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### Background and context and key concerns
- WAEMU membership and monetary framework
  - Members: Benin, Burkina Faso, Côte d'Ivoire, Guinea-Bissau, Mali, Niger, Senegal, and Togo.
  - BCEAO functions: issues CFA Franc pegged to the euro, conducts single regional monetary policy, pools foreign exchange reserves, contributes to regional financial supervision.
- Purpose of the paper
  - Assess adequacy and effectiveness of WAEMU fiscal framework focusing on three pillars: common fiscal rules, shared PFM systems, fiscal coordination mechanisms.
  - Provide inputs to WAEMU Commission review ahead of reform proposals to WAEMU Council of Ministers in 2022.
- Key weaknesses of existing surveillance framework
  - Fiscal rules weakly enforced; repeated slippages since 1996 and postponements of Pact deadlines.
  - Debt accumulation driven by high fiscal deficits and debt-creating operations not captured by fiscal deficits.
  - Prevalence of ad hoc below-the-line and off-budget operations escaping official scrutiny.
  - Lack of formal fiscal-sharing mechanisms complicates stabilization for countries facing idiosyncratic shocks.
  - Pact suspended in April 2020 in response to Covid-19.

### Literature and three pillars for fiscal coordination
- Theoretical role of fiscal coordination
  - Monetary union ensures coordination for symmetric shocks; fiscal policy required for national stabilization under asymmetric shocks and imperfect factor mobility.
  - “Deficit bias” risk from common resource pool without coordination.
- Three pillars (Eyraud, 2019)
  1. Fiscal rules: commitment and signaling; effectiveness depends on design and enforcement.
  2. Public Financial Management (PFM): formulation, approval, execution; MTEFs and expenditure controls important.
  3. Fiscal coordination mechanisms: tax competition avoidance, insurance/risk-sharing schemes, common budget.

### Historical design and compliance (1996–2019)
- Initial Pact (1996) and 2015 revisions
  - 1994/1996 rules included eight criteria; deficit rule based on basic fiscal balance excluding grants and externally financed capital expenditure; debt ceiling 70 percent of GDP.
  - 2015 reform simplified to six criteria; first-order criteria: overall fiscal balance (including grants) ≥ -3 percent of GDP; CPI inflation ≤ 3 percent; total public debt ≤ 70 percent of GDP. Second-order: wages/salaries ≤ 35 percent of tax revenue; tax revenue ≥ 20 percent of GDP.
- Compliance outcomes to end-2019
  - Regional (aggregate) first-order criteria met at end-2019; all countries except Guinea-Bissau and Senegal met all first-order criteria.
  - Regional fiscal deficit estimated at 2.5 percent of GDP at end-2019.
  - Public debt increased by about almost 17 percentage points of GDP between end-2012 and end-2019 to about 45 percent of GDP.
  - CPI inflation estimated at -0.7 percent.
  - Second-order criteria not met at regional level; tax revenue criterion breached by all countries.

### Debt ceiling calibration — approaches and findings
- Calibration sequencing and trade-offs
  - First set debt anchor (debt-to-GDP ceiling), then calibrate operational deficit rule consistent with debt anchor.
  - Trade-off: not too high (vulnerability) vs not too low (space for development spending).
- Two approaches to estimate maximum debt limit
  1. “Safe” debt / stochastic simulations
     - Use historical distribution of macro-fiscal shocks; simulate 6-year debt trajectories; set debt anchor so fan chart stays below maximum debt limit with high probability.
  2. Growth-maximizing (theoretical) approach
     - Checherita-Westphal and others (2014) golden-rule model where public debt finances public capital; derive optimal debt-to-GDP D* as a function of output elasticity of public capital α.

- Appendix results and numerical findings
  - Fiscal-fatigue approach:
    - 95th percentile r−g: 3.3 percent
    - 95th percentile maximum primary balance: 2.7 percent of GDP
    - Implied debt limit: 80 percent of GDP
  - Debt-servicing-capacity approach (WAEMU averages 2015–2019):
    - Revenue/GDP: 14.9%
    - Effective interest rate: 3.3%
    - Debt limits:
      - τ = 16% → 72%
      - τ = 19% → 86%
  - Simulations and safety buffers:
    - A debt anchor of around 70 percent of GDP if policymakers accept a 10 percent probability of breaching the maximum debt limit by year 6.
    - Accounting for an expected contingent liability realization of 3 percent of GDP over 6 years implies a debt anchor of 68 percent of GDP.
    - Contingent liability evidence: average episode every 12 years with fiscal cost of 6.1 percent of GDP per episode.
  - Growth-maximizing approach:
    - Estimated α ≈ 0.31 → optimal debt-to-GDP ≈ 74 percent.
    - 90 percent confidence interval for α (0.28–0.34) → optimal ratios range 65 percent to 84 percent.

