legally duty-free but limited in practice due to non-tariff barriers (lack of common documentation, ad hoc transit levies).
- Priorities:
  - Reduce customs exemptions.
  - Eliminate non-tariff barriers and harmonize standards and procedures.
  - Strengthen competition framework: revise legal framework to enhance cooperation between WAEMU Commission and national competition authorities.

### Regional fiscal framework: debt and deficit ceilings — key estimates
- Current regional numerical targets:
  - debt ceiling of 70 percent of GDP.
  - overall deficit ceiling of 3 percent of GDP.
- Multiple approaches to estimate debt anchor/limit yield central tendency around 70 percent of GDP:
  - Fiscal-fatigue approach (historical evidence): debt limit of about 80 percent of GDP (using 95th percentiles: interest-growth differential ~3.3 percent; maximum primary surplus 2.7 percent of GDP).
  - Debt-carrying capacity (interest-to-revenue ratio):
    - Revenue (excluding grants)/GDP: 14.8%
    - Effective Interest Rate: 3.2%
    - Implied Debt Limits: 74.0% (threshold 16%) and 87.9% (threshold 19%).
  - Growth-maximizing (optimal debt) approach:
    - Point estimate α ≈ 0.31 implies optimal debt-to-GDP ≈ 74 percent.
    - 90% confidence interval for α (0.28–0.34) yields optimal debt ratios ranging from 65 to 84 percent.
  - LIC-DSF-derived nominal benchmark: aggregated implied nominal debt benchmark ~65 percent of GDP (most WAEMU countries classified as “medium” debt carrying capacity with NPV benchmark 55 percent of GDP).
- Stochastic simulations and safety buffer:
  - Simulations suggest a debt anchor of around 70 percent of GDP if policymakers accept a 10 percent probability of breaching the maximum debt limit over a 6-year horizon.
  - If contingent liabilities expected realization is 3 percent of GDP over 6 years, implied debt anchor ≈ 68 percent of GDP.
- Sensitivity:
  - A 100 basis points increase in interest rates would increase the safety buffer to over 16 percent of GDP and bring the anchor below 65 percent of GDP if debt limit is 80 percent.
  - If revenue (excluding grants)/GDP increases from 14.8 to 16 percent, debt limit could be revised upward to 95 percent of GDP.

### Calibration of the deficit ceiling and stabilization implications
- Relationship linking overall deficit (OB), debt share of GDP (D), and nominal GDP growth (휃휃): OB = [−휃휃/(1+휃휃)] * D
- Assumptions:
  - Potential medium-term real growth between 5 to 6 percent.
  - BCEAO objective inflation rate of 2 percent (+/- 1 percent band).
  - Implied nominal potential growth (휃휃) between 6 and 9 percent.
- Implications:
  - Absent stock-flow adjustments, a 3 percent deficit ceiling would stabilize debt at around 40 to 50 percent of GDP.
  - A 4 percent deficit ceiling may be compatible with a debt ceiling ranging from 50 to 70 percent of GDP:
    - If nominal growth = 6 percent, 4 percent deficit stabilizes debt at ~70 percent of GDP.
    - If nominal growth = 8 percent, 4 percent deficit stabilizes debt at ~54 percent of GDP.
- Average SFAs for WAEMU: around 1 percent of GDP between 2013-2019; preliminary estimates for 2020 indicate historically high SFAs.

### Policy options assessed: raising the deficit ceiling to 4 percent
- Option 1: 4 percent deficit ceiling measured “above the line” (revenue minus expenditure).
  - Simulated with a structural general equilibrium model (FSGM calibrated to WAEMU).
  - Four scenarios for convergence to overall deficit of 4 percent by 2024:
    - Scenario 1: No SFAs; high quality spending; external financing.
      - Half of additional deficit devoted to public investment; financed fully externally.
      - Real GDP would increase by over 0.5 percent relative to baseline near to medium-term; long-term GDP +0.7 percent by 2031.
    - Scenario 2: No SFAs; low quality spending; external financing.
      - Additional spending on current expenditures; financed fully externally.
      - Medium-term GDP increase negligible.
    - Scenario 3: No SFAs; low quality spending; domestic financing.
      - Domestic financing leads to risk premium increase of 50 basis points.
      - Increases in deficit fail to stimulate growth because of crowding-out.
    - Scenario 4: SFAs = 1 percent of GDP; low quality spending; domestic financing.
      - De facto deficit 5 percent of GDP; domestic financing raises risk premium by 80 basis points.
      - Output declines close to 1.5 percent in 2022 and 2023; debt about 8 percent of GDP higher by 2026 and 15 percent higher over long run.
- Option 2: 4 percent deficit ceiling measured “below the line” (change in financial liabilities minus change in financial assets).
  - Would include SFAs in the deficit measure; if SFAs ≈ 1 percent of GDP, redefinition would not differ much from recent past in debt dynamics.
  - If additional financing comes from domestic sources, simulations show higher debt (≈7 percentage points of GDP by end of projection) and lower reserve coverage relative to baseline.
  - Advantages: improved transparency and monitoring potential; Measurement challenge: measuring change in financial assets.

### Conditions for favorable outcomes and risks
- Two key conditions for favorable outcomes from higher deficits:
  1. Reliance on (and unconstrained access to) external financing.
  2. Sound public financial management (PFM) to reduce SFAs.
- Practical constraints:
  - Long-term decline in overseas development assistance: ratio to GNI declined by over 7 percentage points since mid-1990s peak and by about 3 percentage points from 2000s average.
  - External financing may be constrained by donors’ domestic pressures, debt sustainability concerns, and potential investor risk-premium increases.
  - PFM reforms take time; mixed implementation since directives in 2009.
- Main conclusion:
  - Raising the deficit ceiling to 4 percent could undermine domestic and external stability unless the two conditions are met; meeting both simultaneously is likely very challenging.
  - Measuring the ceiling “below the line” could mitigate some negatives and foster transparency but faces measurement difficulties.

### Domestic revenue mobilization as alternative financing (Annex I summary)
- Simulation: finance 1 percent of GDP increase in expenditure via consumption tax (VAT-like) with deficit unchanged.
- Two spending compositions:
  - Low-quality spending:
    - Short run: muted output effects.
    - Long run: GDP −0.6 percent by 2031 relative to baseline.
    - Trade balance: improves (import compression); official reserves gradually increase by one month of imports over long run.
  - Half to potential-output-enhancing spending:
    - Short run: economic activity slightly higher as private investment is stimulated.
    - Long run: GDP somewhat higher; trade balance and reserves improve more gradually.
- Overall: tax-financed expenditure can dominate domestic-borrowing scenarios; consumption tax acts as “compulsory saving” reducing domestic interest rate pressure.

### WAEMU sovereign security market assessment and recommendations
- Overall assessment: sovereign security market at developing stage (stage 2).
- Key quantitative points:
  - Nominal stock of government securities grew ~20 percent a year from 2010 to 2020; stock rose from <5 percent of GDP to 15 percent of GDP.
  - Share of sovereign debt issued on regional market rose from 14 percent to 30 percent.
  - Turnover ratios:
    - Overall turnover ratio increased from 4.1 percent in 2017 to 20.9 percent in 2020.
    - Turnover ratio for auctioned securities reached 32.7 percent in 2020.
    - Emerging Asian comparators average turnover ratio: 143.4 percent.
  - Interbank loans: equivalent to 2 percent of total bank loans and less than 1 percent of GDP at end 2020.
- Principal constraints:
  - Fragmentation of primary market (auctions vs syndications) impeding fungibility and benchmark creation.
  - Shallow interbank market lacking reference rates and pre/post-trade transparency.
  - Shallow secondary market with concentrated trading and low liquidity; lack of public pricing dissemination.
  - Weak investor base: banks ~85 percent of domestic investor base; international investors <1 percent for auctioned securities.
  - Financial market infrastructure gaps: limited support for intra-day repos, fragmented custody arrangements.
  - Legal/regulatory strengths exist but tax treatment distortions and supervisory clarity gaps remain.
- Priority policy recommendations (by building block):
  - Money Market:
    - Promote transparency of interbank repo market; ensure daily availability of trading information; promote reference prices/rates.
  - Primary Market:
    - Reduce fragmentation by generalizing bullet structure for sovereign securities and unifying trading infrastructure and regulatory environment.
    - Enhance benchmark issuance via reopenings; improve sovereign cash management and build cash buffers.
    - Remunerate sovereign deposits at BCEAO at market rates while ring-fencing them for debt management purposes.
  - Secondary Market:
    - Develop an electronic platform for auctioned securities to improve transparency and price formation.
    - Increase incentives for SVTs: continuous price quotations, securities lending facility, liquidity support, structured non-competitive auctions.
  - Investor Base:
    - Stimulate institutional investors and private pension funds; enhance investor relations programs at national level.
  - Market Infrastructure:
    - Allow intra-day repos and same-day settlement; unify central depository system for sovereign securities.
  - Legal and Regulatory:
    - Remove distortionary tax treatments that discriminate by investor country of residence within WAEMU.
    - Require investment funds to mark-to-market asset portfolios.
- Implementation sequencing:
  - Some measures (BCEAO-led) could be implemented in ≤1 year; others requiring cross-country coordination in 1–3 years or >3 years.

