## 1. Debt Dynamics

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### A. Overview and key policy messages
- WAEMU economy: rebounded from Q3-2020 through 2022 following Covid shock; Convergence Pact and fiscal rules suspended in April 2020 (including deficit ceiling of 3 percent of GDP and debt ceiling of 70 percent of GDP).
- Pandemic-era response: surge in public debt driven by larger fiscal deficits and particularly large extra-budgetary and below-the-line transactions (stock flow adjustments, SFA).
- Core policy recommendations and strategic priorities:
  - Reintroduce a regional set of fiscal rules and a Convergence Pact urgently.
  - Introduce a debt correction mechanism to ensure the debt ceiling is not breached and to compensate deviations via fiscal adjustments in subsequent years except under exceptional circumstances.
  - Capture extra-budgetary and below-the-line operations (SFA) implicitly or explicitly in the fiscal rule; if inclusion in the deficit measure is infeasible, establish a well-designed and enforced correction mechanism triggered when debt increases too fast.
  - Add an escape clause to the fiscal framework to increase predictability about temporary alterations of targets and include stronger mechanisms for assessment, accountability, enforcement, and discipline.
  - Do not increase the debt ceiling above 70 percent of GDP.
  - Prioritize domestic revenue mobilization to increase capacity to service debt and restore fiscal credibility.

### B. Stock Flow Adjustments (SFA): magnitude, heterogeneity, and contribution to debt
- Definition: SFA represent extra-budgetary and below-the-line operations not captured in above-the-line fiscal balances but that require financing and thus contribute to debt accumulation; ideally SFA should be around zero.
- Historical magnitudes (2013–2021):
  - WAEMU regional average SFA: 1.5 percent of GDP (Avg: 2013–2021).
  - Excluding pandemic (2013–2019): historical SFA average: 1.1 percent of regional GDP.
- Country average SFA, 2013–2021 (percent of GDP):
  - BEN: 1.7
  - BFA: 0.6
  - CIV: 2.0
  - GNB: 2.4
  - MLI: 1.2
  - NER: 1.0
  - SEN: 0.9
  - TGO: 1.7
- Contribution of SFA to debt:
  - SFA contributed about 13 percentage points of regional GDP to existing debt since 2013.
  - SFA account for about half of the increase in debt to GDP over 2013–2021 (28 percent).
  - Over 2019–2021, SFA contributed 5 percentage points of regional GDP to debt; total increase in debt to GDP over that window was about 12 percentage points.
- Empirical correlation:
  - Positive correlation (0.34) between the level of initial debt and the contribution of SFA to debt accumulation over 2013–2021 at the country level.

### C. Debt dynamics, deficits, and drivers
- Year-on-year change in debt = function of: previous year’s debt, fiscal deficit, nominal growth effect, exchange rate effect, guarantees effect, and a residual (SFA).
- Fiscal deficit alone provides incomplete information on debt accumulation because SFA and other factors materially alter the debt path.
- Drivers of SFA (enumerated):
  - asset valuation effects;
  - differences in institutional coverage;
  - extra-budgetary and off-budget funds;
  - change in financial assets (privatizations, contingent liability realizations/recognitions, accumulation/depletion of government deposits);
  - arrears;
  - carryover;
  - differences in accounting between debt and deficit;
  - financial instruments covered in the debt;
  - debt relief.
- Data limitations: quantification of specific drivers is constrained by lack of information.

### D. Counterfactuals, scenario analysis, and headline simulation results
- Counterfactual: absence of historical SFA since 2013 would have left 2021 debt levels substantially lower across all WAEMU countries; at the regional level SFA raise 2021 debt by almost 13 percentage points of GDP.
- Scenario matrix (Table 2): converge in 2025 to 3 percent deficit versus converge in 2025 to 4 percent deficit; combined with either Zero SFA or Historical SFA.
  - Baseline: Zero SFA and converge to 3 percent deficit.
  - Scenario 1: Zero SFA and converge to 4 percent deficit.
  - Scenario 2: Historical SFA and converge to 3 percent deficit.
  - Scenario 3: Historical SFA and converge to 4 percent deficit.
- Historical SFA assumed in scenarios: 1.5 percent of GDP annually.
- Main simulation findings:
  - Baseline (Zero SFA, 3 percent deficit): debt gradually declines.
  - Scenario 1 (Zero SFA, 4 percent deficit): debt slightly higher in 2027 and broadly stable; would not restore buffers.
  - Scenario 2 (Historical SFA, 3 percent deficit): non-stabilizing debt path over medium term, with a mild increase.
  - Scenario 3 (Historical SFA, 4 percent deficit): quickly explosive debt pattern over medium term.
- Policy implication: "The only option to stabilize debt and recover buffers is to stick to the 3 percent fiscal deficit target while addressing the SFA."
- Country-level stabilization outcomes (summary):
  - Baseline (3 percent deficit, zero SFA): debt stabilizes for all countries except Mali (MLI).
  - 3 percent deficit with Historical SFA: six member states have non-stabilizing debt patterns — BEN, CIV, GNB, MLI, NER, TGO.
  - 4 percent deficit with zero SFA: CIV, MLI, NER show non-stabilizing debt paths.
  - 4 percent deficit with Historical SFA: BEN, BFA, CIV, GNB, MLI, NER, SEN, TGO — non-stabilizing paths.
- Equity point: heterogeneous SFA across countries implies identical nominal deficit targets produce different effective fiscal constraints across countries.

### E. Public financial management (PFM) and fiscal framework recommendations
- PFM recommendations to contain SFA:
  - Increase coverage of the measured fiscal deficit to better align deficit measure with debt coverage.
  - Limit off-budget operations, including quasi-fiscal operations by SOEs.
  - Strengthen oversight of SOEs and internal control over expenditures.
  - Implement an accrual accounting system and adopt GFSM 2001/14 (instead of GFSM 1986).
  - Prevent accumulation of new expenditure arrears and prepare settlement plans to reduce old arrears.
  - Improve management of public-private partnerships.
  - Broaden institutional coverage beyond budgetary central government to include all government units.
- Correction mechanism and perimeter:
  - A well-designed correction mechanism is essential; deviations from targets (and large SFA) should be compensated in future years after exceeding a cumulative threshold, except in extreme circumstances.
  - Harmonize perimeter of the deficit and the debt to avoid artificial SFA; define a common feasible perimeter for debt-creating flows.
  - Move operations through a Single Treasury account to enhance transparency.
- Coverage mismatch (current):
  - Fiscal deficit coverage is restricted to central government for all countries; public debt often has broader perimeter.
  - Only two countries (BFA, MLI) have the same coverage for fiscal deficit and public debt.
  - Country coverage (reported exactly):
    - BEN: Debt — Central government, guarantees, and central bank debt borrowed on behalf of the government; Deficit — Central government.
    - BFA: Debt — Central government; Deficit — Central government.
    - CIV: Debt — Central government, and SOEs; Deficit — Central government.
    - GNB: Debt — Central government, guarantees, and central bank debt borrowed on behalf of the government; Deficit — Central government.
    - MLI: Debt — Central government; Deficit — Central government.
    - NER: Debt — Central government, and guarantees; Deficit — Central government.
    - SEN: Debt — Central government, state and local governments, social security fund, guarantees, SOEs, and central bank debt borrowed on behalf of the government; Deficit — Central government.
    - TGO: Debt — Central government, SOEs, and guarantees provided by the central government; Deficit — Central government.

