## 1sycea2023002 ## Source details **Canonical URL:** [1sycea2023002](https://www.imf.org/-/media/files/publications/cr/2023/english/1sycea2023002.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2023/english/1sycea2023002.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2023/english/1sycea2023002.pdf.json) --- ### Mission, purpose, and approach - Mission: Monetary and Capital Markets (MCM) Department mission visited Victoria, Seychelles, from July 17 to 27, 2023, at the request of the Central Bank of Seychelles (CBS) to assist the authorities in stress testing the CBS balance sheet. - Meetings: Governor, Deputy Governors, Directors of Research and Statistics, Banking Services, Risk Management, Legal, Communications, Financial Markets, and Deloitte South Africa (CBS external auditor). - Objective: Assess CBS financial reporting, risk exposures, and recapitalization needs; project equity under baseline, deterministic, and at-risk scenarios; benchmark operational efficiency against peers. - Stress testing approach: - Equity projected from forecasts of balance sheet items, provisioning for risks, and realized profits. - Satellite models forecast provisions for expected credit losses (ECL), currency in circulation, and operational costs using macro variables: inflation, GDP growth, exchange rate, and policy rate. - Policy rate determined by a Taylor-rule reaction function with an inflation objective. - Deterministic macro scenarios and at-risk (95th/5th percentile) inflation and GDP growth shocks applied. ### Key findings on risk management and financial reporting - Risk management: - CBS has a risk management function, detailed operational guidance, and a statement of risk appetite and tolerance. - A credit impairment policy governs computation of expected credit losses. - CBS conducts a comprehensive stress testing exercise uncommon among emerging market central banks. - Financial reporting: - Financial statements prepared in accordance with IFRS and finalized within the statutory deadline of three months after year-end. - In-house capacity and policies for IFRS 9 valuation and impairment exist. - Suggested disclosure improvements: - Enrich sensitivity analysis for other price risks to distinguish market-factor impacts from managerial decisions (e.g., effective duration). - Expand disclosures on Other Balances and Placements and Financial Assets at FVTPL (type of assets, average interest rate, duration). - Expand disclosures on the Private Sector Relief Credit Line Facilities (PSRCLF) to include loan maturities/average duration. ### Main balance sheet exposures and structural issues - Primary exposures: - Carry cost of FX reserves required as insurance for a small open economy. - Credit risk on the sovereign and monetary policy counterparties, including unsecured exposures (although small). - Carry cost from long-term, interest-rate-free loans (PSRCLF) provided during COVID-19. - Income/expense dynamics: - Foreign assets yield less than domestic currency liabilities; CBS remunerates only a small fraction of monetary liabilities, allowing net interest income to remain positive but insufficient to cover operational costs in recent years. - Net interest income has not been enough to cover operational costs; statutory capital weakened as a result. ### COVID-19 lending (PSRCLF) specifics and implications - PSRCLF features: - Loans were interest free, initially up to three years, later extended to eight years, partially secured via a government guarantee to CBS. - As of end-December 2022, outstanding balance was SCR 187 million, just under 2 percent of CBS’s total assets. - Accounting/valuation consequences: - Zero-interest loans led to fair value losses at initial recognition. - Expected credit losses (ECLs) should be increased for uncollateralized credit risk exposure that is currently not covered. - Zero-interest loans inconsistent with CBS interest rate corridor—could undermine monetary policy stance. ### Capital, statutory targets, and profit distribution mechanics - Statutory requirement: - Act sets target statutory capital at 10 percent of monetary liabilities and segregates it from revaluation reserves. - Law protects CBS from negative unrealized revaluations; unrealized gains are not distributed. - Profit allocation rule: 50 percent of distributable earnings allocated to raise statutory capital until target reached (3.33 percent to authorized capital; 6.67 percent to general reserve). - End-2022 positions: - Statutory capital = 2.73 percent of total monetary liabilities (3.26 percent at end-2021). - Authorized capital = 2.09 percent of monetary liabilities. - General reserve = 0.64 percent of monetary liabilities. - Recommendation: - Revise profit distribution rule to allow CBS to retain all distributable earnings if statutory capital is below 10 percent of monetary liabilities. ### Recapitalization needs and recommendations - Baseline upfront recapitalization finding: - Upfront recapitalization in 2023 of at least SCR 390 million, or about 1.0 percent of GDP, would be necessary to reach the minimum statutory capital target by end-2028 based on retained earnings. - Mission recapitalization estimate ranges: - Authorized capital increase required between SCR 125 million and SCR 785 million (between 0.4 and 2.6 percent of GDP), depending on scenario. - Mission also reported a range between SCR 125 and SCR 758 million in an earlier section for five-year convergence. - Recommended modalities: - Increase authorized capital through cash or marketable government securities issued under market conditions. - Set authorized capital at SCR 550 million (proposal text contained placeholders in source). - Automatic recapitalization trigger if statutory capital expected to decline below SCR [550] million (proposal contains placeholders). - Review authorized capital at least every 10 years. - Strengthen profit retention: allow CBS to retain all distributable earnings until statutory capital reaches 10 percent of monetary liabilities. ### Key recommendations, priorities, and timeframes (selected) - Revise profit distribution rule to allow CBS to retain all distributable earnings if statutory capital below 10 percent of monetary liabilities. - Priority: High - Timeframe: March 2024 - Amend CBS Act to set authorized capital at SCR 550 million and review at least every 10 years. - Priority: High - Timeframe: March 2024 - Recapitalize the CBS up to the minimum capital with cash or marketable securities. - Priority: High - Timeframe: December 2028* - Reduce reliance on financial repression by absorbing excess reserves via Deposit Auction Arrangements and reducing the reserve requirement ratio. - Priority: Medium - Timeframe: March 2024 - Conduct an efficiency review to identify savings in operational expenses and cost recovery options. - Priority: High - Timeframe: March 2024 - Adopt a five-year CBS budget capping operational expense growth to forecast inflation. - Priority: High - Timeframe: December 2023 - Prepare a communications strategy including a defensive Q&A to explain recapitalization need. - Priority: High - Timeframe: December 2028 - Add a forward-looking component to risk disclosures, including a forecast of equity and stress scenarios. - Priority: Medium - Timeframe: March 2024 ### Stress test scenarios and quantified outcomes - Deterministic scenarios (impact on 2023 recapitalization need and 2028 statutory capital): - Expected Path: - 2023 recapitalization need = 390 SCR million, 1.30 percent of GDP - Deterministic—Policy Cost (reserve requirement unremunerated; DAAs replace excess reserves): - 2023 recapitalization need = 437 SCR million, 1.48 percent of GDP - Statutory capital in 2028 is SCR 52.7 million lower than expected path. - Deterministic—No Financial Repression (reserve requirement remunerated at policy rate): - 2023 recapitalization need = 785 SCR million, 2.66 percent of GDP - Statutory capital declines to -1.5 percent of monetary liabilities by 2028. - Deterministic—Efficiency Gains (operational costs capped at forecast inflation): - 2023 recapitalization need = 125 SCR million, 0.41 percent of GDP - Statutory capital increases to 8.05 percent of monetary liabilities by 2028; retained earnings increase to SCR 1.08 billion by 2028. - At-risk scenarios (95th/5th percentile tail risks): - At-Risk—GDP (severe downturn): - 2023 recapitalization need = 0.00 SCR million, 0.00 percent of GDP - Statutory capital in 2028 would be SCR 743.1 million (approximately SCR 70 million higher than the target in 2028). - At-Risk—Inflation (exceptionally high inflation): - 2023 recapitalization need = 603 SCR million, 2.05 percent of GDP - Statutory capital declines to 1.2 percent of monetary liabilities by 2028. - At-Risk—Exchange