*Source: DAMAGE CONTROL: QUANTIFYING THE MEDIUM-TERM SCARRING EFFECTS OF COVID-19 IN THE WAEMU (January 20, 2022).*

### 1. Average Growth in Total Investment Across WEO Vintages __________________________ 7

### 1. Average Growth in Total Investment Across WEO Vintages

### Key findings on medium-term scarring from COVID-19
- The pandemic may have reduced medium-term growth by up to 1 percentage point under a scenario in which no mitigating policies are implemented.
- Three main channels of scarring analyzed: i) investment in physical capital; ii) human capital accumulation; iii) total factor productivity (TFP).
- Analysis focuses on the change in medium-term growth over the 2021-26 horizon relative to pre-crisis estimates.

### Framework and methodology
- Production function with human capital-adjusted labor used:
  - Y_t = A_t K_t^α (h_t L_t)^{1−α}
  - Log-growth approximation applied:
    - g_{Y_t} ≈ g_{A_t} + α g_{K_t} + (1−α) g_{h_t} + (1−α) g_{L_t}
- Historical data sources:
  - Penn World Table (PWT) version 10.0 for capital stock, human capital index, and parameter α (1950–2019).
  - UN labor force growth projections as reported in the ILOSTATs database.
- Comparison across three scenarios:
  - Scenario (1) Pre-crisis estimate (WEO January 2020 vintage).
  - Scenario (2) Post-crisis scarring without active mitigating measures (WEO April 2021 vintage and schooling losses).
  - Scenario (3) Post-crisis proactive scenario under policies to mitigate scarring (ambitious private investment boost, rapid schooling recovery, technology adoption).

### Assumptions under alternative scenarios (summary from Table 1)
- Physical Capital:
  - Scenario (1): Investment (public + private) based on WEO forecast from January 2020 vintage (pre-pandemic).
  - Scenario (2): Investment based on WEO forecast from April 2021 vintage (post-pandemic).
  - Scenario (3): An ambitious but feasible boost in private investment to gradually catch up with the global average investment share by 2030.
- Labor and Human Capital:
  - Scenario (1): UN labor force growth projections; years of schooling growing at the average long-term rate pre-pandemic.
  - Scenario (2): UN labor force growth projections; decline in years of schooling in 2020 due to school closures, with growth rate of schooling years only gradually catching up with pre-pandemic long-term rate.
  - Scenario (3): UN labor force growth projections; decline in years of schooling in 2020 due to school closures, but quickly resuming pre-pandemic growth rate starting from 2021 with active policies.
- Productivity (TFP):
  - Scenario (1): TFP growth calibrated to match IMF staff growth forecasts (as of January 2020) at the end of projection period.
  - Scenario (2): Reduction in TFP relative to pre-pandemic scenario based on estimates of the effects of increase in informality (sectoral reallocation) and its dynamic link to TFP.
  - Scenario (3): Impact of crisis on TFP attenuated by accelerated adoption of new technologies.

### Investment dynamics and vintages
- Different WEO vintages show a deceleration in expected investment growth over the medium term, with heterogeneity across WAEMU countries:
  - Benin: decline in average expected investment growth rate by 2.4 percentage points (relative to pre-pandemic estimates).
  - Burkina Faso: decline by 1.1 percentage point (relative to pre-pandemic estimates).
  - Senegal: decline more muted.
  - Niger and Togo: acceleration of expected investment growth across vintages.
- Private investment prospects have declined relative to pre-pandemic projections; public investment is projected to partially compensate only up to 2021 and then fall below pre-pandemic levels thereafter.

### Proactive policy scenario for investment
- Under the proactive scenario, WAEMU countries would gradually catch up with the global average investment share, completing the process by 2030 to support the SDGs.
- Regression of investment share on log GDP per capita (global data 1960–2019) used to estimate implied investment rates consistent with development level.
- Calculations suggest additional private investment of around 0.8 percent of WAEMU GDP relative to the April 2021 WEO starting from 2022 is needed annually to fill the investment gap.

### Human capital impacts from school closures
- School closures in 2020 are used to proxy losses in years of schooling given limited access to online learning; COVID-19 related school closures were longer than one month for the majority of countries in the region (UNESCO monitoring).
- In the passive scenario, growth rate of years of schooling only gradually catches up with the pre-pandemic rate by 2026.
- In the proactive scenario, years of schooling are assumed to quickly resume pre-pandemic growth starting from 2021 with active educational policies.
- Limited remote learning effectiveness in low-income countries and high rates of unconnected school children in West and Central Africa inform the assumptions.

### Policy implications highlighted
- Active policies to promote private investment and support education can substantially diminish scarring:
  - Support private investment to fill an estimated annual gap of around 0.8 percent of WAEMU GDP (relative to April 2021 WEO) starting from 2022.
  - Implement educational policies to rapidly restore years of schooling growth to pre-pandemic rates beginning in 2021 under the proactive scenario.
  - Foster accelerated adoption of new technologies to attenuate TFP losses.

*Source: DAMAGE CONTROL: QUANTIFYING THE MEDIUM-TERM SCARRING EFFECTS OF COVID-19 IN THE WAEMU (January 20, 2022).*

### 11.      Nevertheless, active government policies and investment in education could prevent

### 1wauea2022002 - 11.      Nevertheless, active government policies and investment in education could prevent

### Education, hysteresis, and scenario assumption
- Active government policies and investment in education could prevent the hysteresis effect by minimizing drop-out and lower enrollment as schools reopen.
- If such policies succeed, students would return to schools without an increase in dropouts or lower enrollment rates and the pace of growth in years of schooling would catch up with the pre-pandemic rate quickly.
- Scenario assumption: the growth rate of years of schooling would go back to the pre-pandemic long-term rate starting from 2021 in the WAEMU (solid line in Figure 3).
- Active policies to prevent persistent educational losses due to school closures are crucial and further described below.

### Productivity and the COVID-19 pandemic: key drivers and effects
- Two key drivers of productivity growth in developing economies likely affected by COVID-19: (i) sectoral reallocation towards an increase in informality and (ii) the role of digitalization.
- Large shocks (COVID-19, global financial crisis) tend to be associated with increases in the share of informal activities as firm bankruptcies rise and formal employment declines; simultaneously, the pandemic may have accelerated digitalization via increased demand for remote working, learning, and digital services.

### Size and evolution of informality in the WAEMU
- Informal sector estimates (Medina and Schneider, 2020):
  - around 43 percent of official GDP across the WAEMU region during the 1990s;
  - 40 percent during the 2000s;
  - 36 percent during the 2010s.
- Heterogeneity across countries: Niger, Senegal, and Benin have larger informal sectors amounting above 35 percent of their official GDPs (based on latest available estimates).
- Informal economy definition used: value added of all economic activities that are hidden from official authorities for monetary, regulatory, and institutional reasons.