### F. Debt ceiling, buffers, and institutional design
- IMF staff view: "the 70 percent of GDP debt ceiling seems appropriate."
- Recommendation: do not increase the debt ceiling; could be reduced or at most kept unchanged.
- Supporting arrangements:
  - Include an escape clause with limited triggers, time limits, and requirement to return to targets and possibly offset deviations.
  - Specify conditions for temporary changes to the fiscal deficit target, duration and smoothing of adjustments, and treatment of debt ceiling breaches.
  - Strengthen monitoring and accountability (annual assessments by WAEMU commission or national fiscal councils).
  - Establish fiscal sharing mechanisms (compensation across members, regional stabilization fund, pooling risks through targeted common budget).
  - Build a communication strategy: publish credible medium-term fiscal strategy and regular reports on measures and costs; involve independent assessments.

### G. Concluding strategic elements
- Fiscal discipline with adequate frameworks and institutions is instrumental to ensure debt sustainability and external viability.
- Address extra-budgetary and below-the-line operations; maintaining historical SFA levels would not allow debt to be on a sustainable path nor rebuild buffers.
- Domestic revenue mobilization is "a crucial part of the ability to service debt" and should be emphasized.
- Technical Assistance could elaborate PFM reforms needed to contain SFA.

*Prepared by IMF staff; chapter: "1. Debt Dynamics" — January 19, 2023.*

### Inflation dynamics, monetary policy, and WAEMU financial markets

#### Inflation: recent levels, drivers, and projections
- Central bank target: BCEAO target range centered on "3 percent".
- Recent headline inflation:
  - Above the upper limit of the target range since April 2021.
  - Headline inflation peaked in August at "8.8 percent" before slowing to "8.0 percent" in November 2022.
  - Country examples (November 2022): Burkina Faso "12.2 percent"; Benin "3.2 percent".
- Contributions (WAEMU consumption basket weights):
  - Food weight is "42 percent;"
  - Housing weight is "11 percent;"
  - Transportation weight is "9 percent."
- Historical contributions (January 1999–October 2022):
  - food contributions averaged "1.2 percentage points" against a "2.3 percent" average inflation rate;
  - housing and transport jointly contributed approximately "0.5 percentage points";
  - remaining nine components contributed "0.6 percentage points."
- Recent (November 2022) contributions to inflation:
  - Food: 5.3 percentage points
  - Housing: 0.7 percentage points
  - Transportation: 0.6 percentage points
- Food inflation drivers:
  - Cereals main driver; other strong contributors: oils, sugar, tubers, meat.
  - Change in contribution from food: increased from 1.4 percent in January 2021 to 5.3 percent in November 2022.
  - Selected food item inflation changes between January 2021 and June 2022:
    - Bread: -0.4 to 15.9 percent
    - Cooking oil: 4.5 to 19.4 percent
    - Flour and groats: 0.7 to 14.8 percent
- Inflation persistence:
  - Persistence index (AR(1) with 48-month rolling window) increased from 0.10 in January 2021 to 0.55 in September 2022; historical average is 0.2.
- Diffusion and contagion:
  - Share of items with inflation rates above 2 percent:
    - Surpassed 50 percent in March 2022
    - Reached 68 percent in September 2022 (had been around 30 percent since 2019)
  - Diffusion index using 3 percent threshold also risen since 2021 and now above 50 percent.

#### Forecasting approaches and model outcomes
- SARIMAX (1997Q1–2022Q2 estimation; forecast 2022Q3–2024Q4):
  - Dependent: WAEMU headline inflation; exogenous: international fuel and food prices and nominal effective exchange rate (based on IMF WEO).
  - Forecast: inflation expected to decrease to 1¾ percent by 2024Q4 under WEO GAS projections and minimal exchange rate pressure.
  - SARIMAX does not capture broader general equilibrium effects or stronger second-round effects.
- AFRMOD-FSGM (multi-region forward-looking model calibrated for WAEMU):
  - Two exchange rate scenarios: Fixed with small country risk premium; Managed float.
  - Shock simulations:
    - Shock 1 — 30 percent global food price increase in 2022: Headline inflation in WAEMU increases by 5 percentage points in 2022 (short-lived); negligible impact on traditional core inflation.
    - Shock 2 — increases in Euro area and US inflation path: Headline inflation gradually increases by approximately 1 percentage point and slowly decreases by half percentage point by end of 2026; triggers policy rate response ranging between 0.9 and 2 percentage points by end-2023 depending on exchange rate regime.
- Policy interpretation:
  - SARIMAX does not call for monetary tightening; AFRMOD suggests central bank should react to persistent global inflationary shocks but not to pure, short-lived food shocks without second-round effects.
  - Projection: inflation expected to converge to target range "within 24 months" given reduced exogenous shocks and exhaustion of base effects, but downside and upside risks remain.

#### Monetary policy constraints and risks
- BCEAO operational constraint: Article 76 — monthly average of foreign exchange reserves should not fall below 20 percent of its sight liabilities for three consecutive months.
- External risks that could push inflation upwards:
  - developments in the war in Ukraine; further sanctions on Russia; tighter than expected monetary policy in developed countries; transportation bottlenecks; increases in natural gas and fertilizers prices; further depreciation of the Euro versus the U.S. dollar.
- Fiscal consolidation risks: deviations from fiscal consolidation would exert additional pressure on inflation and reserves.
- Recommendation: further monetary policy tightening would be necessary unless downside risks to inflation and external buffer forecasts improve; policy should be data-dependent.