Rate (SCR depreciation vs USD): - 2023 recapitalization need = 365 SCR million, 1.24 percent of GDP - Statutory capital slightly declines to 0.9 percent of monetary liabilities by 2028. ### Credit risk measurement and ECL projections (sovereign CDS-implied ECL for domestic assets, Percent of monetary liabilities) - Calculated ECLs implied by sovereign CDS spread for domestic assets: - 2023: Treasury Bills 2.37, PSRCLF 0.74, Staff Loans 0.53, Total 3.64 - 2024: Treasury Bills 1.94, PSRCLF 0.60, Staff Loans 0.42, Total 2.95 - 2025: Treasury Bills 1.55, PSRCLF 0.48, Staff Loans 0.34, Total 2.37 - 2026: Treasury Bills 1.15, PSRCLF 0.36, Staff Loans 0.25, Total 1.76 - 2027: Treasury Bills 0.76, PSRCLF 0.24, Staff Loans 0.17, Total 1.17 - 2028: Treasury Bills 0.36, PSRCLF 0.11, Staff Loans 0.08, Total 0.56 - PD estimation approaches discussed: - Credit-rating-based PDs (currently predominant). - Discounted cash flow (DCF) for FVTPL assets. - CDS-implied PD approach (TA proposes for forward-looking incorporation of macro scenarios). - CDS regression specification and estimated coefficients: - s_CDS_t = α_0 + α_1 π_t + α_2 (y_t − ȳ) + α_3 ω_t + ε_t - Estimated coefficients: α_0 = 0.009, α_1 = 0.012, α_2 = 0.033, α_3 = -0.0439. ### Interest rate, exchange rate, and valuation exposures - Interest rate risk: - Current CBS approach: measure impact on statutory capital from a 1.0 percent change in domestic and foreign interest rates. - CBS operated in a liquidity surplus of SCR 3.6 billion at end-2022 (currently unremunerated). - Fair valuation for foreign-denominated securities uses discounting of expected cash flows; increases in foreign interest rates raise discounting and reduce fair value, affecting income, equity, and revaluation reserves. - Exchange rate risk: - Exchange rate revaluation booked in a revaluation reserve (not distributable; not part of statutory capital). - CBS calculates impact on equity from a 5 percent depreciation and appreciation of the SCR against all currencies. - Specific euro / USD mismatch exposure: - CBS “borrowed” euro and “invested” in USD to avoid negative euro rates. - CBS has a short position in euro equivalent to its total equity as of end-2023. - Since January 2023, euro appreciated by 6.02 percent vis-à-vis the dollar; this would represent a loss equivalent to 3.1 percent of monetary liabilities on an end-2022 exposure of SCR 282.2 million. - Currency composition of CBS balance sheet (millions of SCR as of December 31, 2022): - USD: Assets 7,646,524; Liabilities 1,229,154; Net Position 6,417,371; Percentage of Equity 813.40 - EUR: Assets 84,591; Liabilities 864,081; Net Position -779,490; Percentage of Equity -101.21 - CAD: Assets 204,356; Liabilities 0; Net Position 204,356; Percentage of Equity 25.90 - Other Currencies: Assets 657,439; Liabilities 688; Net Position 656,751; Percentage of Equity 83.24 ### CBST model structure, key equations, and satellite models - CBST model: - Projects central bank balance sheet using macro forecasts and IFRS 9-consistent accounting. - All balance sheet items modeled separately; aggregated to calculate realized income, provisioning, statutory capital, and revaluation income. - Macroeconomic inputs: real GDP, inflation, net foreign reserves, exchange rate (Seychelles IMF country team); policy rate and foreign rates from TA/WEO/Bloomberg. - Selected core equations: - Equity_t = Total Assets_t − Total Liabilities_t - Equity_t = Equity_{t−1} + RR_sources_t + Δ Revaluation_t - DAA_t = DAA_{t−1} [ − ΔFXInt_t − ΔGovBond_t + ΔCiC_t + ΔRR_t + IRIncome_t − Op_t ] - FXRes_t = FXRes_{t−1} + FIRIncome_t + Revaluation^{FXRes}_t + ΔFXInt_t - Satellite model highlights: - Currency in circulation: log form CiC_t = η_CiC * NGDP_t * (Σ_i 0_i_t)^{γ_CiC}; estimated η_CiC = -3.8, γ_CiC = 1.28; empirical result: CiC grows approximately with nominal GDP. - Policy interest rate (Taylor rule): d_t = π̄ + s^* + γ1 + γ_π(π_t − π̄) + γ_y(y_t − ȳ) + γ_C d_{t−1} + ε_t; estimated coefficients γ1 = -0.01, γ_π = 0.076, γ_C = 0.395, s^* = 0.01. - Neutral interest rate: s^* ≈ 1.0 percent (reduced-form estimate). - Operational costs: ln(μ) = -3.95, α = 1.59 (Operational Cost_t = μ * NL GDP_t^{α}), implying operational costs are less than 1.0 percent of GDP but have grown slightly faster than nominal GDP. ### Baseline macro forecasts and policy rate path - Macroeconomic forecasts (Seychelles IMF country team): - Real GDP growth: 4.3 percent in 2023; average 3.8 percent from 2024 to 2028. - Inflation: 2.2 percent in 2023; average 3.3 percent from 2024 to 2028. - USD/SCR exchange rate: expected stable at 14.12 from 2023 to 2028. - Taylor-rule based policy rate forecast (predicted domestic policy rates): - 2022: 2.00 (Actual) - 2023: 1.95 - 2024: 2.14 - 2025: 2.31 - 2026: 2.37 - 2027: 2.39 - 2028: 2.40 - Interpretation: Lower policy rates predicted in 2023 driven by forecast inflation lower than implicit 3.0 percent target; marginal increases from 2025 consistent with projected inflation rises and interest-rate inertia. ### Efficiency assessment and cost-recovery recommendations - International benchmarking: - Sample: 90 central banks (2008–2021) and stochastic frontier analysis (75–90 banks across specifications). - CBS operational expenses to GDP are higher than comparators; CBS is at the tail of the raw distribution. - Stochastic frontier results: - CBS median efficiency score = 0.43 (whole-sample median 0.55). - For emerging and low-income countries, CBS median score = 0.43 and ranks above group median 0.29. - In model 4, underlying inefficiency explains 81 percent of variation; model 1 baseline explains 72 percent. - Cost structure: - Staff costs = 56 percent of operational expenses in 2021. - Average salary per headcount lower than peers when controlled for real GDP per capita. - Headcount appears higher than expected based on population. - Currency costs = 6 percent of total expenditures in 2021; Seychelles aligned with comparators on cost per unit of currency. - Recommendations: - Conduct an external efficiency review focusing on noncore activities and unfunded mandates (banking supervision, customer protection, AML/CFT, service to government). - Adopt a multiyear budget (example horizon: five years) to cap operational expense growth to forecast inflation or nominal GDP growth. - IMF TA could assist in drafting terms of reference for the efficiency review. ### Communications strategy for losses and recapitalization - Objectives: safeguard CBS credibility, garner stakeholder support, enhance transparency and accountability, preserve policy effectiveness. - Core messaging elements: - Explain causes of losses and links to economic objectives (e.g., pandemic mitigation). - Reiterate commitment to price stability and financial stability regardless of financial outcomes. - Present solution: recapitalization (MoF) and cost rationalization/recovery (CBS). - Tailor messages by audience: markets and specialized journalists vs general public; use creole for wider reach; consider off-the-record briefings. - Suggested actions: - Publish reports on material financial deterioration with coordinated MoF and CBS statements. - Announce possible measures: upfront recapitalization and temporary suspension of dividend distribution. - Prepare defensive Q&A to address typical questions (e.g., why not print money?). - Include annual five-year equity forecast and some stress test results in CBS Annual Report. - Seychelles-specific structured messages: - Stress origin in 2020–22 pandemic actions; need for FX insurance for a small open economy with associated carry cost; temporary equity falls do not impede policy solvency; planned combination of MoF recapitalization, revision of dividend policy, and CBS efficiency measures expected to return statutory capital to 10 percent of monetary liabilities by 2028. *Italic: Source: IMF Staff (Seychelles — Stress Testing the Central Bank Balance Sheet).