### Short-term buffer vs. medium-term cost of increased informality
- Short-term: informal economy may have acted as an immediate buffer during COVID-19, absorbing some job losses and mitigating immediate adverse effects on GDP.
- Medium-term risks:
  - Productivity is typically lower in the informal sector and the informal sector is less capital intensive (La Porta and Shleifer 2008, Benjamin and Mbaye, 2012).
  - Resource misallocation is typically more prominent in countries with large informal sectors (IMF, 2019a).
  - A likely increase in informality due to the pandemic could lead to adverse effects on potential GDP.

### Empirical evidence: informality’s effect on total factor productivity (TFP)
- Sample: 64 emerging markets and developing economies, 1991-2017.
- Impulse response finding: an increase in informality calibrated to the average size observed during the global financial crisis of 2009 is associated with:
  - a decline of TFP of 0.9 percent on impact;
  - widening to 1.5 percent after one year;
  - gradual receding at longer horizons.
- Estimation method: local projections at an annual frequency with controls and country/time fixed effects.
- In simulations, TFP growth is assumed to decline relative to the pre-pandemic baseline on impact and persist over the next two years (solid black impulse response function in Figure 5).

### Digitalization: potential offsetting channel
- Evidence: more than one in five firms in sub-Saharan Africa have started or expanded use of digital technology in response to COVID-19 (World Bank, 2021b).
- Calibrated effect used in scenario with policies to mitigate scarring:
  - IMF (2020a) evidence suggests a 1 percentage point increase in the share of the population using internet leads, on average, to a 0.125 percentage point increase in the growth of real per capita income.
  - For the scenario, assume the bulk of that increase in income per capita is due to productivity growth.
  - Proactive scenario assumes COVID-19 shock would lead to a one standard deviation increase in internet use (calculated based on historical information for the WAEMU), corresponding to an increase in internet use of a little under 2 percent of population, or alternatively two times the average yearly increase in the WAEMU countries over last two decades.

### Aggregate scenarios and medium-term growth outcomes
- Scenario with scarring and no new policies:
  - COVID-19 would reduce medium-term growth in the region by 0.7 percentage points (gap between case (1) and (2)).
  - Over 2021-26, decline in potential growth of about 0.7 percentage point per annum relative to pre-pandemic estimates.
  - Cumulative potential output losses of around 3 percent in five years (potential output 3 percent lower relative to pre-pandemic expectations).
- Proactive scenario with policy response:
  - Assumes policies that boost investment, mitigate human capital losses, and improve productivity growth.
  - Growth losses relative to pre-pandemic estimates (gap between case (1) and (3)) could be reduced to a little over 0.2 percentage point over the medium term.
  - Associated output losses of less than 1 percent over the period.
- Decomposition of medium-term growth loss (Table 2) — exact reported values:
  - Post-pandemic scarring under no new policies: Medium-term growth loss -0.7.
  - Proactive scenario with policy response: Medium-term growth loss -0.2.
  - Of which due to effects on:
    - Human Capital: -0.3 (no policies) ; -0.1 (proactive).
    - Investment: -0.2 (no policies) ; -0.2 (proactive).
    - Productivity: -0.2 (no policies) ; 0.0 (proactive).
  - Note: rounding explanation in source: the fact that the sum of investment (-0.2) and human capital (-0.1) numbers does not add up to -0.2 in the second column is due to rounding to 1-digit. In two digits, the growth loss due to investment and human capital are -0.16 and -0.06, respectively.

### Sensitivity analysis and uncertainty
- Under no proactive policies, medium-term growth could decline by between 0.3 to 1.0 percentage points in the WAEMU under alternative assumptions (reflecting bounds of the 90 percent confidence interval of informality effects on TFP and alternative human capital convergence paths).
- Under the proactive scenario, the decline in medium-term growth could range from 0.1 percent to 0.4 percent under alternative assumptions (reflecting different spans to reach global average investment rates, slower catch up in years of schooling, and different estimates of internet use effects on TFP).
- Overall conclusion: absence of proactive policies could reduce growth by up to 1 percentage point over the medium term; proactive policies could virtually erase adverse effects.

### Policy options to address scarring — national and regional initiatives
- General:
  - Policies comprise initiatives at both national and regional levels with complementarities and potential coordinating role for WAEMU institutions.
- Investment and business environment:
  - Address long-standing investment climate shortcomings, including access to reliable electricity and finance.
  - Enterprise survey evidence: close to 70 percent of firms surveyed in Cote d’Ivoire and over 50 percent of firms in Senegal cite access to finance as a major impediment.
  - Access to reliable electricity is listed by over 60 percent of firms in Benin, Cote d’Ivoire, and Mali and over 70 percent in Guinea-Bissau.
  - Competition from informal firms is perceived as a barrier, especially in Cote d’Ivoire, Mali, and Niger.
  - Regional coordination of energy investments and SOE reforms could increase electricity reliability; addressing SOE inefficiencies and achieving cost recovery in tariff setting is necessary.
  - Strengthening oversight of SOEs by Ministries of Finance is desirable.
  - Banking sector: WAEMU banking commission should monitor and guide Basel II/III implementation and operationalize the new resolution framework; weak banks should be restructured; reduce bank concentration risks; resolve non-performing loans.
  - Microfinance institutions (MFIs): role could be strengthened to expand credit access; BCEAO, in coordination with national institutions, could restructure the sector by encouraging exit of unviable MFIs and enhancing monitoring.
  - Public investment efficiency: enhance how each CFAF spent translates into effective public capital stock; WAEMU lags comparators on public investment efficiency; PIMA-identified areas for improvement include PPP management, project appraisal and selection, monitoring project implementation, investment programming, multiyear commitment authorization, and supporting investment information systems.
- Productivity:
  - High informality partly linked to cumbersome regulations and procedures increasing costs of formal sector operation; senior management spend significant time dealing with government regulation requirements.
  - Measures to reduce informality: simplify tax payment processes and tackle excessively rigid labor market regulations.
  - Invest in digital infrastructure to boost productivity across manufacturing, commerce, health, and education; WAEMU Commission coordinates telecom liberalization and harmonization; measures include investments in IT infrastructure and ensuring reliable electricity supply.

*Source: IMF staff calculations.*

### 32.      Deeper trade integration can also foster productivity. More integrated countries can

### 1wauea2022002 - 32.      Deeper trade integration can also foster productivity. More integrated countries can

### Trade integration and productivity
- Deeper trade integration can foster productivity through:
  - increased trade, specialization gains and larger markets that make production and the use of capital and labor more efficient.
  - increased competition, greater diffusion of technological innovation, and upgrading of labor skills.
- Trade in local products is by law free of customs’ duties within the WAEMU and the broader ECOWAS community.
- Despite duty-free intra-regional trade by law, trade among WAEMU member states remains relatively limited due to non-tariff barriers.

### Barriers to intraregional trade and policy priorities
- Identified non-tariff barriers include:
  - lack of common documentation for customs procedures.
  - ad hoc levies charged for road transit.
- More generally, barriers to trade are more prominent in the WAEMU region relative to Advanced Economies and other Emerging Markets and Developing Economies.
- Priorities to reduce trade barriers:
  - reducing the extensive use of customs’ exemptions.
  - eliminating non-tariff barriers through less cumbersome customs procedures.
  - harmonization of national regulations on standards and procedures of customs.

### Competition framework and productivity gains
- IMF (2019b) finding:
  - increased competition can boost real per capita GDP growth rate in SSA by about 1 percentage point through improved competitiveness, productivity growth, and investment.
- Institutional recommendations:
  - revise the legal framework to enhance division of responsibilities and cooperation between the WAEMU Commission and national competition authorities.
  - improve capacity to monitor and sanction anti-competitive practices within the region.

### Education and human capital — challenges and policy responses
- Key weaknesses noted:
  - the ratio of teachers per student in the WAEMU is low compared with other EMEs at both primary and secondary levels.
  - PPP-adjusted expenditure per student substantially lags other EMEs.
  - enrollment rates are significantly lower in WAEMU, particularly in secondary education.
- Priorities for education policy:
  - increase the amount and efficiency of public spending on education.
  - teacher training and financial support to meet schooling demands.
  - support programs for students affected by school closures during 2020.
- Policies to mitigate long-term effects of school closures:
  - closely monitor re-enrollment and attendance by different groups and underprivileged communities (e.g., girls, students from lower-income families or regions) or senior students.
  - assess students’ skills and needs in the post-pandemic period to guide remedial actions.
  - remedial programs (before or after school), modified schedules, adjusting/extending school years, continuing distance learning in parallel to schools re-opening.