#### WAEMU regional market for government debt — composition, conditions, and risks
- Debt composition:
  - Approximately 60 percent of WAEMU public debt is external.
  - Domestically financed debt accounted for almost 40 percent of total debt in 2021 and has been growing.
- Domestic market and auction shares:
  - Debt issued in the regional auction market is a significant source; auctions account for about one fifth of total debt at the union level, ranging between 10 and 50 percent across countries.
    - Côte d‘Ivoire: approx. 12 percent auction share.
    - Togo: approx. 48 percent auction share.
- Local yields and borrowing costs:
  - Interest rates on regional auction markets generally in the region of 5-7 percent.
  - Short-end rates lie somewhat above the central bank’s lending facility rate which is at 4.75% as of December 2022.
  - External rates are more volatile and can make borrowing prohibitive when conditions are tight.
- Market segmentation evidence:
  - First two PCA components account for 63 percent of observed variation; first component explains 37 percent and is tilted toward domestic markets; second component closely related to international series (Eurobond spreads).
  - Correlations between external spreads of Benin, Côte d‘Ivoire, and Senegal are elevated: Benin–Cote d'Ivoire 0.90; Benin–Senegal 0.93; Cote d'Ivoire–Senegal 0.95.
- Maturities, rollover risks, and market size:
  - Average maturities: local bonds weighted by principal above two years for all members.
    - Côte d‘Ivoire average maturity just under 29 months.
    - Togo average maturity approximately 47 months.
  - Short-term exposure:
    - About one-fourth of regional debt on the auction market is coming due in the next year and one-third within two years.
    - All members have at least 15% of their debt maturing in the next twelve months; Côte d‘Ivoire and Niger roughly 30% maturing within twelve months.
    - Cumulative nominal amounts maturing:
      - More than 2.5CFA trn (or about 23 percent of the total) is due within 12 months.
      - Almost 4.5 CFAFtrn (or 6.5 EURbn, about 35 percent of the total) is due within the next 24 months.
      - This is equivalent to 4.1% of estimated 2022 GDP.
  - Market size and turnover:
    - Outstanding local sovereign debt around CFAF12.2 trn, compared to annual turnover of CFAF 3 trn (low turnover ratio).
- Interest-payment pressures and distributional implications:
  - Expected increases in interest payments due to normalization of monetary policy and tighter global financial conditions.
  - Gradual loss of concessional financing will raise effective interest rates on stock of government debt.
  - Smaller countries will be disproportionately affected by rising interest payments and tighter rollover conditions.
- Policy recommendations for markets and debt management:
  - Restore credibility of fiscal strategy through revamped fiscal rules.
  - Prioritize domestic revenue mobilization and prudent debt management.
  - Deepen secondary markets to improve liquidity and price discovery and facilitate yield curve construction.
  - Strengthen debt management operations to contain rollover risk and interest costs.

*Source: IMF staff calculations and analysis as presented in the provided content unit.*

### 1.    Debt Dynamics _______________________________________________________________________ 7

### 1.    Debt Dynamics

### A. Overview and Key Policy Messages
- The WAEMU’s economy exhibited resilience to the Covid shock and growth rebounded from Q3-2020 through 2022, supported by prior favorable macroeconomic performance and swift policy actions.
- The Convergence Pact and fiscal rules were suspended in April 2020, including a deficit ceiling of 3 percent of GDP and a debt ceiling of 70 percent of GDP.
- The pandemic-era policy response contributed to a surge in public debt, driven by larger fiscal deficits and particularly large extra-budgetary and below-the-line transactions (stock flow adjustments, SFA).
- Policy recommendations and strategic priorities:
  - Reintroduce a regional set of fiscal rules and a Convergence Pact urgently.
  - Introduce a debt correction mechanism to ensure the debt ceiling is not breached and to compensate deviations via fiscal adjustments in subsequent years except under exceptional circumstances.
  - Capture extra-budgetary and below-the-line operations (SFA) implicitly or explicitly in the fiscal rule; if inclusion in the deficit measure is infeasible, establish a well-designed and enforced correction mechanism triggered when debt increases too fast.
  - Add an escape clause to the fiscal framework to increase predictability about temporary alterations of targets and include stronger mechanisms for assessment, accountability, enforcement, and discipline.
  - Do not increase the debt ceiling above 70 percent of GDP given heightened global volatility and financing risks.
  - Prioritize domestic revenue mobilization to increase the capacity to service debt and restore fiscal credibility.

### B. Stock Flow Adjustments (SFA): Magnitude and Role
- Definition and role:
  - SFA represent extra-budgetary and below-the-line operations not captured in above-the-line fiscal balances but that require financing and thus contribute to debt accumulation. Ideally, SFA should be around zero.
- Historical magnitudes and heterogeneity (2013–2021):
  - WAEMU regional average SFA: 1.5 percent of GDP (Avg: 2013–2021).
  - Excluding the pandemic period (2020–2021), historical SFA average: 1.1 percent of regional GDP (2013–2019).
  - Country average SFA, 2013–2021 (percent of GDP, from Table 1):
    - BEN: 1.7
    - BFA: 0.6
    - CIV: 2.0
    - GNB: 2.4
    - MLI: 1.2
    - NER: 1.0
    - SEN: 0.9
    - TGO: 1.7
  - Heterogeneity: two countries exhibit an average SFA of 2 percent of GDP or above, and two countries with SFA below 1 percent of GDP.
- Contribution of SFA to debt:
  - SFA contributed about 13 percentage points of regional GDP to existing debt since 2013.
  - SFA account for about half of the increase in debt to GDP over 2013–2021 (28 percent).
  - Over 2019–2021, SFA contributed 5 percentage points of regional GDP to debt; total increase in debt to GDP over that window was about 12 percentage points.

### C. Debt Dynamics, Deficits, and Correlations
- Debt dynamics elements:
  - Year-on-year change in debt is a function of: previous year’s debt, fiscal deficit, a nominal growth effect, an exchange rate effect, a guarantees effect, and a residual (SFA).
- Fiscal deficit provides incomplete information on debt accumulation in WAEMU because SFA and other factors materially alter the debt path.
- Empirical relationship:
  - Positive correlation (0.34) between the level of initial debt and the contribution of SFA to debt accumulation over 2013–2021 at the country level. This suggests more highly indebted countries accumulated more debt through SFA on average.

### D. Counterfactual and Scenario Analysis (summary)
- Counterfactual finding:
  - In the absence of historical SFA since 2013, the 2021 debt levels would have been substantially lower across all WAEMU countries; at the regional level, SFA raise 2021 debt by almost 13 percentage points of GDP.
- Scenario work (described in the chapter):
  - The chapter undertakes simulations to examine implications of differing fiscal deficit targets and SFA paths on future debt dynamics.
  - Table 2 represents four scenarios based on two assumptions about SFA: (i) future SFA being close to zero versus (ii) future SFA staying at the historical average.
  - (Detailed scenario assumptions and quantitative projections are presented in Table 2 of the source material.)

### E. Strategic Implications
- Restoring a credible fiscal anchor (reintroduced and enhanced fiscal rules) is essential to preserve debt sustainability and fiscal credibility.
- The fiscal framework revamp should:
  - Include a correction mechanism for debt breaches, consider capturing or offsetting SFA, and incorporate an escape clause plus stronger enforcement and accountability.
  - Ensure any delay in fiscal convergence from 2024 is justified by exceptional needs and supported by reasonable financing prospects consistent with debt sustainability.
- Fiscal ceiling stance:
  - Arguments against increasing the debt ceiling above 70 percent of GDP are grounded in elevated global volatility, potentially higher future market rates, and the need for fiscal buffers.
- Revenue strategy:
  - Emphasize domestic revenue mobilization to improve the capacity to service debt and reduce reliance on debt for financing development and social needs.