* ### Preface................................................................................................................. ### 1sycea2023002 - Preface ### Preface - A Monetary and Capital Markets (MCM) Department mission visited Victoria, Seychelles, from July 17 to 27, 2023, at the request of the Central Bank of Seychelles (CBS) to assist the authorities in stress testing the CBS balance sheet. - The mission met with the Governor, Deputy Governors, Directors of the Research and Statistics, Banking Services, Risk Management, Legal, Communications, and Financial Markets Divisions/Units, and Deloitte South Africa (the CBS’s external auditor). - The mission expresses thanks to the CBS for cooperation, productive discussions, and hospitality. ### Executive Summary — Key Findings - CBS has a robust risk management framework: - Presence of a risk management function, detailed operational guidance, and a statement of risk appetite and tolerance. - A credit impairment policy governs computation of expected credit losses. - Financial statements disclose exposures to credit, interest rate, exchange rate, and liquidity risks. - CBS conducts a comprehensive stress testing exercise, uncommon among emerging markets’ central banks. - Financial reporting is generally good but improvements are recommended: - Expand sensitivity analysis for other price risks to differentiate market-factor impacts from managerial decisions. - Enhance disclosures on Other Balances and Placements and Financial Assets at Fair Value Through Profit and Loss (FVTPL). - CBS balance sheet is weak due to the carry cost of FX reserves: - Small open economy necessitates a high level of FX reserves as insurance against external shocks; these reserves have a carry cost. - CBS remunerates only a fraction of its liabilities, limiting impact on financial statements but effectively passing the insurance cost to monetary policy counterparties (banks), hampering monetary policy transmission and possibly undermining price stability. - Net interest income has not been enough to cover operational costs over recent years. - Conditions of CBS lending in Seychellois rupees (SCR) also weakened the balance sheet: - Provision of long-term, low-(zero)-interest rate loans and partially unsecured loans to domestic counterparties during the COVID-19 pandemic required fair valuation and provisioning that weighed on CBS capital. - These loans generate less income than the cost to re-absorb them. - Without recapitalization, CBS financial strength relies on financial repression and operational expense control: - Remunerating the reserve requirement at the policy rate would significantly reduce CBS capital. - Full sterilization of only excess reserves with Deposit Auction Arrangements (DAAs) appears manageable. - Capping operational expense growth to forecast inflation would improve CBS capital via retained earnings. - CBS financial strength is exposed to inflation risk: - An unexpected high inflation outcome would cause CBS capital to decline. - CBS capital appears less exposed to a severe economic downturn. - Efficiency review recommended: - International comparisons suggest possible efficiency gains. - By expense type, average salary and currency cost appear below comparators’, but headcount is higher. - An efficiency review should focus on unfunded mandates and activities deviating from core missions. - Multiyear budget planning recommended: - A five-year budget plan would help control operational expense growth, possibly capping growth to forecast inflation. - Capital injection required: - Increase in authorized capital and revision of profit distribution rule recommended to allow retention of distributable earnings if statutory capital is below the target level of 10 percent of monetary liabilities. - As of July 2023, estimated new capital needed ranged between SCR 125 and SCR 785 million, depending on the scenario, for statutory capital to converge to the minimum of 10 percent of the monetary liabilities at the five-year horizon. - Capital injection could take the form of cash or government securities issued under the same conditions as those necessary to raise cash in the market (i.e., marketable government securities). - Communications strategy recommended: - Explain causes of losses, reiterate commitment to policy objectives regardless of financial considerations, and present the solution (recapitalization and profit retention). - Coordinate communications between the Ministry of Finance (MoF) and the CBS to explain measures by each party, including financial support through recapitalization (MoF) and cost rationalization/recovery (CBS). - Tailor types and channels of communication by audience (e.g., banks and foreign counterparties vs. general public). - Prepare a defensive Q&A to address typical questions on recapitalization (e.g., why is recapitalization a priority? why isn’t the central bank just printing money?). ### Table 1 — Key Recommendations (selected entries and implementation details) - Revise the profit distribution rule to allow the CBS to retain all distributable earnings if the statutory capital is below the target level of 10 percent of monetary liabilities. - Priority: High - Timeframe: March 2024 - Amend the CBS Act to set the authorized capital at SCR 550 million and review it as necessary, but at least every 10 years, for statutory capital to converge toward the target level of 10 percent of monetary liabilities. - Priority: High - Timeframe: March 2024 - Recapitalize the CBS up to the minimum capital with cash or marketable securities. - Priority: High - Timeframe: December 2028* - Reduce reliance on financial repression by absorbing excess reserves via Deposit Auction Arrangements and reducing the reserve requirement ratio. - Priority: Medium - Timeframe: March 2024 - Conduct an efficiency review to identify savings in operational expenses and cost recovery options. - Priority: High - Timeframe: March 2024 - Adopt a five-year CBS budget capping operational expense growth to forecast inflation. - Priority: High - Timeframe: December 2023 - Prepare a communications strategy including a defensive Q&A to explain the need for recapitalization and measures taken. - Priority: High - Timeframe: December 2028 - Add a forward-looking component to risk disclosures, including a forecast of equity and stress scenarios. - Priority: Medium - Timeframe: March 2024 - Note: At the time of the mission, the recapitalization needs ranged from 0.4 to 2.6 percent of GDP depending on the scenarios. The recapitalization horizon was assumed to occur by the end of the stress test horizon, not necessarily in 2023. ### I. Introduction — Purpose and Approach - Context and discussions: - CBS and the Ministry of Finance are discussing the need for recapitalization of the CBS. - The CBS Act prescribes automatic recapitalization, with marketable securities, if the general reserve of the CBS is exhausted. - National Assembly may request the Board and external auditors to report and explain causes for losses. - CBS staff are stress-testing the balance sheet to inform the MoF decision. - Latest results show automatic recapitalization provision would not be triggered in 2023, but statutory capital would remain well below the Act’s target of 10 percent of monetary liabilities. - Main exposures identified: - Carry cost of FX reserves required as insurance for a small open economy. - Credit risk on the sovereign and monetary policy counterparties, including unsecured exposures (although small). - Carry cost from long-term, interest-rate-free loans provided to local banks for on-lending during the COVID-19 pandemic. - Role of capital: - Capital of central banks functions as insurance against financial losses. - Adequate capital must absorb expected losses consistent with policymakers’ risk appetite. - For Seychelles, statutory capital comprises authorized capital and general reserves and should be at least 10 percent of monetary liabilities per the Act. - Policy solvency test assesses whether CBS has sufficient income for statutory capital to meet the legal minimum at the policy horizon (e.g., five years or end-2028). - Stress testing approach: - Equity is projected based on forecasts of balance sheet items, provisioning for risks, and realized profits. - Satellite models forecast provisions for expected credit losses, currency in circulation, and operational costs using macro variables: inflation, GDP growth, exchange rate, and policy rate. - Policy rate is determined by a rule that has an inflation objective. - Expected equity path is stressed under deterministic macro scenarios and at-risk inflation and GDP growth. - Efficiency assessment: - International comparison with 90 central banks that disclose financial statements. - Methods range from cost-to-GDP metrics to efficiency scoring using stochastic frontier analysis, aiming to control for factors justifying different cost structures and diseconomies of scale for a small island economy. - Report organization: - Section II: Financial reporting. - Section III: Balance sheet stress testing. - Section IV: International efficiency scoring. - Final section: Communications around losses and recapitalization. ### II. Financial Reporting — Opening - The report proceeds to discuss financial disclosures and the CBS balance sheet structure, capital structure and profit distribution in subsequent sections. *IMF | SEYCHELLES Stress Testing the Central Bank Balance Sheet | Preface and Executive Summary (excerpts).