### Regional fiscal framework: debt and deficit ceilings — summary of findings
- Current regional numerical targets:
  - debt ceiling of 70 percent of GDP.
  - overall deficit ceiling of 3 percent of GDP.
- Context and recent decisions:
  - These criteria were suspended in the context of the COVID-19 crisis.
  - In June 2021, a decision was taken at the ECOWAS level to maintain the current debt and deficit numerical targets (70 percent of GDP and 3 percent of GDP), but adopt a more gradual convergence path, with a majority of countries expected to reach the 3 percent deficit ceiling by 2024.
- High-level conclusion:
  - Overall, it seems advisable to maintain the two ceilings at their previous levels.
  - The 70 percent of GDP debt ceiling seems to strike the right balance between growth and fiscal prudence considerations.
  - Model-based simulations show that raising the deficit ceiling from 3 to 4 percent of GDP would likely undermine domestic and external stability, except in very specific circumstances (if access to external financing is unconstrained and significant progress in fiscal transparency is achieved).

### Calibration of the debt ceiling — methodological approach and "safe" debt estimate
- Sequential calibration approach:
  - estimate the debt anchor (level of debt toward which countries are expected to converge in the medium to long term).
  - infer the associated fiscal deficit ceiling.
- Three approaches to estimate the debt anchor:
  - i) calculate a debt limit above which dynamics become explosive, from which the anchor is derived given a safety margin or buffer.
  - ii) focus on the debt level that would maximize growth in the context of a simple model.
  - iii) obtain the debt anchor based on the current IMF’s debt sustainability framework (IMF, 2018).
- Approach 1 — “safe” debt estimate:
  - the “safe” debt level is defined as the debt-to-GDP ratio that ensures debt dynamics remain under control even if adverse economic shocks occur.
  - two principles: a maximum debt limit exists beyond which debt dynamics can spiral out of control; the fiscal framework should keep debt well below this limit.
  - the debt anchor is measured as the difference between the debt limit and the safety buffer.
  - three steps in the approach:
    - estimate the maximum debt limit.
    - estimate the required safety margin via stochastic simulations.
    - infer the debt anchor as the debt limit minus the safety margin.
  - stochastic simulations:
    - estimate the distribution of macroeconomic and fiscal shocks faced in the past.
    - simulate future debt trajectories under these shocks over a 6-year horizon to create a fan chart of debt realizations.
    - calibrate the debt anchor and calculate the probability that public debt would exceed the maximum debt limit in the medium-term.
- Estimating a regional debt limit:
  - one method uses the principle of “fiscal fatigue” (Gosh et al., 2013):
    - maximum debt level approximated by the ratio of the maximum achievable primary balance to the interest rate-economic growth differential (r-g) under stress: D* = PPPmax / (r - g) [formula context preserved as described].

_Italic: Source — https://www.imf.org/-/media/files/publications/cr/2022/english/1wauea2022002.pdf_

### 9.      Using historical evidence for WAEMU countries, we estimate a debt limit of about

### 9.      Using historical evidence for WAEMU countries, we estimate a debt limit of about 

### Estimates of the debt limit (historical evidence / fiscal-fatigue approach)
- Using data from the April 2021 vintage of the WEO database over the period 2000-20, the 95th percentile of the distribution of the interest growth differential (based on effective interest rates on debt) for countries in the region stands at around 3.3 percent.
- Using historical evidence from the WEO dataset since 1996, the 95th percentile of the distribution of primary balances for WAEMU countries is 2.7 percent of GDP.
- This larger maximum primary surplus would result in a debt limit of 80 percent of GDP.
- Conclusion from this approach: debt limit of about 80 percent of GDP for the WAEMU.

### Approach 2: Debt-carrying capacity (interest-to-revenue ratio)
- Principle: focus on the ratio of interest expenses to revenues (excluding grants) as an indicator of the ability to repay debt.
- Empirical thresholds from econometric models for emerging markets and developing economies: interest to revenue ratio thresholds range from 16 to 19 percent (denoted 휏휏).
- Using the average revenue (excluding grants) to GDP ratio and average effective interest rates over 2015-2019 for the WAEMU from the WEO database yields the following implied debt limits (Table 1 values):
  - Threshold 16%:
    - Revenue (excluding grants)/GDP: 14.8%
    - Effective Interest Rate: 3.2%
    - Debt Limit: 74.0%
  - Threshold 19%:
    - Revenue (excluding grants)/GDP: 14.8%
    - Effective Interest Rate: 3.2%
    - Debt Limit: 87.9%
- Overall interpretation: approaches based on fiscal fatigue and debt servicing capacity yield broadly similar results, supporting a debt limit around 80 percent of GDP.

### Estimating the safety buffer and debt anchor (simulations and shocks)
- Safety buffer reflects:
  - i) the history of macroeconomic shocks for the region; and
  - ii) contingent liabilities, estimated at 3 percent of GDP every 6-years (based on Bova et al. (2019) evidence).
- Shock distribution estimated from a multivariate normal distribution based on annual regional data for: real GDP growth, the primary balance, real interest rates, and the real exchange rate (data from WEO database, 2000-20).
- Simulations of future debt trajectories use the standard debt dynamics equation and a fiscal reaction function; results presented as fan charts with debt anchor calibrated to keep fan below the debt limit over a 6-year horizon with high probability.
- Simulation results:
  - Debt anchor of around 70 percent of GDP if policymakers accept a 10 percent probability of breaching the maximum debt limit in the medium-term.
  - If contingent liabilities expected realization is 3 percent of GDP over 6 years, the implied debt anchor would be 68 percent of GDP.
- Interpretation: an anchor of around 70 percent of GDP is considered a “safe” level ensuring resilience to negative shocks without breaching a 70 percent debt limit by the 6th year with very high probability.

### Robustness and sensitivity
- The safety buffer and anchor are subject to uncertainty because key inputs (maximum primary balance, interest-growth differentials) are estimated from historical information and may change.
- Example sensitivity:
  - A 100 basis points increase in interest rates relative to recent levels would increase the size of the buffer to over 16 percent of GDP, bringing the debt anchor below 65 percent of GDP if a debt limit of 80 percent of GDP is considered.
- Countervailing factor:
  - If revenues excluding grants to GDP ratio increases from 14.8 to 16 percent of GDP (other things equal), the debt limit would be revised upward to 95 percent of GDP.

### Approach 3: Growth-maximizing (optimal debt) approach
- Uses Checherita-Westphal and others (2014) theoretical model: derives debt-to-GDP ratio beyond which debt negatively affects growth even considering public investment benefits.
- Production function includes labor (L), private capital (K), and public capital (Kg); output elasticity of public capital denoted α.
- Optimal debt-to-GDP ratio formula given by:
  - D* = ( (α/(1−α))^2 )^(1−α)   (expression preserved as in source)
- Econometric estimation of α for WAEMU using pooled data 1960-2015 (Penn-World Tables v10.0 and IMF Investment and Capital Stock Dataset) yields:
  - Point estimates of α around 0.31 across regressions.
  - Point estimate α ≈ 0.31 implies an optimal debt-to-GDP ratio of about 74 percent.
  - A 90 percent confidence interval around α (upper bound 0.34, lower bound 0.28) yields optimal debt-to-GDP ratios ranging from 65 percent to 84 percent.
- Result: using the “optimal debt” approach, the debt anchor would range between 65 and 84 percent of GDP; point estimate around 74 percent.