*Prepared by IMF staff; chapter: "1. Debt Dynamics" — January 19, 2023.*

### 1.5 percent of regional GDP per annum), and (ii) two possibilities for the fiscal deficit target

### 1.5 percent of regional GDP per annum), and (ii) two possibilities for the fiscal deficit target

### Scenario design and headline simulation results
- Scenario matrix (Table 2): converge in 2025 to 3 percent deficit versus converge in 2025 to 4 percent deficit; combined with either Zero SFA or Historical SFA.
  - Baseline: Zero SFA and converge to 3 percent deficit.
  - Scenario 1: Zero SFA and converge to 4 percent deficit.
  - Scenario 2: Historical SFA and converge to 3 percent deficit.
  - Scenario 3: Historical SFA and converge to 4 percent deficit.
- Historical SFA implicitly assumed at 1.5 percent of GDP annually (noted as historical SFA in scenarios).
- Main simulation findings (paragraphs 18–19):
  - Baseline (Zero SFA, 3 percent deficit): debt gradually declines (solid blue line).
  - Scenario 1 (Zero SFA, 4 percent deficit): debt would be slightly higher in 2027 and broadly stable (dotted line); debt would no longer decline and buffers would not be restored.
  - Scenario 2 (Historical SFA, 3 percent deficit): non-stabilizing debt path over medium term, with a mild increase (dashed green line).
  - Scenario 3 (Historical SFA, 4 percent deficit): quickly explosive debt pattern over medium term (dotted gray line).
- Caveats:
  - Simulations do not account for additional negative shocks that could push debt further upward.
  - Forecasts should continue to check impacts of medium-term changes to growth and interest rate paths for each country.

### Policy implication: only baseline stabilizes debt and recovers buffers
- Key conclusion (paragraph 19): "The only option to stabilize debt and recover buffers is to stick to the 3 percent fiscal deficit target while addressing the SFA."
- Operational interpretation: measure the deficit to include both above- and below-the-line as well as extra-budgetary operations (i.e., conceptually equivalent to financing minus accumulation of assets), although including SFA directly in a deficit measure may be challenging from a feasibility point of view.
- Alternative (4 percent deficit with elimination of historical SFA): would barely stabilize debt and would not recover buffers — future shocks would likely increase debt and reduce fiscal space.
- If SFA persist at historical levels under either 3 percent or 4 percent deficit targets, debt trajectories are on an increasing path.

### Country-level outcomes and distributional effects of SFA
- Country-specific stabilization results (paragraph 20 and Table 3):
  - Baseline (3 percent deficit, zero SFA): debt stabilizes for all countries except Mali (MLI).
  - 3 percent deficit with Historical SFA: six member states have non-stabilizing debt patterns — BEN, CIV, GNB, MLI, NER, TGO.
  - 4 percent deficit with zero SFA: CIV, MLI, NER show non-stabilizing debt paths.
  - 4 percent deficit with Historical SFA: BEN, BFA, CIV, GNB, MLI, NER, SEN, TGO — all listed countries have non-stabilizing paths.
- Equity/unevenness point (paragraph 21): heterogeneous SFA across countries implies an unfair fiscal burden under a common above-the-line deficit rule; identical nominal deficit targets (e.g., 3 percent) with differing SFA produce different effective fiscal constraints across countries.

### Drivers of Stock-Flow Adjustments (SFA) and constraints on quantification
- Enumerated potential drivers of SFA (paragraph 22):
  - asset valuation effects;
  - differences in institutional coverage;
  - extra-budgetary and off-budget funds;
  - change in financial assets (privatizations, contingent liability realizations/recognitions, accumulation/depletion of government deposits);
  - arrears;
  - carryover;
  - differences in accounting between debt and deficit;
  - financial instruments covered in the debt;
  - debt relief.
- Practical assessment: a significant portion of SFA in WAEMU is likely due to low capacity or poor PFM, but quantification of specific drivers is not possible generally due to data limitations and lack of information.

### Public financial management (PFM) recommendations to contain SFA (paragraphs 23, 21)
- Increase coverage of the measured fiscal deficit to better align deficit measure with debt coverage and improve comprehensiveness and reliability of fiscal data.
- Limit off-budget operations, including quasi-fiscal operations carried out by SOEs.
- Strengthen oversight of SOEs to limit fiscal risks, such as contingent liabilities.
- Strengthen internal control over expenditures.
- Implement an accrual accounting system.
- Strictly prevent accumulation of new expenditure arrears and prepare settlement plans to reduce old arrears.
- Improve management of public-private partnerships to reduce fiscal risks.
- Improve accounting practices: adopt GFSM 2001/14 (instead of GFSM 1986 which prevails in most WAEMU countries), achieve consistent institutional coverage above and below the line, and broaden institutional coverage beyond budgetary central government to include all government units.
- Practical measurement note: measuring the overall deficit as financing minus asset accumulation could address SFA conceptually, though international experience indicates risks (e.g., accumulation of poor quality assets, on-lending to SOEs, exposure to implicit subsidies).

### Debt ceiling, buffers, and fiscal space (paragraph 24)
- Recent context: rising uncertainty and growing role of extra-budgetary and below-the-line operations increase uncertainty of debt-creating flows; global interest rates may not return quickly to historically low levels.
- IMF staff analysis view: "the 70 percent of GDP debt ceiling seems appropriate, striking the right balance between growth and fiscal sustainability in the region."
- Recommendation: the debt ceiling should not be increased and could be reduced or at most kept unchanged; domestic revenue mobilization is preferred over debt for financing development and social objectives.

### Supporting arrangements and institutional design (paragraphs 25–27)
- Correction mechanism necessity:
  - A well-designed correction mechanism is essential to contain debt, irrespective of changes to the level or definition of the deficit target.
  - Deviations from targets (and large SFA) should be compensated in future years after exceeding a cumulative threshold, except in extreme circumstances.
  - The mechanism should specify conditions for temporary changes to the fiscal deficit target, the duration and smoothing of adjustments, and treatment of debt ceiling breaches.
- Harmonization and perimeter definition:
  - Define a common and feasible perimeter for debt-creating flows to improve evenhandedness and identify debt-creating institutions.
  - Harmonize perimeter of the deficit and the debt to avoid artificial SFA.
  - Review the role and responsibilities of debt agencies and check perimeters of their operations.
  - Authorities should commit to broaden perimeter over time and move operations through a Single Treasury account to enhance transparency.
- Current coverage mismatch (paragraph 27 and Table 4):
  - Fiscal deficit coverage is restricted to central government for all countries in the region; public debt often has broader perimeter.
  - Only two countries (BFA, MLI) have the same coverage for fiscal deficit and public debt.
  - Country coverage entries reported exactly as in source:
    - BEN: Debt — Central government, guarantees, and central bank debt borrowed on behalf of the government; Deficit — Central government.
    - BFA: Debt — Central government; Deficit — Central government.
    - CIV: Debt — Central government, and SOEs; Deficit — Central government.
    - GNB: Debt — Central government, guarantees, and central bank debt borrowed on behalf of the government; Deficit — Central government.
    - MLI: Debt — Central government; Deficit — Central government.
    - NER: Debt — Central government, and guarantees; Deficit — Central government.
    - SEN: Debt — Central government, state and local governments, social security fund, guarantees, SOEs, and central bank debt borrowed on behalf of the government; Deficit — Central government.
    - TGO: Debt — Central government, SOEs, and guarantees provided by the central government; Deficit — Central government.