* ### 8. The CBS prepares its financial statements in accordance with International ### 8. The CBS prepares its financial statements in accordance with International ### Financial reporting and disclosures - The CBS prepares its financial statements in accordance with International Financial Reporting Standards (IFRS). - Financial statements are finalized and published within the statutory deadline of three months after the end of the year. - The CBS has sufficient in-house capacity in the financial reporting function and established policies and procedures to ensure compliance with key standards, including for valuation and impairment under IFRS 9 Financial Instruments. - While the financial statements are aligned with IFRS requirements in all material respects, disclosures could be further improved. Suggested improvements: - Enrich sensitivity analysis for other price risks by decomposing the impact of market factors (other than exchange rates) and managerial decisions (e.g., effective duration of the securities portfolio) to better explain gains/losses from fair valuation of foreign financial assets held at fair value through profit or loss (FVTPL). - Expand disclosures on Other Balances and Placements and Financial Assets at FVTPL to clarify the nature and risks of these instruments, including information on the type of assets and the average interest rate and duration of the portfolios (similar to Investment Securities). - Expand disclosures on the Private Sector Relief Credit Line Facilities (PSRCLF) to include maturities of the loans, e.g., average duration of outstanding loans. *IMF | SEYCHELLES Stress Testing the Central Bank Balance Sheet | 12* ### CBS balance sheet structure and interest allocation - The ideal balance sheet should provide a consistent and reliable stream of income and the tools necessary for implementing monetary and financial stability policies. - The CBS’s current balance sheet provides some of these characteristics. Table 2 (not reproduced here) summarizes the CBS’s balance sheet and associated interest income and expense, excluding revaluation gains and losses, realized or not. - The CBS’s COVID-19-related lending under the PSRCLF: - Loans were interest free, initially had maturities up to three years, later extended to eight years, and were only partially secured through a government guarantee provided to the CBS. - Banks and other financial institutions bear the full credit risk from borrowers. - As of end-December 2022, the outstanding balance was SCR 187 million, just under 2 percent of CBS’s total assets. - Implications of zero-interest rates and a partial government guarantee: - The CBS incurred fair value losses at initial recognition of the assets due to the zero-interest rate. - The expected credit losses (ECLs) provision on these loans should be increased to account for the uncollateralized credit risk exposure, which currently is not covered. - Zero-interest rates are inconsistent with the CBS’s interest rate corridor and could undermine the central bank’s monetary policy stance and blur the line between monetary policy and government fiscal policy. - Interest income context: - The CBS’s income is driven by the cost of maintaining foreign assets as insurance against external shocks; foreign assets typically yield less than domestic currency liabilities. - Interest income remained positive because the CBS remunerated only a small fraction of its monetary liabilities. - Low interest rates in major reserve currencies reduced net interest income such that operational expenses were not being covered, weakening statutory capital and leaving the CBS with little buffer for future shocks. *IMF | SEYCHELLES Stress Testing the Central Bank Balance Sheet | 13–14* ### Capital structure, profit distribution, and statutory targets - The Act sets the target statutory capital level as 10 percent of monetary liabilities and segregates it from revaluation reserves. - Appropriately, the CBS does not distribute unrealized gains; the law includes a mechanism to protect the CBS from negative unrealized revaluations. - The Act allows the CBS to retain distributable profits up to 10 percent of monetary liabilities. Statutory capital is increased through allocation of 50 percent of distributable earnings until the target is reached: - 3.33 percent shall relate to authorized capital. - 6.67 percent shall relate to the general reserve. - As of December 31, 2022: - Statutory capital stood at 2.73 percent of total monetary liabilities (3.26 percent at end-2021). - Authorized capital was 2.09 percent of monetary liabilities. - General reserve was 0.64 percent of monetary liabilities. - Authorized capital cannot be distributed or reallocated and provides a permanent reserve. The general reserve is used to absorb realized losses and can be reallocated to revaluation reserves when those become negative. *IMF | SEYCHELLES Stress Testing the Central Bank Balance Sheet | 14–15* ### Recommendations to strengthen capital and income (some requiring Act changes) - Upfront recapitalization: - Increase authorized capital through a capital injection in the form of cash or marketable securities. - The mission estimates that between SCR 125 and SCR 758 million in additional authorized capital is required for statutory capital to converge to the target level over a five-year horizon. - The securities, likely of one-year maturity, will be fully or partially rolled over at maturity at prevailing market conditions. - Recapitalization rule (proposal text contains placeholders): - Authorized capital would be fixed at SCR [550] million. - An automatic recapitalization would be triggered if statutory capital is expected to decline below SCR [550] million. - The recapitalization amount should put statutory capital back on track to reach the minimum of 10 percent of monetary liabilities in the medium term. - Authorized capital would be reviewed as necessary, at least every 10 years. - Profit distribution rule: - Strengthen profit retention mechanism to allow the CBS to retain all distributable earnings until statutory capital reaches the target level of 10 percent of monetary liabilities. *IMF | SEYCHELLES Stress Testing the Central Bank Balance Sheet | 15* ### Modeling risks and forward-looking risk management - The CBS balance sheet is exposed to credit, interest rate, and exchange rate risks. - The CBS employs quantitative methods and adheres to IFRS 9 Financial Instruments. The balance sheet is asset driven, with few interest-bearing liabilities, increasing exposure to shocks that reduce asset quality and impair interest earnings. - The risk management unit periodically assesses financial risks (including liquidity risk) and recommends mitigations; however, the assessment time horizon is only one year, limiting forward-looking risk measurement. - This TA proposes augmenting the approach with forward-looking components and proactive risk measurement and mitigation. *IMF | SEYCHELLES Stress Testing the Central Bank Balance Sheet | 16* ### Credit risk measurement and Expected Credit Losses (ECL) - ECLs are modeled using a probability of default (PD) approach: ECL_t = PD_t ⋅ ELGD ⋅ EAD - EAD is constant and can be set equal to the fair value of the instrument using the risk-free discount rate. - LGD is derived from recovery rate R, where R = 1 − ELGD. - PD estimation methods discussed: - Credit-rating-based PDs (mapping rating categories to historical default probabilities) — currently predominantly used by the CBS; accurate but not well suited for incorporating macroeconomic variables in a forward-looking context. - Discounted cash flow (DCF) method — used for assets measured at FVTPL; fair value difference between risk-free and default-risk-embedded discount rates can be considered the ECL assuming LGD = 100 percent. - CDS-implied PD approach — proposed by TA as well suited for forward-looking incorporation of macroeconomic scenarios; sovereign CDS spreads reflect default probability and recovery rate via spread ≈ (1 − R_CDS) ⋅ λ_t, where λ_t is default intensity. Recovery rate for sovereign CDS often assumed to be 25 percent by market participants. - CDS spread forecasting approach: - Historical CDS spreads are conditioned on macroeconomic variables (inflation, output gap, public debt per GDP). - Estimated coefficients are combined with forecast macro variables to project future CDS-implied PDs. - Regression specification: s_CDS_t = α_0 + α_1 π_t + α_2 (y_t − ȳ) + α_3 ω_t + ε_t - Estimated coefficients: α_0 = 0.009, α_1 = 0.012, α_2 = 0.033, α_3 = -0.0439. *IMF | SEYCHELLES Stress Testing the Central Bank Balance Sheet | 17–18* ### Scenario-based credit-risk stress testing and ECL projections - The TA subjects the CBS balance sheet to credit-risk stress tests using scenario-based forecasts of macroeconomic variables; ECLs