### Approach 4: Thresholds from the Bank-Fund LIC Debt Sustainability Framework (DSF)
- LIC-DSF estimates indicative thresholds/benchmarks for debt burden indicators in NPV terms, varying by debt carrying capacity classification (weak, medium, strong).
- Converting DSF public sector debt benchmarks in NPV terms to nominal debt using the 2020 ratio of nominal to NPV debt yields implied nominal debt thresholds by country and aggregated for the region.
- For WAEMU (most countries classified as “medium” debt carrying capacity with NPV public debt benchmark of 55 percent of GDP; exceptions noted):
  - Aggregated implied nominal debt benchmark: 65 percent of GDP (average weighted by share of 2020 WAEMU GDP).
  - Individual country implied upper limits range from 42 to 80 percent of GDP in nominal terms.
- Interpretation: under simplifying assumptions, the LIC-DSF suggests a nominal public debt threshold of around 65 percent of GDP for the region.

### Synthesis and policy implication: putting approaches together
- Different approaches yield a range of estimated debt anchors/limits; central tendency supports a regional anchor/ceiling around 70 percent of GDP.
- Conclusion: changing the regional debt ceiling presently embedded in the fiscal framework does not seem warranted.
- Recommendation at aggregate level: the 70 percent of GDP ceiling for the region is appropriate, balancing fiscal prudence and growth considerations.
- Caveat: possible differentiation of ceilings across countries could be considered given heterogeneous repayment capacities and initial conditions, but practical implementation faces challenges (limited historical precedent in currency unions, complexity for fiscal coordination and monitoring, data limitations to calibrate country-specific inputs).

### Calibration of the deficit ceiling (from debt anchor to overall deficit ceiling)
- Relationship linking overall deficit (OB), debt share of GDP (D), and nominal GDP growth (휃휃): OB = [−휃휃/(1+휃휃)] * D  (expression preserved as in source).
- Assumptions:
  - Potential medium-term real growth ranges between 5 to 6 percent.
  - BCEAO objective inflation rate of 2 percent (+/- 1 percent band).
  - Implied nominal potential growth (휃휃): between 6 and 9 percent.
- Implications:
  - Absent stock-flow adjustments, the current deficit ceiling of 3 percent of GDP would stabilize debt at around 40 to 50 percent of GDP.
  - A 4 percent of GDP deficit ceiling may be compatible with a debt ceiling ranging from 50 to 70 percent of GDP:
    - If nominal growth = 6 percent, a 4 percent deficit would stabilize debt at around 70 percent of GDP.
    - If nominal growth = 8 percent, a 4 percent deficit would stabilize debt at 54 percent of GDP.
- Macro categories of implications from raising the regional deficit ceiling to 4 percent of GDP:
  - External stability:
    - Permanently wider fiscal deficits could strain the currency peg by draining international reserves, increasing imports and potentially provoking real exchange rate appreciation.
  - Absorptive capacity of the regional market and crowding-out:
    - Limited liquidity in the regional sovereign bond market could create financial pressures if additional borrowing requirements are large.
    - Staff analysis: a 1 percent increase in government securities held by regional banks as share of M2 is on average associated with a 3.6 percent decline in the subscription rates of sovereign bonds’ issuances.
  - Effect on debt dynamics:
    - Higher deficits likely raise debt ratio trajectories, depending also on composition of spending and whether deficits capture all debt-creating flows.
    - Stock-Flow Adjustments (SFAs) can create gaps between above-the-line deficits and debt evolution (includes off-budget/below-the-line operations and realization of contingent liabilities).
    - Average SFAs for the WAEMU region were around 1 percent of GDP between 2013-2019.
    - Preliminary estimates for 2020 indicate historically high SFAs in part due to accounting issues (timing of disbursements of investment projects).
    - IMF staff baseline projections typically assume convergence to a 3 percent deficit ceiling without large SFAs (on average SFAs would amount to 0.2 percent of GDP over 2021-2016).

*Source: IMF Staff Estimates; WEO Database; Bova et al. (2019); Checherita-Westphal and others (2014); LIC-DSF Guidance note (as presented in the chapter).*

### 28.      The rest of the analysis will center around two policy options. These two options are

### The rest of the analysis will center around two policy options. These two options are

### Policy options assessed
- Option 1: 4 percent deficit ceiling measured “above the line”.
  - Deficit defined as revenue minus expenditure (same definition as current rule).
  - Ceiling increased from 3 percent of GDP to 4 percent of GDP.
  - Relative to IMF staff baseline projections, implies higher financing needs of, at least, 1 percent of GDP.
- Option 2: 4 percent deficit ceiling measured “below the line”.
  - Deficit redefined as the change in financial liabilities minus the change in financial assets.

### Structural model used for the simulations (Box 1)
- Model type: structural general equilibrium model, akin to Andrle and others (2015); African version of the Flexible System of Global Models (FSGM) calibrated to the WAEMU region.
- Key model mechanisms:
  - Inflation, imports and GDP determined by aggregated demand and potential output.
  - Private consumption depends mainly on current income (liquidity constrained households) and, to a lesser extent, on the interest rate.
  - Private investment depends on the gap between current and desired capital stock (function of financial conditions and potential output).
  - Domestic nominal interest rate = euro area interest rate + interest premium; monetary policy adjusts the domestic interest rate to the level of official reserves.
  - Potential output depends on labor supply, private capital stock, and a productivity term that increases with public capital stock.
  - Official reserves changes match any discrepancy between the current account and net private capital outflows to guarantee the fixed nominal exchange rate regime.
  - Simulated behavioral assumption: domestic interest rate increases by one percent for each reduction in official reserves representing one month of imports.
- Important caveats stated in the model:
  - Assumes countries do not face difficulties accessing external financing at favorable rates; rollover risk not taken into account; access to external markets is maintained with permanently higher deficits.
  - Estimates of the effect of public investment on productivity are based on evidence from advanced economies.
  - Import content is assumed the same for consumption, private investment, and government investment.

### Option 1 — Scenarios simulated and key assumptions
- Four scenarios simulated for convergence to an overall deficit of 4 percent of GDP by 2024 (1 percent of GDP higher than baseline 3 percent), differing by:
  - Composition of spending: government consumption versus investment (spending that increases potential output).
  - Financing: external financing versus financing in the regional market (domestic).
  - Stock-flow adjustments (SFAs): contained (no added SFAs) versus adding 1 percent of GDP in SFAs.
- Scenario summaries (Table 4 assumptions preserved):
  - Scenario 1: No SFAs; high quality spending; external financing.
    - Convergence to 4 percent of GDP by 2024.
    - Half of the increase relative to baseline devoted to higher public investment.
    - Higher deficit financed fully externally; no effect on domestic rates.
  - Scenario 2: No SFAs; low quality spending; external financing.
    - Convergence to 4 percent of GDP by 2024.
    - Additional spending geared entirely towards current expenditures (does not increase potential output relative to baseline).
    - Higher deficit financed fully externally; no effect on domestic rates.
  - Scenario 3: No SFAs; low quality spending; domestic financing.
    - Convergence to 4 percent of GDP by 2024.
    - Additional spending geared towards current expenditures.
    - Recourse to domestic financing leads to increase in interest rates (risk premium) by 50 basis points.
  - Scenario 4: Includes SFAs of 1 percent of GDP; low quality spending; domestic financing.
    - Convergence to 4 percent of GDP by 2024 but SFAs bring the de facto deficit to 5 percent of GDP.
    - Additional spending devoted to public consumption.
    - Recourse to domestic financing leads to increase in interest rates (risk premium) by 80 basis points.