*Source: IMF staff calculations and projections as presented in the provided content unit.*

### 28. Escape clause. An escape clause is a provision that envisages under what conditions the

### 1wauea2023002 - 28. Escape clause. An escape clause is a provision that envisages under what conditions the

### Escape clause: definition and design criteria
- An escape clause "is a provision that envisages under what conditions the authorities may not need to respect the standard targets of the fiscal rule, and can follow alternative adjustment paths."
- A well-designed escape clause should have:
  - (i) "a limited and clearly defined set of events triggering the operation of the clause,"
  - (ii) "time limits on how long fiscal policy can deviate from the targets in the rule," and
  - (iii) "a requirement for fiscal policy to return to the targets after the operation of the escape clause is terminated and possibly offset the accumulated deviations." (Eyraud et al (2018))
- Clear communication of the escape clause is crucial to provide feasible and realistic patterns for the adjustment path.

### Operational targets
- Operational targets are useful for planning, budgeting, communication, and helping to reach the deficit target defined by the fiscal rule.
- Operational targets help manage political economy constraints and are particularly valuable if a correction mechanism requires a tighter deficit target than normal.
- Example application: define operational targets in terms of wage bill to prevent spending concentration in long-term items that are difficult to adjust in the short term.
- Different definitions of operational deficit targets could be associated with different levels of targets.

### Other issues and supporting arrangements
- Recalibrating the rule:
  - "The deficit target may need to be revisited over time, especially if the expected growth path declines—for example due to income convergence with advanced economies—which would affect the debt sustainability calculations."
  - A common time interval for recalibration is "every 5 years."
  - General guidelines could specify conditions (growth, interest rates, debt ratios, among other indicators) that may warrant a change in the rule.
- Enhancing monitoring and accountability:
  - Strengthen the role of the existing WAEMU commission by envisaging the task to publish annually specific assessments related to how fiscal accounts respect the targets.
  - Alternative: establish eight national fiscal councils in the WAEMU.
  - In resource-limited countries, associate national councils with other existing independent institutions.
- Establishing fiscal sharing mechanisms to help countries facing idiosyncratic shocks:
  - Potential approaches include:
    - (1) compensating temporary deviations from the deficit rules in member states experiencing shocks with additional fiscal efforts in countries that are not affected;
    - (2) establishing a regional stabilization fund with the annual contributions from all members to provide temporary transfers to countries affected by adverse macroeconomic shocks;
    - (3) pooling risks through a targeted common budget (for instance, for security or health emergency allocations).
- Building a communication strategy:
  - Communication preserves credibility and ensures transparency of the reintroduced fiscal rule.
  - Communication is especially crucial during activation of escape clauses: explain implications, expected duration and size of deviation, and the adjustment path reverting to the rule.
  - Elements of good communication include publishing:
    - (1) a credible medium-term fiscal strategy aimed at anchoring expectations;
    - (2) regular reports by the government on implemented measures (including associated fiscal costs, and risks to the budget);
    - (3) reports by independent agencies (such as a fiscal council, or an audit agency) assessing conformity of fiscal policy to the fiscal rule.

### Conclusions (summary of policy strategy)
- Overall message:
  - Fiscal discipline supported by adequate frameworks and institutions is instrumental to ensure debt sustainability and external viability, and to contain inflationary pressures.
  - The paper highlights the substantial increase in debt over the past decade, the significant role of extra-budgetary and below-the-line operations, and the need to revamp the fiscal rule with several improvements.
- Key strategic elements:
  - Change the fiscal rule to include a correction mechanism when debt exceeds certain thresholds or increases too fast.
  - Address extra-budgetary and below-the-line operations: debt increases have often exceeded what was driven by fiscal deficits due to large extra-budgetary and below-the-line operations; maintaining historical levels of SFA would not allow debt to be on a sustainable path nor rebuild buffers.
  - Include supporting arrangements in the revamped fiscal rule: an escape clause, mechanisms for enforcement and discipline, and operational frameworks based on intermediate and complementary targets.
  - Any delay in the expected path for fiscal consolidation should be grounded on solid justifications and financing prospects; delays should be considered only in presence of exceptional needs and supported by reasonable expectations that additional financing would be available at terms in line with debt sustainability.
  - Domestic revenue mobilization must be part of the broad fiscal strategy: domestic revenue mobilization is "a crucial part of the ability to service debt," and the threshold on the tax revenue to GDP ratio should be emphasized.
- Technical Assistance: could offer more detailed elaboration of specific needs, including necessary PFM reforms to contain SFA.

### Annex I — Reasons for discrepancies between change in debt and fiscal deficit (stock-flow adjustments)
- Possible debt-creating factors include:
  - Extra-budgetary and off-budget funds: borrowing outside the central government budget (e.g., emergency spending) drives a positive SFA.
  - Difference in institutional coverage between fiscal balance and debt: deficits measured at general government vs. debt coverage of the wider public sector; profit-losing SOEs could drive a high SFA residual.
  - Asset valuation effects: persistent changes in real exchange rate or globally declining interest rates can create disconnects in debt valuation.
  - Change in financial assets due to privatizations, contingent liability realizations/recognitions (e.g., bank or SOE recapitalization), or accumulation/depletion of government deposits: accumulation of assets drives a positive SFA residual; sales (privatizations) drive a negative residual.
  - Arrears: using cash vs. accrual accounting inconsistently can create temporary disconnects; these should not affect average SFA residual over many years unless increasing.
  - Carryover: committed expenditure in one year spent in the next year creates timing differences between deficit and debt.
  - Government guarantees: when created, they drive a positive SFA residual (they have no equivalent in the deficit until called and generate a financing need).
  - Differences in accounting between debt and deficit: cash vs. accrual bases or valuation differences in debt compilation.
  - Financial instruments covered in the debt: some instruments (other accounts payable) may finance deficits but not be included in debt measures (e.g., Maastricht debt covers loans, debt securities, and currency and deposits).
  - Debt relief: restructuring disconnects debt evolution from the deficit and offers a negative contribution to the SFA residual.