are recalibrated using the CDS spread-implied PD approach and projected over the forecast horizon. - Deterioration in macroconditions in scenarios drives higher ECLs and lower statutory capital. - Nine balance sheet items apply an ECL calculated by the CBS (does not include assets measured at FVTPL, which have an implicit ECL applied in fair valuation adjustment). - The sovereign CDS spread-implied ECL is calculated for three domestic assets: Treasury bills, PSRCLF loans, and staff loans. Remaining six balance sheet items are foreign cash assets subject to rating-implied ECLs growing linearly with asset size. ### Calculated ECLs implied by sovereign CDS spread for domestic assets (Percent of monetary liabilities) - 2023: Treasury Bills 2.37, PSRCLF 0.74, Staff Loans 0.53, Total 3.64 - 2024: Treasury Bills 1.94, PSRCLF 0.60, Staff Loans 0.42, Total 2.95 - 2025: Treasury Bills 1.55, PSRCLF 0.48, Staff Loans 0.34, Total 2.37 - 2026: Treasury Bills 1.15, PSRCLF 0.36, Staff Loans 0.25, Total 1.76 - 2027: Treasury Bills 0.76, PSRCLF 0.24, Staff Loans 0.17, Total 1.17 - 2028: Treasury Bills 0.36, PSRCLF 0.11, Staff Loans 0.08, Total 0.56 *Sources: IMF Staff calculations and CBS. IMF | SEYCHELLES Stress Testing the Central Bank Balance Sheet | 18–19* ### 25. The CBS balance sheet is exposed to interest rate risks. The current approach of the ### 1sycea2023002 - 25. The CBS balance sheet is exposed to interest rate risks. The current approach of the ### Interest rate risk: channels and measurement - Current CBS approach: measure impact on statutory capital from a 1.0 percent change in domestic and foreign interest rates. - TA extension: method will be extended to provide further stress tests to the balance sheet. - Two main channels through which interest rate changes impact the balance sheet: - Policy interest rate changes—as derived from a forward-looking Taylor rule reaction function—impact interest rate earnings received from domestic investments and interest rate paid on interest-bearing liabilities, including interest paid on the absorption of excess reserves. - Foreign interest rate changes—as derived from deterministic scenarios developed in this TA—significantly impact the measurement of financial assets measured at FVTPL. - Domestic interest rate risk depends on macroeconomic variables: - CBS operated in a liquidity surplus of SCR 3.6 billion at end-2022 (and this should be remunerated to transmit monetary policy, although currently it is not). - Exposure arises from possible need to increase policy rate to address inflationary pressures. - Measurement requires forecasting (i) the policy rate; and (ii) liquidity surplus, both depending on inflation and real GDP. - Fair valuation mechanics for foreign interest rate risk: - Fair value formula for a financial asset: FVs = sum_{t=1}^n (E[cashflow_t] / (1 + s_t)^tau) where n denotes number of future time periods until maturity, s is the discount rate. - Zero-coupon bond fair value: FVs_t = F_t / (1 + s_t)^tau where F_t is face value, s is discount rate, and tau is time to maturity. - This is the current method used to value future cashflows from sovereign and corporate bonds in the CBS FX investment portfolio; these appear on the CBS balance sheet as financial assets measured at FVTPL. - Valuation impact: - Increases in foreign interest rates result in a higher discount on future cash flows, which impacts income, equity, and the revaluation reserve. ### Exchange rate risk and valuation - Interest income is predominantly driven by foreign currency investments that are subject to exchange rate revaluation; CBS balance sheet is generally exposed to exchange rate risk. - USD foreign currency assets (cash deposits and FX securities held at fair value) measured on the balance sheet using: - E_{shr,USD,t} = FX_{USD,t} / FX_{USD,t-1} * (1 + d_{cash,USD,t}) * E_{shr,USD,t-1} - FV_{USD CBS, t} = FX_{USD,t} / FX_{USD,t-1} * (1 + d_{YTM,USD,t}) * (F_{USD,t} / (1 + s_t)^tau) - Where FX_{USD,t} is USD/SCR exchange rate, d_{cash,USD,t} is short term (three months) foreign interest rate, d_{YTM,USD,t} is the yield to maturity, and F_{USD,t} is the face value of USD investments. - Exchange rate appreciation against the US dollar reduces the SCR valuation of foreign currency assets, leading to FX revaluation loss (or gain if depreciation). FX revaluation is booked in a revaluation reserve (not distributable; not part of statutory capital). - Currencies on balance sheet as of end-2022 include US dollar, euro, Canadian dollar, Chinese yuan, and British pound. - Current CBS practice for exchange rate risk: - CBS analyzes impact on equity from a depreciation and appreciation percentage change of the SCR against all currencies. - Latest balance sheet simulation: exchange rate risk to equity was 5 percent in each direction (CBS calculates impact on equity from a 5 percent depreciation and appreciation of the SCR against all currencies). - TA developments: scenario-based exchange rate changes implied by an exchange at risk model; an exchange rate passthrough model to show impact on inflation; a satellite model for the policy interest rate reaction function to determine impact of inflation on policy interest rate. - Specific exposure: euro / USD mismatch - CBS “borrowed” euro (government and banks’ accounts at the CBS) and “invested” them in US dollars to avoid negative interest rates in the euro area. - CBS has a short position in euro equivalent to its total equity as of end-2023; exposed to appreciation of the euro vis-à-vis the dollar. - Since January 2023, the euro appreciated by 6.02 percent vis-à-vis the dollar; this would represent a loss equivalent to 3.1 percent of monetary liabilities on an end-2022 exposure of SCR 282.2 million. - Currency Composition of the Central Bank of Seychelles’ Balance Sheet (millions of SCR as of December 31, 2022) - USD: Assets 7,646,524; Liabilities 1,229,154; Net Position 6,417,371; Percentage of Equity 813.40 - EUR: Assets 84,591; Liabilities 864,081; Net Position -779,490; Percentage of Equity -101.21 - CAD: Assets 204,356; Liabilities 0; Net Position 204,356; Percentage of Equity 25.90 - Other Currencies: Assets 657,439; Liabilities 688; Net Position 656,751; Percentage of Equity 83.24 - (Source: CBS.) ### Forecasting balance sheet items and CBST model - The Central Bank Stress Testing (CBST) model projections: - Projects central bank balance sheet using macroeconomic forecasts and accounting techniques consistent with IFRS 9. - All balance sheet items modeled separately, then aggregated to calculate realized income, provisioning, statutory capital, and revaluation income. - Macroeconomic forecasts sourced from the Seychelles IMF country team: real GDP, inflation, net foreign reserves, exchange rate. - Other forecasts (policy interest rate, foreign interest rates, CDS spreads) sourced or calculated by TA; foreign interest rates and CDS from WEO and Bloomberg. - Several techniques used depending on balance sheet item types. - Classification of balance sheet items: - Autonomous items: determined by macroeconomic variables (do not explicitly depend on other balance sheet items). Main autonomous items: currency in circulation and reserve requirement (assuming unchanged reserve requirement ratio). - Endogenous items: derived from other balance sheet items. Main endogenous item: open market operations (for Seychelles derived from changes in currency in circulation and required reserves on liability side and net purchase of USD and investment in government bonds on asset side). Banks have structural surplus; reserves above requirement absorbed through CBS open market operations (DAA), seven-day deposits auctioned weekly. - Exogenous items: policy-determined items (e.g., net purchases of foreign currencies, investments in domestic government bonds). - Core CBST model equations (selected): - Equityt = Total Assetst − Total Liabilitiest - Equityt = Equityt−1 + RRsources_t + Δ Revaluation_t (equation as presented in source) - DAAt = DAAt−1 [ − ΔFXInt_t − ΔGovBond_t + ΔCiC_t + ΔRR_t + IRIncome_t − Op_t ] - Where GovBond is government bond holdings, CiC_t is currency in circulation, IRIncome_t is interest rate income, RR_t is required reserves, Op_t is operational expenses. - FXRest = FXRes_{t−1} + FIRIncome_t + Revaluation_{t}^{FXRes} + ΔFXInt_t - Valuation conventions for CBS: - Foreign reserves in cash are term deposits valued at amortized cost. - Foreign currency securities are longer-term investments measured using fair valuation. - Domestic loans and securities are valued at amortized cost. - All domestic and foreign currency assets are subject to provisioning and ECLs. - On liabilities side, hardly any interest-bearing items; CBS currently does not remunerate required