### Macroeconomic implications across scenarios
- Growth:
  - Scenario 1 (external financing + half to public investment):
    - Real GDP would increase by over 0.5 percent relative to the baseline over the near to medium-term.
    - Long-term GDP increase of 0.7 percent by 2031.
  - Scenario 2 (external financing + current spending only):
    - Medium-term increase in GDP would be negligible.
  - Scenarios 3 and 4 (domestic financing):
    - Increases in the deficit fail to stimulate growth because of crowding-out and limited effects on potential output.
    - Output declines relative to the baseline would be substantial in the near-term, reaching close to 1.5 percent in 2022 and 2023 in scenario 4 (with SFAs).
- Debt dynamics:
  - All scenarios lead to higher debt levels as a share of GDP relative to the baseline.
  - Scenario 4 (SFAs included and domestically financed): debt would be about 8 percent of GDP higher than under the baseline by 2026 and 15 percent of GDP higher over the long run.
  - A scenario discussed later (external finance available, no PFM improvements, low-quality spending) leads to debt levels 14 percent of GDP higher than under the baseline by 2031.
- Trade balance:
  - Scenarios 1 and 2 (external financing): trade balance would modestly deteriorate as higher government expenditures and private investment generate larger imports.
  - Scenarios 3 and 4 (domestic financing): trade balance would improve due to import compression from lasting reduction of domestic demand and tightened monetary policy.
  - Scenario 2 (consumption-only, external financing): short-run trade balance deterioration is smaller because of smaller effects on private investment; long run risk of tradable sector contraction and Dutch disease effects could raise the trade deficit again.
- Foreign exchange reserves (months of imports):
  - Scenarios 1 and 2 (external financing): reserve coverage improves relative to baseline by about 0.8 months of imports in the near term due to strong capital inflows; reserve accumulation moderates over the long term as the trade balance deteriorates.
  - Scenario 3 (domestic financing, no SFAs): reserves fall; central bank tightens domestic credit conditions; reserve coverage reduction limited to about 1.5 months of imports over 2022-2024; reserve coverage improves over the medium term as the trade balance improves.
  - Scenario 4 (SFAs included, domestic financing): deterioration in reserve coverage relative to baseline reaches 2.5 months of imports by 2023-24 and could fall well below the 3-months of imports reserve adequacy benchmark, potentially undermining external stability.

### Key conditions for favorable outcomes and summary assessment
- Two conditions are identified as key for an increase in the deficit to lead to favorable regional outcomes:
  1. Reliance on (and unconstrained access to) external financing.
  2. Sound public financial management (PFM) to reduce the size of SFAs.
- Rationale:
  - External financing mitigates crowding-out effects and helps maintain reserve coverage.
  - Improvements in PFM and transparency limit off-budget and below-the-line operations, ensuring the de facto deficit ceiling is close to the “above the line” one and may improve spending quality.
- Additional favorable factor:
  - Composition of additional spending geared toward items that enhance potential output (investment) yields better outcomes relative to the baseline.

### Uncooperative equilibria and their implications
- Uncooperative equilibrium A: External finance available; no PFM reform; low-quality spending.
  - Medium-term: modestly higher GDP (less than 1 percent increase relative to baseline).
  - Long-term: small or negative effects on growth.
  - Debt: would be 14 percent of GDP higher than under the baseline by 2031.
- Uncooperative equilibrium B: PFM reforms implemented (eliminating SFAs) and high-quality spending; access to external financing constrained.
  - Near-term: adverse effects on output (crowding-out of private spending) and decline in reserve coverage by less than 1 month of imports due to a moderate increase in risk premium and lower capital flows.
  - Medium/long-term: positive effects as additional investment raises potential GDP and attenuates reserve pressures.

*Source: IMF staff estimates and analysis in the provided WAEMU chapter.*

### 33.      In practice, meeting these two conditions simultaneously may prove very challenging

### 1wauea2022002 - 33.      In practice, meeting these two conditions simultaneously may prove very challenging

### Challenges to financing higher "above the line" deficits
- Two conditions identified as essential for raising the “above the line” deficit to 4 percent of GDP to yield favorable outcomes:
  - Unconstrained access to external financing.
  - Significant progress in public financial management (PFM) to pare down stock-flow adjustments (SFAs).
- Practical constraints that limit the ability to finance additional deficits externally and transparently:
  - Long-term decline in overseas development assistance: the ratio of overseas development assistance received to gross national income for the typical WAEMU country has declined by over 7 percentage points since the peak of the mid-1990s and by about 3 percentage points from the average ratio of the 2000s.
  - Recent factors making external financing more difficult:
    - Some donors facing political pressures to concentrate resources on domestic priorities after the COVID-19 pandemic.
    - Concerns about debt sustainability constraining support from international and bilateral institutions.
    - Potential increase in spreads if international investor risk appetite changes and monetary policy normalizes in advanced economies, despite Benin, Cote d’Ivoire, and Senegal tapping Eurobond markets in 2020 and 2021 at favorable rates.
  - Large improvements in PFM likely take time:
    - A set of directives issued in 2009 guides reforms, but implementation has been mixed across member states and reform areas.
    - Adoption of laws to improve internal expenditure controls and transparency of accounts has lagged.

### Option 2: raising the deficit ceiling to 4 percent of GDP “below the line”
- Definition and implications:
  - Deficit measured “below-the-line” = change in government’s financial liabilities minus change in government’s financial assets (instead of revenue minus expenditure).
  - This redefinition would include operations that account for SFAs in debt dynamics and are not captured by the current “above the line” deficit concept.
  - If SFAs amount to 1 percent of GDP (historical average), the redefinition would not make much difference in terms of debt dynamics relative to the recent past, though it would differ from current WEO projections that assume insignificant SFAs over the medium-term.
- Simulation outcomes:
  - Scenarios 1–3 and Scenario 5 in Table 5 are compatible with this policy option; conclusions about the importance of external financing and the quality of spending apply.
  - If additional deficit financing comes from domestic sources rather than external financing, simulations show:
    - Higher debt, quantified as 7 percentage points of GDP by the end of the projection period.
    - Lower reserve coverage relative to the baseline.
    - A looser fiscal stance relative to the baseline embedded in IMF staff’s projections, which assume limited SFAs.
- Advantages and measurement challenges:
  - Potential advantages not captured by the model:
    - Better control and monitoring of governments’ borrowing needs and debt dynamics.
    - Enhanced transparency of the fiscal rules framework.
    - Reduced incentives to move spending off-budget.
  - Measurement difficulties:
    - Particularly in measuring the change in financial assets.

### Main conclusions on fiscal ceilings and risks
- Debt ceiling assessment:
  - The analysis indicates the 70 percent of GDP debt ceiling seems adequate, striking a balance between growth and fiscal sustainability considerations.
  - Raising the regional debt ceiling beyond 70 percent of GDP could create significant fiscal risks and expose countries to adverse debt dynamics.
  - Even with the regional ceiling at 70 percent of GDP, there is room for a majority of WAEMU countries to accumulate more debt; differentiating individual country ceilings within the aggregated regional ceiling is not precluded.
  - Estimates for the ceiling vary according to methodology and uncertainty about key parameters (such as interest rates).
  - Results are very sensitive to prospects for revenue mobilization: significant progress in mobilizing revenue would increase debt carrying capacity and allow sustaining higher debt levels.
- Risk of higher deficit ceiling:
  - A higher fiscal deficit ceiling of 4 percent of GDP could undermine domestic and external stability unless the two specific conditions above are met.
  - In practice, meeting both conditions simultaneously is likely very challenging in the WAEMU given uncertain prospects for increased external financing and the time needed for improvements in the composition and quality of spending.
  - If the deficit ceiling is raised, measuring it “below the line” could, in principle, mitigate some negative outcomes and might foster fiscal transparency.
- Policy stance:
  - The analysis does not support a significant revision in WAEMU fiscal rule ceilings given challenges in PFM and revenue mobilization and the limited size/depth of the regional bond market.
  - Various approaches in the chapter show limited scope to revisit debt and deficit ceilings at the moment; no recalibration would bring unequivocally superior outcomes relative to the current situation.
  - Simulations highlight trade-offs and risks associated with higher deficits and debt.