### Inflation dynamics (WAEMU) — key findings and projections
- Recent pattern:
  - Headline inflation has been above the upper limit of the central bank’s target range ("3 percent") since April 2021.
  - Headline inflation peaked in August at "8.8 percent" before slowing to "8.0 percent" in November 2022.
  - Heterogeneity example: in November 2022, inflation in Burkina Faso was "12.2 percent" while in Benin it was "3.2 percent."
- Drivers and contributions:
  - Historically, food is the main driver of headline inflation.
  - Between January 1999 and October 2022:
    - food contributions averaged "1.2 percentage points" against a "2.3 percent" average inflation rate in this period;
    - housing and transport jointly contributed approximately "0.5 percentage points" to headline inflation;
    - the remaining nine components contributed "0.6 percentage points."
  - Weights in the WAEMU consumption basket:
    - food weight is "42 percent;"
    - housing weight is "11 percent;"
    - transportation weight is "9 percent."
- Volatility and outlook:
  - Domestic food prices drive most inflation volatility and large spikes; domestic food prices tend to follow international prices closely.
  - International food price inflation is expected to decline significantly (based on WEO forecasts), making a quick reversal of regional food inflation conceivable.
  - Projections from two models suggest that inflation is expected to converge to its target range "within 24 months" given reduction of exogenous shocks to food and energy prices, exhaustion of base effects, and a reduction in supply and demand imbalances.
  - However, numerous external and internal factors affect inflation prospects and should be carefully monitored; further monetary policy tightening would be necessary unless downside risks to forecasts for baseline inflation and external buffers improve.

*Source: 1wauea2023002 - 28. Escape clause. An escape clause is a provision that envisages under what conditions the — WEST AFRICAN ECONOMIC AND MONETARY UNION, INTERNATIONAL MONETARY FUND*

### 4.      Consistently with historical patterns, the recent surge in inflation is particularly driven

### 1wauea2023002 - 4.      Consistently with historical patterns, the recent surge in inflation is particularly driven

### Recent drivers of inflation
- Food (and to a lesser extent energy) prices are the primary drivers of the recent surge in inflation, with levels similar to third quarter of 2008.
- November 2022 contributions to inflation:
  - Food: 5.3 percentage points
  - Housing: 0.7 percentage points
  - Transportation: 0.6 percentage points
- Historical peak (August 2008) contributions:
  - Food: 7.4 percentage points
  - Housing: 0.5 percentage points
  - Transportation: 0.75 percentage points
- Historical average contributions:
  - Food: 1.2 percentage points
  - Housing: 0.2 percentage points
  - Transportation: 0.3 percentage points
- Country notes:
  - Food contributions are particularly relevant in Burkina Faso.
  - Togo and Ivory Coast show more diversified contributions across inflation components.

### Non-food inflation and core inflation
- Non-food inflation increased from about half a percent to about 2.7 percent over the past year and a half.
- Three non-food categories mainly responsible:
  - Housing (driven mainly by higher energy prices)
  - Transportation (driven mainly by higher energy prices)
  - “Other” items (may reflect second-round effects from services)
- Contribution to headline inflation from energy prices has remained muted despite large increases in international oil prices, mainly because of domestic policies in most countries.
- Official core inflation excludes “fresh” food and energy but retains several non-perishable and other food items; thus official core is affected by food prices and may not adequately represent underlying inflation.

### Food components and drivers
- Cereals have been the main driver of the surge in food inflation in most countries since recently.
- Other food categories contributing strongly: oils, sugar, tubers, and meat.
- Country specifics:
  - Cereals especially important in Burkina Faso.
  - Benin and Ivory Coast have more diversified sources of food contribution.
- Change in contribution to headline inflation from food:
  - Increased from 1.4 percent in January 2021 to 5.3 percent in November 2022.
- Selected food item inflation changes between January 2021 and June 2022:
  - Bread: -0.4 to 15.9 percent
  - Cooking oil: 4.5 to 19.4 percent
  - Flour and groats: 0.7 to 14.8 percent

### Inflation persistence and expectations
- Persistence index (AR(1) with 48-month rolling window) increased from 0.10 in January 2021 to 0.55 in September 2022; historical average is 0.2.
- Higher inflation persistence complicates central bank control due to stronger influence from past inflation on expectations and price formation.
- Non-food inflation persistence:
  - Historically negative (month-over-month non-food inflation mean around zero since June 2014).
  - Recently shifted: non-food inflation averaging a positive number and its persistence has moved towards zero from being negative.
- Inflation expectations (BCEAO survey of companies' leaders, one-year horizon):
  - Share expecting inflation above 3 percent:
    - December 2021: 11.9 percent
    - September 2022: 28.5 percent
  - Share expecting one-year inflation between 1 percent and 3 percent:
    - December 2021: 81.1 percent
    - September 2022: 66.8 percent

### Sectoral dynamics and inflation contagion
- High informality and scarce labor market data hinder analysis of second-round wage-price dynamics.
- Diffusion index (share of items with inflation above a threshold) as proxy for contagion across 126 items:
  - Share of items with inflation rates above 2 percent:
    - Surpassed 50 percent in March 2022
    - Reached 68 percent in September 2022 (had been around 30 percent since 2019)
  - Diffusion index using 3 percent threshold has also risen since 2021 and is now above 50 percent.
- Diffusion index by sector (inflation > 2 percent), excluding food/housing/transport:
  - Sectors with highest price increases: beverages & tobacco, clothing, furnishing, and “others” (services)
  - Contagion remains limited in sectors such as leisure, education, health, and communication.
- When threshold raised to inflation > 3 percent:
  - Contagion evidence persists mainly in beverages & tobacco and furnishing.
  - Hotels and restaurants category is highly volatile and strongly related to food and energy.
- Distributional changes since 2020:
  - Dispersion of inflation rates across consumption basket increased, concentrated in food, housing, and transport.
  - Excluding food items, movements in mean and dispersion are more nuanced.
- Highest price increases excluding food and energy come from services (examples: hairdresser, insurance, maintenance and repair for housing, clothing) — a potential signal of second-round effects if sustained.