reserves. ### Satellite models (specifications and estimated parameters) - Currency in circulation forecasts: - First specification: seasonal ARIMA with nominal GDP as exogenous variable. - Second specification (log form): CiC_t = η_CiC * NGDP_t * (Σ_i 0_i_t)^{γ_CiC} (as presented); estimation results: η_CiC = -3.8, γ_CiC = 1.28. - Note: Σ_i 0_i_t^{γ_CiC} captures impact of policy rate changes to currency in circulation; γ_CiC measures sensitivity. Based on estimations, η_CiC stable; Σ term not statistically significant and dropped. Currency in circulation grows approximately at same rate as nominal GDP growth. - Domestic policy interest rate (Taylor rule) specification and estimates: - Policy rate equation: d_t = π̄ + s^* + γ1 + γ_π(π_t − π̄) + γ_y(y_t − ȳ) + γ_C d_{t−1} + ε_t (as presented). - Estimated coefficients: γ1 = -0.01, γ_π = 0.076, γ_C = 0.395, s^* = 0.01. - Inflation target π̄ set at long-term average of inflation (3 percent, or 0.03, using data from 2010Q1 to 2020Q1). - Potential output ȳ estimated using HP filter. - Output gap not statistically significant and dropped. - Interest rate inertia: current policy rates incorporate roughly 40 percent of past values. - Neutral interest rate estimation: - Reduced form approach estimated neutral interest rate s^* = 1.0 percent, or 0.01. - Reduced form: s_t^* = α1 + α2 s_{t−1}^* + α3 d_t^* + α4 Δŷ + α5 s1 + α6 s2 + ε_t - Estimated coefficients: α1 = -0.001, α2 = 0.697, α3 = 0.166, α4 = 1.589, α5 = -0.22, α6 = 0.004. - Method uses proxy policy interest rate, growth in potential GDP (Δŷ), real foreign interest rates (ECB monetary policy rate in real terms), and crisis dummy variables. - Operational costs satellite model: - Operational Cost_t = μ * NL GDP_t^{α} (in log-linear form). - Estimation results: ln(μ) = -3.95, α = 1.59. - Interpretation: operational costs are less than 1.0 percent of GDP; α > 1.0 indicates operational costs have been growing at slightly higher rate relative to nominal GDP. ### Expected path, baseline forecasts, and projections - Starting point: end-2022 balance sheet; all financial assets either fair valued or sufficiently provisioned as of end-2022; financial statements at end-2022 used without further fair valuation or provisioning. - Macroeconomic forecasts (from Seychelles IMF country team): - Real GDP growth: expected to grow by 4.3 percent in 2023 with an average growth of 3.8 percent from 2024 to 2028. - Inflation: 2.2 percent forecast for 2023; average of 3.3 percent from 2024 to 2028. - USD/SCR exchange rate: expected to remain stable at 14.12 from 2023 to 2028. - Taylor rule-based policy rate forecast: - Taylor rule estimation indicates domestic policy interest rate will marginally decline in 2023 to 1.9 percent, reflecting lower-than-target inflation. - Forecasted marginal increase in domestic policy rate from 2025 to 2028 consistent with forecast increase in inflation and interest rate inertia/smoothing. - Projections included (as per Figure 4): - Projection of Equity, Accumulated Earnings, & Accumulated Revaluation Gains. - Projection of Equity/GDP & Statutory Capital/Reserve Money. - Projection of Balance Sheet by Category. - Projection of Income & Expenses. - Note: Income flows are cumulative. Balance sheet items are presented in level. DAA = Deposit Auction Arrangement; SDF = Standing Deposit Facility. *IMF | SEYCHELLES Stress Testing the Central Bank Balance Sheet* ### 43. All else being equal, a recapitalization of more than 1.0 percent of GDP would be ### 1sycea2023002 - 43. All else being equal, a recapitalization of more than 1.0 percent of GDP would be ### Recapitalization need and baseline finding - An upfront recapitalization in 2023 of at least SCR 390 million, or about 1.0 percent of GDP, would be necessary to reach the minimum statutory capital target by end-2028 based on retained earnings. - Statutory capital marginally increases as a percentage of monetary liabilities under the baseline retained earnings path but remains well below the legal 10 percent target. - Higher FX reserves returns allow the CBS to cover operational expenses, while the nonremuneration of banks’ liquidity surplus keeps policy cost null. ### Deterministic scenarios (stress tests of the forecast equity path) - Test design: - Deterministic scenarios assume (i) the CBS absorbs all excess reserves at the policy rate via DAA issuances while keeping the reserve requirement unremunerated (policy cost scenario); (ii) the CBS absorbs all excess reserves and remunerates the reserve requirement at the policy rate (non-financial repression scenario); and (iii) operational costs are capped at the forecast inflation (efficiency scenario). - The CBS target interest rate is in a mid-corridor system implying absorption of all excess reserves in practice. - Policy Cost scenario (reserve requirement unremunerated; DAAs replace excess reserves): - Statutory capital in 2028 is SCR 52.7 million lower than in the expected path. - The recapitalization need in 2023 increases by SCR 47.1 million relative to the expected path. - Policy cost only marginally affects the equity path because currency in circulation growth and unremunerated reserve requirements keep the stock of DAAs low and interest rates remain low. - No Financial Repression scenario (reserve requirement remunerated at policy rate; reserve requirement = 13 percent of banks’ deposit base and currently unremunerated): - Interest rate expense increases significantly; the stock of DAAs snowballs due to compounded interest. - Statutory capital declines to -1.5 percent of monetary liabilities by 2028. - The recapitalization need in 2023 increases by SCR 392.9 million relative to the expected path. - Conclusion: The CBS needs some degree of financial repression to remain policy solvent in the absence of recapitalization. - Efficiency scenario (operational costs capped at forecast inflation in a five-year budget): - Assumes operational expenses growth rate equals inflation, replacing the satellite operational expenses specification. - Statutory capital increases to 8.05 percent of monetary liabilities by 2028. - Retained earnings increase to SCR 1.08 billion by 2028. - The 2023 recapitalization need declines by SCR 266.4 million compared with the expected path. - Caveat: Cost recovery would likely require the government to pay for a fair amount of the unfunded services currently provided by the CBS. ### At-risk scenarios (tail-risk macroeconomic shocks) - Method: - The TA projects the forecast distribution of inflation, real GDP, and the SCR/USD exchange rate and selects the 95th and the 5th percentiles to define tail risks (inflation and growth shocks respectively). - Exchange rate at-risk scenario focuses on SCR/USD risk as more material than SCR/EUR risk. - Growth at Risk: - An economic downturn improves statutory capital in terms of monetary liabilities because the reduction in seigniorage and slower operational expense growth more than offsets effects on monetary liabilities. - Statutory capital in 2028 would be SCR 743.1 million, which is approximately SCR 70 million higher than the target in 2028. - No recapitalization is needed under this scenario. - Inflation at Risk (exceptionally high inflation): - Higher inflation increases operational expenses and the cost of monetary policy (via the Taylor rule), outweighing faster growth in monetary liabilities. - Statutory capital declines to 1.2 percent of monetary liabilities by 2028. - The recapitalization need in 2023 increases by SCR 213.3 million relative to the expected path. - Exchange Rate at Risk (SCR depreciation vs USD): - Depreciation materially affects the revaluation reserve but only marginally affects statutory capital via inflation and interest earnings channels. - Statutory capital slightly declines to 0.9 percent of monetary liabilities by 2028. - The recapitalization need in 2023 increases by SCR 24.8 million relative to the expected path. ### Summary of recapitalization needs (scenario outcomes) - Depending on the scenario, authorized capital should be increased between SCR 125 million and SCR 785 million, that is, between 0.4 and 2.6 percent of GDP. - Prioritizing price stability (reducing financial repression) increases recapitalization cost; efficiency gains could help keep final cost reasonable. - Table of 2023 recapitalization needs (values preserved): - Expected Path: 390 SCR million, 1.30 percent of GDP - Deterministic—Policy Cost: 437 SCR million, 1.48 percent of GDP - Deterministic—No Financial Repression: 785 SCR million, 2.66 percent of GDP - Deterministic—Efficiency Gains: 125 SCR million, 0.41 percent of GDP - At-Risk—GDP: 0.00 SCR million, 0.00 percent of GDP - At-Risk—Inflation: 603 SCR million, 2.05 percent of GDP - At-Risk—Exchange