### Annex I — Financing additional expenditures via domestic revenue mobilization (summary)
- Context and motivation:
  - Main-text simulations assumed a permanent increase in expenditure with taxes broadly unchanged, widening fiscal deficits funded externally or domestically.
  - Domestic revenue mobilization in WAEMU is still falling short relative to other EMDEs; mobilizing revenues instead of further borrowing is an alternative.
- Simulation setup:
  - Considered a 1 percent of GDP increase in expenditures financed by an increase in consumption taxes (VAT-like), with the fiscal deficit unchanged.
  - Two scenarios for the additional spending:
    - Scenario A: additional 1 percent of GDP spent as low-quality spending (no boost to potential output).
    - Scenario B: half of the additional spending devoted to items that increase potential output.
  - Assumption: the VAT-like tax has no incidence on investment.
- Results — tax-financed low-quality expenditure:
  - Short run: muted effects on output because additional public expenditures offset reduction in private consumption.
  - Long run: negative effects on labor supply and GDP; by 2031, GDP would be 0.6 percent lower than under the baseline.
  - Debt/GDP: increase is negligible since the fiscal deficit does not widen relative to the baseline.
  - Trade balance: improves in the medium run; import compression increases the trade balance by 0.4 percentage points of GDP relative to the baseline by 2026 before gradually falling over the long run.
  - Official reserves: short run little effect; reserve coverage gradually increases by one month of imports over the long run.
- Results — tax-financed expenditure that boosts potential GDP:
  - Short run: economic activity slightly higher as private investment is stimulated because additional public expenditure increases potential output.
  - Long run: GDP somewhat higher; trade balance and official reserves improve more gradually.
  - Mechanism: public and private capital stock increases raise real wages, partially offsetting the negative effect of taxes on labor supply.
- Overall assessment:
  - Tax-financed increases in expenditures can dominate scenarios based on domestic borrowing:
    - The consumption tax acts as “compulsory saving,” reducing the effect of additional public expenditures on the domestic interest rate compared to domestic-financing scenarios.
    - Negative GDP effects from the tax increase can be reversed if additional spending enhances potential output rather than being low-quality.

### WAEMU sovereign security market development (selected facts)
- Market growth since 2010:
  - Nominal stock of government securities (T-Bills and bonds) issued in CFAF on the regional market grew on average by about 20 percent a year from 2010 to 2020.
  - Stock rose from less than 5 percent of GDP to 15 percent of GDP over that period.
  - Share of sovereign debt issued on the regional security market in total government debt more than doubled from 14 percent to 30 percent.
- Institutional improvements:
  - 2013: creation of Agence UMOA-Titres (AUT) to coordinate regional market issuance.
  - Strengthened regulatory framework for primary market operations and measures to promote predictability and transparency of sovereign securities auctions.
  - CREPMF strengthened rules and procedures for syndication issuance.
  - Capacity building with IMF and World Bank assistance on issuance programs, investor demand assessment, yield curve development, and issuance techniques.
- Remaining gaps:
  - The primary sovereign security market remains underdeveloped by international standards.
  - At end-2020, the share of sovereign debt issued on the domestic fixed income market in WAEMU was well below other Sub-Saharan countries:
    - Ghana: 35 percent
    - Kenya: 48 percent
    - Nigeria: 75 percent

*Source: IMF Staff estimates and excerpts from the provided IMF chapter PDF.*

### 5. There is still significant scope for further

### 5. There is still significant scope for further

### Overview
- The WAEMU region satisfies several conditions conducive to local currency bond market (LCBM) development, including economic and monetary integration of eight countries creating economies of scale.
- Strong growth, macroeconomic stability, and strengthened bank soundness during 2012-2019 helped the WAEMU enter the COVID crisis from a position of strength; prospects for recovery are favorable, with some downside risks.
- Projected convergence of fiscal deficits back to the regional norm of 3 percent of GDP by 2024 should sustain sovereign demand on the regional fixed income market while preserving fiscal and external viability.
- Inflation is expected to remain well-contained given the peg of the CFA Franc to the Euro.
- This paper applies the IMF/World Bank diagnostic LCBM framework to identify reforms needed to lift constraints impeding the development of the WAEMU’s sovereign security market.

### Diagnostic framework and methodology
- The IMF/World Bank LCBM framework identifies six building blocks for sovereign bond market development:
  - The money/interbank market
  - The primary sovereign security market
  - The secondary market
  - The investor base
  - The financial market infrastructure (FMI)
  - The legal and regulatory framework
- Indicators:
  - Four building blocks (money market, primary market, secondary market, investor base) have outcome and policy indicators.
  - Two blocks (FMI and legal/regulatory framework) have only policy indicators.
- Assessment scale:
  - Stages 1 to 4 correspond to nascent (1), developing (2), emerging (3), and mature (4).
  - About 200 questions in the Guidance Note underpin the assessment; answers reflect consultations with regional institutions and Fund staff.
- Overall assessment:
  - The WAEMU’s sovereign security market is assessed as stage 2 (developing).
  - Deficiencies are most prevalent in the primary market and investor base, but also hinder money market, secondary market, and FMI development.

### Money Market (Developing, 2.2)
- Key findings:
  - The BCEAO’s monetary policy operating framework is broadly sound de jure and uses interest rates as an operational target, but the interbank rate has not acted systematically as a credible “operational target.”
  - The interbank market is shallow and lacks proper reference prices for up to one year.
  - Interbank loans equivalent to 2 percent of total bank loans and less than 1 percent of GDP at end 2020.
  - Transactions are often limited to non-collateralized intra-group institutions.
  - Many banks rely on BCEAO refinancing windows and keep reserves at the central bank instead of participating in the interbank market.
  - Pre- and post-trade transparency are lacking: incomplete KYC information, insufficient data on quotes for T-bills or repos, and no short-term rate published daily.
  - The legal framework for repo transactions is broadly in place (allowing full transfer of securities used as collateral), but a shallow secondary market and fragmented sovereign security market constrain collateralization of repo transactions.

### Primary Security Market (Developing, 2.3)
- Key findings:
  - Sovereign funding raised on the regional security market, as a share of total debt, remains low by international standards.
  - The maximum tenure of sovereign bonds issued on the WAEMU market is 12 years, whereas it reaches 15 years in Ghana, Kenya and Tanzania and 30 years in Nigeria.
  - Market segmentation by mode of issuance (auctions vs. syndications) critically constrains development:
    - T-Bills (up to 24-months) are issued only through auctions organized by Agence UMOA Titres (AUT) with securities cleared and deposited at the BCEAO.
    - Bonds and Sukuks may be issued by auctions and syndications; syndicated issues are facilitated/supervised by CREPMF, listed on BRVM, and cleared/deposited at DC/BR.
    - Differences in product characteristics, trading platforms, and regulatory entities reduce fungibility between auctioned and syndicated securities.
  - Creating benchmark securities is hampered by practices such as adjusting coupons of new bonds, reluctance to re-open instruments, and refinancing risk concerns linked to cash management weaknesses.
  - Issuance practices have produced a large number of outstanding instruments of the same maturity with different ISINs, complicating benchmark formation and secondary market activity (examples: two different 5-year bonds by Côte d’Ivoire in September and December 2020; two different 7-year bonds by Senegal in February 2021).
  - Sovereign cash management practices are not sufficiently developed; some countries lack effective cash buffers and regular liability management operations.
  - Positive note: sovereign auction practices are relatively efficient and transparent—yearly and quarterly auction plans are published (often with limited lead time), auctions have been generally oversubscribed in recent years, and results (bid and accepted amounts, cut-off yield) are published shortly after auctions.

### Secondary Security Market (Developing, 1.7)
- Key findings:
  - The secondary market is relatively shallow, lacking depth and liquidity.
  - The bulk of secondary trading occurs between national subsidiaries of banking groups operating across WAEMU countries and mostly involves auctioned securities (predominantly from Côte d’Ivoire).
  - Turnover ratios:
    - Overall turnover ratio (annual volume of secondary transactions / stock of auctioned sovereign securities outstanding at end of previous year) increased from 4.1 percent in 2017 to 20.9 percent in 2020.
    - Turnover ratio for auctioned securities reached 32.7 percent in 2020.
    - Comparison: CEMAC turnover ratio of 20.9 percent; emerging Asian economies (Malaysia, the Philippines, Thailand, Vietnam) average turnover ratio of 143.4 percent.
  - Syndicated securities exhibit an extremely low turnover ratio; in 2019-20 syndicated bonds accounted for 3.4 percent of transactions on the WAEMU secondary market.
  - Côte d’Ivoire’s role: in 2019-20, Côte d’Ivoire’s share in the volume of sovereign securities traded on the regional market averaged 51.2 percent.