### Forecasting approaches and model descriptions
- BCEAO targets a 2 percent year-over-year inflation rate with a symmetrical ceiling and floor of 1 percentage point within a 24-month horizon.
- Two models used for medium-term inflation forecasts:
  - SARIMAX (Seasonal Auto-Regressive Integrated Moving Average with exogenous factors)
    - Dependent variable: WAEMU headline inflation
    - Exogenous variables: international fuel and food prices and the nominal effective exchange rate (based on IMF WEO)
    - Estimation period: 1997Q1 to 2022Q2 (year-over-year quarterly data)
    - Forecast period: 2022Q3 to 2024Q4
    - Assumption: recent depreciation of the nominal effective exchange rate abates so yearly change converges to zero during forecast period
    - Limitation: as econometric exercise, cannot explore alternative monetary policy responses beyond historical behavior captured in coefficients
  - AFRMOD-FSGM (African Module of the Flexible System of Global Models)
    - Multi-region, forward-looking model combining micro-founded and reduced-form sectors, parameterized for WAEMU
    - Real GDP: short-run determined by demand components; long-run by potential output
    - Fiscal policy: stabilizes debt as percent of GDP in long run; responds to output gap in short run
    - Monetary policy: inflation-forecast based interest rate rule
    - Two exchange rate scenarios presented:
      - Fixed exchange rate with a small addition of country risk premium
      - Managed float
    - Three commodities in model: oil, metals, and food
    - Annual frequency; goods prices are sticky

### Model results and scenarios
- SARIMAX results:
  - Forecast: inflation expected to decrease to 1¾ percent by 2024Q4, based on WEO GAS projections of lower fuel and food prices and minimal exchange rate pressure.
  - Confidence intervals shown: 50% and 90% (dark and light shaded areas in original figure).
- AFRMOD simulations of shocks:
  - Shock 1 — 30 percent global food price increase in 2022:
    - Headline inflation in WAEMU increases by 5 percentage points in 2022 (short-lived), fading in subsequent years.
    - Impact on traditional core inflation (excluding food and energy) is negligible.
  - Shock 2 — increases in Euro area and US inflation path:
    - Headline inflation in WAEMU gradually increases by approximately 1 percentage point and slowly decreases by half percentage point by end of 2026.
    - Small inflation impact is cushioned by a moderate central bank monetary policy reaction.
- AFRMOD notes:
  - Charts present deviations from baseline under two exchange rate regimes: Managed floating and Fixed with small country risk premium.

### Monetary policy implications (section heading present in source)
- Robust inflation forecasts are fundamental for BCEAO forward-looking policy.
- The models indicate inflation is expected to decline in the medium term under baseline scenarios and under specified shocks, with differences in magnitude and persistence across scenarios and exchange rate regimes.

*Source: WEST AFRICAN ECONOMIC MONETARY UNION — INTERNATIONAL MONETARY FUND (content from provided chapter).*

### 21.      The results of the SARIMAX estimation—which can be used as a simple benchmark—do

### 1wauea2023002 - 21.      The results of the SARIMAX estimation—which can be used as a simple benchmark—do

### SARIMAX benchmark for inflation and monetary policy
- SARIMAX estimation does not call for a monetary policy tightening.
- By the end of 2024, inflation is expected to reach 1¾ percentage points, which is within the target range.
- The SARIMAX model accounts for food inflation, identified as the key driver of inflation in the region.
- Caveats:
  - The SARIMAX model is a simple benchmark and does not encompass a broad set of fundamentals in a general equilibrium setting.
  - If persistent and second-round effects are stronger than over the historical sample, the SARIMAX model would not capture these effects.

### AFRMOD simulations and central bank reaction
- Main simulation result: central bank should react mainly to global inflationary shocks, not to pure food price shocks in the absence of second-round effects.
- Global food price shock:
  - Headline inflation reacts short-lived.
  - Core inflation shows very limited reaction.
  - Simulation indicates the central bank does not need to react (appropriate for a pure, short-lived supply shock with no contagion or second-round effects).
- Global inflation shock via US and Euro Area:
  - Results in a more persistent and gradual increase in core and headline inflation.
  - Triggers a policy rate response ranging between 0.9 and 2 percentage points by the end of 2023, depending on the exchange rate regime assumed.
- Interpretation:
  - Central banks need to react to sources of global inflation shocks that persistently affect the region and trigger additional inflationary channels.
- Charts (described):
  - Deviations from baseline for core and headline inflation paths under Managed Floating Exchange Rate Regime and Fixed exchange rate with small country risk premium (AFRMOD outputs).

### Other external and domestic risk factors relevant for inflation and policy
- External risks that could push inflation upwards:
  - Critical developments of the war in Ukraine.
  - Further aggravation of sanctions against Russia.
  - Tighter than expected monetary policy in developed countries.
  - Further increases in international transportation bottlenecks.
  - Further increases in European natural gas and fertilizers prices.
  - Further depreciation of the Euro versus the U.S. dollar.
- Fiscal consolidation risks:
  - Challenges in fiscal consolidation should be carefully monitored.
  - Fiscal consolidation is essential to maintain external reserves and is crucial for price stability.
  - Higher deviations of fiscal deficit from current trends would exert additional pressure on inflation.
  - Temporary subsidies and price controls on essential goods, if not sustainable, could create additional inflationary pressure when removed.
- Climate and security risks:
  - Some producing countries have been particularly affected by weather conditions and security issues.

### Reserves, access to international capital, and monetary policy stance
- A deterioration of reserves and more difficult access to international capital could tilt the desirable monetary policy response toward tighter policy.
- Tightening monetary policy helps mitigate inflationary pressures and preserve foreign exchange reserves, though it entails growth costs.
- BCEAO operational constraint:
  - Article 76 stipulates the BCEAO should not let the monthly average of foreign exchange reserves fall below 20 percent of its sight liabilities (banknotes in circulation and deposits at the central bank) for three consecutive months.
- Interaction with ECB policy:
  - Although BCEAO does not traditionally follow ECB monetary policy (due to capital controls), substantial ECB tightening is expected by markets and may place unusual pressure on WAEMU monetary policy.
- Overall recommendation:
  - Further monetary policy tightening would be necessary unless downside risks to current baseline inflation and external buffer forecasts improve.
  - Monetary policy should be data-dependent given numerous external and internal risks that should be carefully monitored.

### WAEMU regional market for government debt — key findings
- Composition of debt:
  - Approximately 60 percent of WAEMU public debt is external.
  - Domestically financed debt accounted for almost 40 percent of total debt in 2021 and has been growing.
- Domestic market structure:
  - Debt issued in the regional auction market represents a significant source of funds.
  - Auctions account for about one fifth of total debt at the union level, ranging between 10 and 50 percent across countries.
    - Côte d‘Ivoire: approx. 12 percent auction share.
    - Togo: approx. 48 percent auction share.
  - The remainder of domestic debt is from syndication and other local financing (e.g., bank loans).
- Market segmentation evidence:
  - WAEMU’s extensive capital controls and limited capital mobility imply considerable segmentation between domestic and external debt instruments.
  - Simple correlations and PCA results indicate segmentation:
    - First two PCA components account for 63 percent of observed variation.
    - The first component explains 37 percent and is heavily tilted toward domestic markets.
    - The second component is closely related to international series (spreads on Eurobonds).
  - Pairwise rolling correlations between local and external rates are on average not far from zero, with pickup during early Covid recovery and recent global tightening.
  - Correlations between external spreads of Benin, Côte d‘Ivoire, and Senegal are elevated (table entries: Benin–Cote d'Ivoire 0.90; Benin–Senegal 0.93; Cote d'Ivoire–Senegal 0.95), indicating closely linked external spreads.
- Financial conditions and policy tightening context:
  - Going forward, maintaining favorable financing conditions will be challenging amid tighter global financial conditions.
  - As of December 12 2022:
    - Eurozone policy rate had been raised by 200 bps.
    - WAEMU policy rate increase was 75 bps.
  - Local composite measure of financial conditions suggests relatively easy local financial conditions compared to tightening globally.
- Policy implications for fiscal and market reforms:
  - Urgent need to revamp credibility of fiscal frameworks given upcoming interest and roll-over risks and rising global uncertainty.
  - Recommendations include:
    - Reintroducing and upgrading fiscal rules.
    - Pushing forward with domestic revenue mobilizations to strengthen debt sustainability and rebuild buffers in the medium term.
    - Prudent debt management operations.
    - Further development of local financial markets, especially to promote activity in secondary markets.