Rate: 365 SCR million, 1.24 percent of GDP ### Cost efficiency and international comparison - Central banks should use resources efficiently; profitability is not an objective but operational cost rationalization matters because losses may require fiscal support and affect credibility. - CBS operational expenses to GDP are higher than comparator countries across development levels; the CBS is at the tail of the distribution in an international sample of 90 central banks (2008–2021). - Reasons for high costs: - Diseconomies of scale for small island central banks (fixed minimum costs). - Broader range of public services provided by central banks in developing countries. - Stochastic frontier analysis (panel of 75–90 central banks, various model specifications) was used to benchmark CBS operational expenses controlling for exogenous variables. - Cost efficiency score ranges from 0 to 1 (1 = maximum efficiency). - In model 4, underlying inefficiency explains 81 percent of variations in observed inefficiency; in model 1 (baseline), it explains 72 percent. - CBS efficiency results: - CBS median efficiency score is 0.43 (below whole-sample median 0.55). - When considering only emerging and low-income countries, CBS median score is 0.43 and ranks above the group median 0.29. - Conclusion: Controlling for exogenous variables, the CBS performs better on efficiency metrics than suggested by raw cost-to-GDP ratios. - Operational expense composition: - Main categories: staff costs, currency expenses, professional charges, and other expenses. - Staff costs share remained stable; share of other expenses steadily increased; currency costs and professional charges show no clear trend. - Since 2008, operational expenses grew consistently ahead of nominal GDP, contributing importantly to realized net earnings dynamics. *Source: IMF Staff.* ### 65. Average salaries are below those of comparators. Staff costs represent the highest ### 65. Average salaries are below those of comparators. Staff costs represent the highest ### Staffing, salaries, and operational cost structure - Staff costs represented 56 percent of operational expenses in 2021. - The average salary per headcount at the CBS is lower compared with peer central banks once controlled for real GDP per capita. - CBS staffing appears above what could have been expected from its population based on the average relationship in other countries; possible explanations: - Diseconomies of scale. - The CBS engages in more activities and has a more sophisticated policy framework than typical small economies in the sample (e.g., Comoros, Djibouti, Vanuatu). ### Currency cost - Currency expenditures trended downward and represented 6 percent of total expenditures in 2021. - In terms of cost per unit of currency, Seychelles is aligned with comparators. ### Efficiency review and cost recovery recommendations - The CBS should conduct an external efficiency review of its activities to identify possible savings and cost recovery options. - The review is commonly requested from an independent firm or a national audit office. - Objective: bring efficiency more in line with the median of the comparators. - Scope: all business lines with particular attention to noncore activities; should not include policies. - Method: cost benchmarking product by product. - The review should identify cost recovery options for unfunded mandates (examples): banking supervision, customer protection, AML/CFT, and service to the government (e.g., issuance of government securities). - IMF TA could assist the CBS in drafting the terms of reference. - The CBS should adopt a multiyear budget (example horizon: five years) to cap the growth of operational expenditures. - Capping increases to forecast inflation or nominal GDP growth is recommended to help strengthen the CBS’ financial position. ### Central bank losses and recapitalization — communications issues (overview) - A recapitalization strategy should incorporate a comprehensive communications plan targeting the public and key stakeholders to: - Safeguard the CBS’s credibility implementing the new framework. - Garner support from relevant constituencies. - Enhance transparency and accountability, maintain credibility, and preserve the bank’s effectiveness. - Losses at many central banks have resulted from balance sheet structures vulnerable to monetary policy tightening (e.g., large net holdings of government securities or FX reserves) and from other sources (e.g., restructuring of government debt owned by the central bank, liquidity assistance to insolvent banks). ### International experiences with communication of losses and recapitalization - Most major central banks have taken a preemptive approach to communications to preserve market confidence, undertaking proactive and transparent efforts when transmitting monetary policy decisions and anticipating adverse market reactions. - Communications have evolved from targeting a professional audience to also producing messages suitable for a wider, less technical audience. ### Communications strategy on the recapitalization process — key elements - Publish reports on material financial deterioration or negative trends with coordinated statements (MoF and other entities) and a communications calendar. - Possible policy measures to announce: - Upfront recapitalization from the government (MoF). - Temporary suspension of dividend distribution to build up reserves organically. - The MoF’s endorsement should ideally be completed by the time the relevant report is published to bolster credibility. - Messages should be tailored to audience technical depth and information needs: - Market participants and specialized journalists require specific information. - The general public focuses on the bottom line and impact. - Opinion makers, academics, and think tanks can be enlisted to explain issues and next steps. - Off-the-record meetings with journalists and communications in creole by the Governor are recommended to reach the public. - Channels: traditional communications, social media, and the CBS’s website. - Possible key messages to communicate: - The causes underlying the losses and/or negative equity and connections to economy-wide objectives (e.g., pandemic mitigation, systemic crisis response). - The key objectives of monetary policy now and going forward, stating losses are temporary and policy objectives remain in place. - Financial outcomes will not prevent the CBS from carrying out monetary policy and maintaining financial stability—the CBS remains policy solvent—backed by experience of other central banks. - Coordination between MoF (principal) and CBS (agent) to strengthen the balance sheet: - Measures by the principal to recapitalize the CBS are in progress and statutory capital is expected to reach the target level over a specific horizon (MoF backing enhances credibility). - Measures by the agent to rationalize costs, mitigate balance sheet risk exposure, and monitor risks (including stress testing). ### Typical public Q&A to address concerns about recapitalization - Q: Why should the taxpayer give money to the central bank and not to other public services (teachers, nurses)? - A: The central bank provides priority public services (stable price and US dollars to buy imports); those services have a financial cost that would be paid by the taxpayer like any other public service. Including it explicitly in the budget is the most transparent action and avoids inflation. - Q: Why does the central bank not just print money? - A: Printing money is not good for price stability; central bank money is a form of public debt. Printing too much creates too much public debt and would result in inflation and rationing of FX. - Q: Recapitalization will challenge debt stability. - A: With recapitalization, the debt remains in the public sector with no rollover risk; any future profits distributed to government assume statutory capital adequacy. Interest payments covering central bank costs represent a budget cost but are necessary. ### Seychelles-specific communications outline and expected outcomes - Structured messaging for specialized audiences: i. Seychelles experienced severe stress in 2020-22 because of the COVID-19 pandemic; mitigation policies by government and CBS came at a cost. The CBS balance sheet reflects cumulative losses related to revaluation of the rupee, repricing of government securities from monetary tightening, FX interventions, etc. ii. Seychelles is a small, externally exposed economy requiring a relatively large stock of FX reserves, which entail a continuous carry cost—the difference between low returns on high-quality liquid FX reserves and the local currency interest rate. iii. Similar situations have affected