### Additional quantitative points and comparisons
- Projected regional fiscal deficit norm: 3 percent of GDP by 2024.
- Share of local currency marketable sovereign debt at end-2019: 47 percent for emerging economies and 95 percent for advanced economies.
- WAEMU’s 2020 GDP: about double that of Ghana and 30 percent larger than that of Kenya.
- Interbank loans: 2 percent of total bank loans and less than 1 percent of GDP at end 2020.
- Maximum tenure of WAEMU CFAF bonds: typically 10 years for most, with exceptions (Côte d’Ivoire 12-year bonds; Togo 11-year auction in 2017; Guinea Bissau maximum 5-year).
- Number of outstanding auctioned securities by maturity shown in assessments (see Figure 7 in source).

### Principal constraints identified
- Fragmentation of the primary market (auctions vs. syndications) leading to lack of fungibility and benchmark creation difficulties.
- Shallow and insufficiently transparent interbank market, limiting monetary policy transmission and maturity extension.
- Shallow secondary market with limited liquidity and concentration of trading among intra-group bank subsidiaries.
- Weak investor base and underdeveloped cash and liability management practices among sovereigns.
- FMI and legal/regulatory issues that, while partly in place (e.g., repo legal framework), require further improvements to support collateralization, settlement, and market confidence.

*Source: 1wauea2022002 - 5. There is still significant scope for further*

### 35.2 percent (slightly less than its contribution of 38.2 percent to regional GDP).

### 1wauea2022002 - 35.2 percent (slightly less than its contribution of 38.2 percent to regional GDP).

### Secondary market liquidity and trading environment
- Public information on secondary market pricing is insufficient; trading for auctioned securities is done over-the-counter (OTC) and no platform to disseminate prices is currently in place.
- Market-makers do not quote firm prices for benchmark securities on a regular basis and do not even provide indicative prices.
- UMOA-Titres publishes a yield curve weekly but only based on data from the primary market.
- A platform exists for trading syndicated securities, but liquidity is even lower, partly driven by the amortizing structure of the bonds.
- Sovereign security dealers (Spécialistes en Valeurs du Trésor or SVT):
  - Introduced in 2013 and became operational 2016 to improve secondary market liquidity.
  - Licensed to act as privileged partners of one or more WAEMU member states with obligations to act as market makers on both primary and secondary markets.
  - In practice, benefits provided to SVTs fall short of incentivizing them to fulfill market-making roles (quoting/trading bonds in secondary market and bidding in primary market).
  - Suggested enhancements include longer periods to buy on a non-competitive basis, building benchmark bonds to provide reference points along the yield curve, establishing a securities lending facility, and providing liquidity support for SVTs.
- Trading environment deficiencies:
  - No electronic inter-dealer trading platform to facilitate trading and promote price transparency.
  - Short-selling is not allowed, which may restrict market-making activity.
  - Market segmentation into two platforms (syndication vs auction) deters secondary market activity.
- Other contributors to low liquidity:
  - Shallow and non-diversified investor base (see Investor Base section).
  - Primary market deficiencies including fragmentation and sub-optimal benchmark issuance policies.

### Investor base
- Building block assessment: Investor Base assessed at a low (1.5) level of development.
- Composition and concentration:
  - Banks constitute about 85 percent of the investor base for government securities issued domestically.
  - Banks account for around 90 percent of domestic issuances through auctions and 75 percent of syndication placements.
  - Banks typically follow buy-and-hold strategies in the absence of a liquid secondary market.
  - Remaining players: pension funds (usually public sector), insurance companies, and investment funds.
  - Participation of international investors from outside WAEMU is estimated at less than 1 percent for auctioned securities.
  - By contrast, international investor participation exceeds 15 percent in comparator SSA countries such as Ghana, Kenya or Nigeria.
- Investor relations practices:
  - Most countries do not have an investor relations unit; task is mostly delegated to UMOA-Titres, which is short-staffed.
  - Authorities do not regularly engage in two-way communication with market participants or conduct regular fora to discuss debt strategy or market conditions.
  - Ministries of finance generally lack a dedicated webpage on debt management issues.

### Financial market infrastructure
- Building block assessment: Financial Market Infrastructure assessed at a relatively low (2.3) level of development.
- Technology and settlement:
  - Auctions are held on an electronic platform and appear to work smoothly.
  - One single custodian exists for instruments issued by each mechanism (auction or syndication), preventing further fragmentation.
  - BCEAO operates a modern RTGS (Real Time Gross Settlement) system.
  - All securities are dematerialized; dematerialization is supported by legal framework.
  - Transactions settle through the RTGS system, minimizing clearing and settlement risks.
  - Governance for the central securities depository (CSD) is broadly in place in the legal framework.
- Areas needing progress:
  - Improve access to liquidity (support same-day settlements and allow the use of intraday repos).
  - Infrastructure does not facilitate provision of transaction volumes and prices, harming market transparency.
  - Fragmentation of the issuance system segments market infrastructure, increasing costs and reducing efficiency.
  - Recommendation to unify the central depository system for sovereign securities.

### Legal and regulatory framework
- Building block assessment: Legal and Regulatory Framework assessed at 3.4 and broadly supportive.
- Strengths:
  - Legal framework for the primary security market is sound and adherent to best practices.
  - Clear borrowing authority to ministries of finance and defined roles for debt management offices.
  - Framework allows liability management operations and, for all WAEMU countries except Guinea Bissau, requires publication of a debt management strategy.
  - Secondary market activities supported: framework prohibits unfair trading practices; regulatory authority perceived to have capacity to monitor secondary market activities and ensure proper market conduct.
  - Depositary intermediaries subject to rules safeguarding investor ownership rights; regulatory authority can oversee compliance.
  - Participation of institutional players such as investment funds is broadly supported by standards for eligibility, governance, operationalization, and disclosure.
- Deficiencies:
  - Need for greater clarity on which institution has supervisory authority on secondary trading of auctioned securities.
  - Tax rules for government bonds lack neutrality and are distortionary; discriminate among investors based on country of residency within WAEMU.
  - Regulatory environment seems to miss requirement for periodic mark-to-market valuation of securities holdings.

### Conclusions and policy recommendations
- Overall assessment:
  - Despite significant growth over the past decade, the WAEMU sovereign security market remains at a developing stage.
  - Development of the secondary sovereign security market is essential to reduce dependence on external financing, improve economic resilience, and enhance monetary policy transmission.
- Priority focus: increase depth and liquidity of the secondary sovereign security market, accompanied by actions addressing deficiencies in other LCBM building blocks.
- Recommended actions by building block:
  - Money Market:
    - Promote transparency of the interbank repo market by ensuring daily availability of information on trading and promoting reference prices/rates for banks’ loans.
  - Primary bond market:
    - Reduce fragmentation by eliminating segmentation derived from the two issuance mechanisms (auctions and syndications) through generalization of a bullet structure for all sovereign securities and unification of trading infrastructure and regulatory environment.
    - Enhance issuance policy of benchmark bonds by more widely using reopenings of the same instrument to facilitate market-makers and better reference prices.
    - Improve sovereigns’ cash management practices, including building cash buffers; remunerate sovereign resources deposited at BCEAO at market rates while ring-fencing them for debt management purposes.
  - Secondary bond market:
    - Develop an electronic platform for auctioned securities to improve transparency and price formation.
    - Increase incentives for SVTs to animate the secondary market, including producing continuous price quotations; provide access to securities lending and credit lines; structure non-competitive auctions to incentivize SVT obligations.
  - Investor Base:
    - Stimulate creation of institutional investors and private pension funds.
    - Enhance investor relations programs at the national level to improve two-way communications with investors.
  - Market Infrastructure:
    - Allow use of intra-day repos and same-day settlement to enhance access to short-term liquidity.
    - Unify the central depository system for sovereign securities.
  - Legal and Regulatory Frameworks:
    - Remove distortionary tax treatments on fixed income securities, particularly exemptions granted to investors purchasing securities from the sovereign of their specific WAEMU country of residence.
    - Require investment funds to mark-to-market their asset portfolio.
- Implementation sequencing:
  - Some measures (involving a single regional institution such as the BCEAO) could take less time to implement.
  - Other measures requiring coordination across agencies and countries will take longer.
  - A proposed sequencing table sets actions across time horizons: ≤1 year, 1–3 years, and >3 years for the various building blocks.

*Source: Excerpt from IMF staff assessment and recommendations in the WAEMU sovereign security market chapter.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1wauea2022002.pdf_