*Source: IMF staff report (WAEMU regional analysis, selected sections).*

### 9. Local financial conditions developments differ at times from global ones, especially

### 9. Local financial conditions developments differ at times from global ones, especially

### Local versus external financial conditions
- Local and external financial conditions have diverged at times, notably during the initial stage of Covid and more recently when global risk aversion increased.
- Adding external spreads to a narrower set of local interest rates produces a sizeable tightening during episodes of global stress.
- The yield on the regional market has been relatively steady with a gradual decline over the whole period, in contrast to rapid tightening externally during the initial stages of the pandemic and more recently.

### Borrowing costs and market segmentation
- Interest rates paid on debt raised in the regional auction markets are generally in the region of 5-7 percent.
- Distributional observations:
  - Most rates on local bonds (maturities from a few months to fifteen years) occur within the 5 to 7 percent range.
  - Local yields have increased from their pandemic lows but remain below pre-pandemic levels (the three-year maturity yield in November 2022 was close to the middle of the distribution).
- External market characteristics:
  - External rates are much more volatile and reached end-2022 levels that make borrowing prohibitive for issuers.
  - Three WAEMU countries with external issuances (Benin, Cote d‘Ivoire, and Senegal) face external yields that fluctuate more wildly than the domestic regional market.
  - The external bond sample used for comparison consists of six bonds with an average maturity of 3.2 years, as of January 2023.
  - External bonds can be cheap in loose global conditions and expensive when conditions are tight.
- Interest-rate components and recent dynamics:
  - Effective interest rates on total government debt, auction market average marginal yields, weighted average coupons and yields on external market debt, and yields-to-date show that:
    - The auction market can be a relatively expensive way of financing government expenditure compared to the effective rate on government debt, partly because of countries’ access to concessional debt.
    - External market debt has been financed at rates quite close to auction market interest rates, but yields on external market debt (market yields) are very volatile and currently considerably above coupon rates at issuance.
    - Average maturities for external bonds for the three issuing countries are quite high, at 12 to 14 years.
- Monetary policy interactions:
  - The short-end rates lie somewhat above the central bank’s lending facility rate which is at 4.75% as of December 2022.
  - Due to underdeveloped local markets and lack of futures markets, decomposing the term structure into expected policy rates versus term/risk premia is not possible.

### Size, country heterogeneity, and access
- Larger member countries enjoy more favorable borrowing costs in local markets and greater access to international financial markets.
- Empirical pattern:
  - Rates on the regional auction market are inversely related to country size for all bonds, short-term bonds, and long-term bonds.
  - The negative slope is considerably steeper for long-term bonds (defined as those maturing in 2025 or later).
- Consequences:
  - Decreased access to regional finance could exacerbate differential borrowing costs and lead to crowding out of smaller members.
  - Loss of external market access by larger issuers could increase their reliance on local markets and indirectly expose smaller members to global financial conditions.

### Rollover risks and maturities
- Average maturities and cross-country heterogeneity:
  - The average maturity of local bonds, weighted by principal, is above two years for all members.
  - Country-specific averages: Cote d‘Ivoire has the lowest average maturity at just under 29 months; Togo has the highest average maturity at approximately 47 months.
- Short-term exposure:
  - About one-fourth of regional debt on the auction market is coming due in the next year and one-third within two years.
  - All members have at least 15% of their debt maturing in the next twelve months; Cote d‘Ivoire and Niger have roughly 30% maturing within twelve months.
  - Cumulative nominal amounts maturing:
    - More than 2.5CFA trn (or about 23 percent of the total) is due within 12 months.
    - Almost 4.5 CFAFtrn (or 6.5 EURbn, about 35 percent of the total) is due within the next 24 months.
    - This is equivalent to 4.1% of estimated 2022 GDP.
- Market liquidity and secondary market activity:
  - The market for local sovereign debt currently has around CFAF12.2 trn outstanding, compared to an annual turnover of CFAF 3 trn, suggesting a still low turnover ratio.
  - Transactions in secondary markets have been increasing but remain low compared to market size, complicating price discovery and yield curve construction.

### Projected interest payment pressures and implications
- Interest payments likely to increase going forward due to:
  - Normalization of monetary policy in WAEMU amid higher global interest rates, pushing local market rates up.
  - Global monetary policy tightening and reduced risk appetite making external market debt more expensive.
  - Gradual loss of concessional financing as WAEMU countries move up the ladder of economic development, raising the effective interest rate on the stock of government debt.
- Distributional impact:
  - Interest payments increases will particularly affect smaller countries.
  - If global financial conditions and monetary policy remain tight, domestic financing conditions and monetary policy are likely to tighten as well, reducing the sheltering effect of market segmentation.
  - This would impair rollover capacity in the short term and worsen regional debt dynamics in the longer term, with larger effects on smaller countries.

### Policy recommendations and debt management priorities
- Restore credibility of fiscal strategy through a revamped fiscal rule within a well-crafted fiscal strategy:
  - Secure fiscal consolidation over the medium term, including by managing Stock Flow Adjustments.
  - Ensure debt ratios remain within the debt ceilings of the expired fiscal rule and place public debt on a downward trajectory.
  - Reintroduce and revamp elements of the fiscal rules.
- Strengthen debt management and financial market development to contain interest rates and rollover risk:
  - Improve debt management operations.
  - Deepen secondary markets to improve liquidity and price discovery.
  - Facilitate the emergence of traditional yield curves to aid monetary policy implementation and transparency.

### Annex highlights (yield-curve estimation and caveats)
- Yield-curve estimation is complicated by shallow local markets, limited secondary market activity, infrequent issuance, and common practice of issuing at a discount.
- Implied regional yield curve (aggregate) shows an upward sloping pattern:
  - Interest rates range from 5-6 percent at the short end to 6-7 percent at the long end.
- Country-level yield curves show significant heterogeneity:
  - Some countries (e.g., Senegal) exhibit a gradually upward sloping curve; others (e.g., Benin) show no discernible term-structure pattern.
- UMOA Titres publishes weekly yield curve data based on primary market yields broadly consistent with the annex calculations.

*Source: IMF staff calculations and analysis as presented in the chapter "9. Local financial conditions developments differ at times from global ones, especially" from the WAEMU staff report.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1wauea2023002.pdf_