other central banks; temporary equity falls do not affect CBS’s capacity to implement policies aimed at price stability and financial sector stability—the CBS is policy solvent. iv. The CBS’s core mandate to maintain price stability and provide FX in an emergency are important public services benefiting all Seychellois; the government is prioritizing assuming the cost, while the CBS commits to cost-effective service delivery. v. Financial position is expected to improve over time under a plan including: - Immediate recapitalization (MoF). - Revision of dividend distribution policy (MoF and CBS). - Optimization of internal efficiency (CBS). - Under these active policies, it is expected that CBS equity will reach the legal target of 10 percent of monetary liability by 2028. vi. CBS and MoF agreed to continue assessing the central bank financial position annually with financial statements; a five-year forecast for equity will be published with the financial statements, including some stress test results (e.g., in the Annual Report). - The outlined content should be unpacked for wider audiences to ensure broader understanding and strengthen credibility. ### Capacity and implementation considerations - In-house capacity to design and implement strategic communications is key. - Consistency and discipline in messaging across levels, audiences, channels, and venues are crucial. - Complement general messages with targeted engagement of key stakeholders (media, influential social media figures) to enhance understandability and impact. _Italic: Source: IMF Staff (Seychelles — Stress Testing the Central Bank Balance Sheet)._ ### APPENDIX II. AT-RISK PROJECTION FOR REAL GDP GROWTH, INFLATION, ### APPENDIX II. AT-RISK PROJECTION FOR REAL GDP GROWTH, INFLATION, AND EXCHANGE RATE ### Methodology: four-step at-risk modeling - Four steps to obtain a full conditional distribution for real GDP growth, inflation, and bilateral exchange rate: - (i) Dimensionality reduction on explanatory variables to avoid overfitting and multicollinearity. - (ii) Conditional average prediction using the Theil-Sen model to accommodate small and “noisy” samples. - (iii) Skewness estimation of the distribution by the Firth model. - (iv) Along with an assumption of Theil-Sen variance, parametrization of an asymmetrical Gaussian distribution. - The method was developed for an IMF FSAP mission to WAEMU. ### Synthetic regressors and data reduction - Synthetic variables obtained via partial least squares (PLS) regression to extract common trends across thematic variable sets. - PLS maximizes covariance between supervisor variable Y and aggregated predictors X, appropriate for numerous multicollinear and potentially noisy variables. - Underlying variable groupings (as listed in the source) include: - Growth at Risk model: Domestic Macro; External Demand; Domestic Financial Conditions (examples include Real GDP growth lag; Domestic debt (first difference); Tourism earnings (first difference); Oil index (first difference); India real GDP growth; Tourist arrival; Capital adequacy ratio (first difference); Nonperforming loans ratio (first difference); Savings rate (first difference); Lending rate (first difference); Deposit rate (first difference); France real GDP growth; US real GDP growth; UK real GDP growth; South Africa real GDP growth; Gold index (first difference); Agricultural index (first difference); Tuna exports (first difference)) - Inflation at Risk model: Domestic Macro; External Demand; Monetary Factor (examples include Real GDP growth; Tourism earnings (first difference); Tuna exports (first difference); SCR/USD (first difference); SCR/EUR (first difference); SCR/GBP (first difference); UK inflation; China inflation; EU inflation; South Africa inflation; India inflation; US inflation; Saving rate (first difference); Lending rate (first difference); Deposit rate (first difference)) - Exchange Rate at Risk model: Domestic Macro; Inflation and Interest Rate; Balance of Payment (examples include Real GDP growth; Tourism earnings (first difference); Tuna exports (first difference); Inflation; Savings rate (first difference); Lending rate (first difference); Deposit rate (first difference); Current account balance to GDP (first difference); Export (first difference); Import (first difference)) - Note: “First difference and percentage change are on a year-on-year basis unless otherwise indicated.” ### Estimation: Theil-Sen for conditional mean and Firth for skewness - Conditional mean: - Estimated with a jackknife Theil-Sen estimator (systematically removes one observation at a time, averages OLS coefficients across subsamples) to improve robustness to outliers in small samples. - Specification: y_{t+h} = α + β_{T S} X_t + ε_{t}^{T S}, where y_{t+h} is the variable (e.g., real GDP growth in t+h), X_t is the vector of conditional variables, α the intercept, and ε residuals of Theil-Sen regression. - Asymmetry (skewness): - Estimated with the Firth model (logistic regression with penalized likelihood) to estimate the probability that y_{t+h} exceeds a threshold ŷ. - Specification: P[y_{t+h} > ŷ | X_t] = α + β_{Firth} X_t + ε_{t}^{Firth}. - Firth modification of the likelihood reduces small-sample bias in logistic estimation. - Variance assumption: - Conditional variance assumed unconditional and equal to the residual variance of the Theil-Sen estimation (i.e., constant heteroskedasticity). - Rationale: Estimating conditional variance from limited samples (e.g., ARCH/GARCH) is discouraged; constant heteroskedasticity avoids horizon-driven variance inflation. - Resulting three conditional moments: - Expectation: Theil-Sen projection E[y_{t+h} | X_{t0}] = α̂ + β̂_{T S} X_{t0}. - Skewness measure: cumulative density at the conditional mean F(y_{t0} | X_t) = α̂ + β̂_{Firth} X_{t0}. - Variance: residual variance from Theil-Sen. ### Parametrization: asymmetric Gaussian fit - An asymmetrical Gaussian distribution is parametrized from the three estimated moments (expectation, variance, skewness). - Reasons for asymmetric Gaussian: - Encompasses standard normal and asymmetric cases. - Requires only the three moments available from the dual Theil-Sen/Firth approach. - Provides analytical relationships between moments, cumulative density, and parameters, allowing closed-form parameter derivation (manual algebraic fit rather than numerical optimization). - Alternatives such as asymmetric Student distributions (require four moments including kurtosis) or nonparametric kernels are infeasible given limited sample sizes. ### Visual outputs referenced - The source includes: - Figure 1. Growth at Risk - Figure 2. Inflation at Risk - Figure 3. Exchange Rate at Risk ### Taylor rule estimation and policy-rate forecasts (Appendix IV) - Domestic policy rate rule specification: - d_t = π* + s* + γ1 + γ_π (π_t − π*) + γ_y (y_t − y*) + γ_C d_{t−1} + ε_t - Inflation target π* = long-term average of inflation = 3 percent (using data from 2010Q1 to 2020Q1). - Potential output y* estimated (HP filter with lambda = 1600). - Domestic savings rate used as a proxy for the policy interest rate. - Neutral (long-run equilibrium) real interest rate estimation: - Reduced-form specification for s_t^* uses lagged s_{t−1}^*, proxy policy rate d_t^*, growth in potential GDP ∆y*, and real foreign interest rates. - Estimated coefficients: α1 = -0.001, α2 = 0.697, α3 = 0.166, α4 = 1.589, α5 = -0.22, α6 = 0.004. - The neutral interest rate in real terms found to be approximately 1.0 percent. - Assumption: ECB monetary policy rate in real terms set to its neutral rate ~ 0 percent in long-run concept. - Taylor-rule estimation results (Table 1): - γ1: -0.010** (Robust Standard Errors 0.004; t-value -2.155; Pr(>|t|) 0.035) - d_{t−1}: 0.395* (Robust Standard Errors 0.218; t-value 1.407; Pr(>|t|) 0.104) - (π_t − π*): 0.076* (Robust Standard Errors 0.043; t-value 1.742; Pr(>|t|) 0.087) - Adjusted R-Sq = 0.78 - Durbin Watson Test Statistic = 1.51 (p-value = 0.02) - Breusch-Pagan Test Statistic = 27.47 (p-value = 1.11e-06) - Robust S.E. applied for heteroscedasticity. - Predicted domestic policy interest rates (Table 2): - Year / Policy Rate - 2022 2.00 (Actual) - 2023 1.95 - 2024 2.14 - 2025 2.31 - 2026 2.37 - 2027 2.39 - 2028 2.40 - Interpretation: - Based on calculations, lower policy rates are predicted, primarily driven by forecast inflation being lower than the implicit inflation target of 3.0 percent. - The output gap was not statistically significant and was dropped from the final Taylor-rule specification. *Source: APPENDIX II–IV, "SEYCHELLES Stress Testing the Central Bank Balance Sheet" (IMF staff calculations as provided in the supplied content).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1sycea2023002.pdf_