- Overall conclusion on debt ceiling
  - Recommended maximum debt limit: around 80 percent of GDP.
  - Recommended operational debt anchor: around 70 percent of GDP (safety buffer of 10 percent of GDP).

### Deficit ceiling (operational rule) implications
- Current rule: headline overall deficit capped below 3 percent of GDP.
- Debt stabilization relationship and assumptions
  - Assumed potential medium-term real growth: between 5 to 6 percent.
  - BCEAO inflation objective: 2 percent (+/− 1 percent band).
  - Implied nominal potential growth rate: between 6 and 9 percent.
  - Under these assumptions, the 3 percent of GDP ceiling would stabilize debt between 40 to 50 percent of GDP.
- Alternative scenarios
  - A 4 percent deficit ceiling would stabilize debt at around 70 percent of GDP if nominal growth assumed at 6 percent.
  - With nominal growth at 8 percent, a 4 percent of GDP deficit would stabilize debt at 54 percent of GDP.
- Risks of raising deficit ceiling to 4 percent of GDP
  - Ceilings can become focal points and induce drift toward the ceiling.
  - External stability risks for the currency peg via reserve depletion and competitiveness pressures.
  - Market absorptive capacity limits and crowding-out risks in regional sovereign bond market.

### Fiscal rule design options and recommendation
- Options considered
  - Retain nominal deficit ceiling: easy to communicate/monitor; downside procyclicality and debt drift.
  - Cyclically-adjusted balance (CAB): better stabilization; practical difficulties estimating output gap timely and reliably.
  - Structural balance rule (SBR): addresses one-offs; poor track record due to optimistic potential output estimates and complexity.
  - Expenditure rule: easier to monitor and enforce; may discourage revenue mobilization unless paired with revenue guidance.
- Recommendation
  - On balance, a rule focusing on the nominal headline deficit appears most appropriate for WAEMU given implementation, monitoring, and communication considerations.
- Differentiation across countries
  - Potentially justifiable by differing capacities but complicates coordination and monitoring; limited historical precedent within currency unions.

### Enforcement, escape clauses, correction mechanisms, and sanctions
- Monitoring and institutional roles
  - WAEMU Commission conducts multilateral surveillance; two reports per year (June and December); administrative capacity enhanced after 2015 but may need further strengthening and potential treaty changes to act as independent enforcer.
- Escape clauses and improvements needed
  - Current framework allows Commission to propose activation and Council to lift first-order criteria temporarily; member must propose corrective measures within 30 days.
  - Needed improvements:
    - Precise and quantitative triggers (current “exceptional circumstances” wording vague).
    - Clear activation process, timelines, procedures to revert to rules.
    - Institutional safeguards to limit political influence over activation (EU practice cited as reference).
  - Caution about escape clauses for persistent security problems that could permit repeated deviations.
- Correction mechanisms and sanctions
  - Current enforcement resides with Council of Ministers; corrective measures required for observed breaches in convergence phase; framework lacks detailed pace, milestones, deadlines.
  - Article 74 sanctions: declarative or financial (publication, withdrawal of positive measures, recommendation to West African Development Bank, suspension of Union assistance); financial sanctions never applied.
  - Recommendations to increase credibility:
    - Grant Commission stronger role to determine non-compliance and submit enforcement recommendations; require qualified-majority rejection to block adoption.
    - Raise reputational costs via independent fiscal councils (either national councils in each member or a single regional fiscal council); in resource-constrained contexts, host national councils within existing independent institutions.

### PFM weaknesses, Stock-Flow Adjustments (SFA), and recommended reforms
- SFA and debt dynamics
  - SFA averaged about 1.3 percent of GDP per year between 2013 and 2019.
  - SFA peaked in 2017 at 3.3 percent of GDP due to a one-off operation expanding the debt perimeter in Senegal.
  - Two-thirds of debt increase due to cumulated fiscal deficits; about one-third due to cumulative SFA.
  - Debt ratio increased by about 17 percentage points of GDP between end-2012 and end-2019.
  - Forecast errors in debt projections mostly due to underestimation of SFA.
- Nature and drivers of SFA
  - Mix of sound (e.g., arrears clearance in Côte d’Ivoire 2018; debt perimeter extension in Senegal 2017) and poor/off-budget practices (e.g., prefinancing schemes in Benin, Togo, Senegal; treasury financing of SOE deficits in Senegal).
  - Irregularities cause disconnect between above-the-line fiscal balance and below-the-line net financing, producing stock-flow discrepancies.
- PFM directives and implementation
  - Six regional directives (2009) plus two (2011) aimed at GFSM 2001 alignment and results-based budgeting; directives do not cover fiscal risk management.
  - By end-2019 all WAEMU countries transposed the six directives into national legislation; implementation slow and uneven; five-year implementation target to January 2017 was missed.
  - 2021 evaluation: improved progress but gaps in internal controls and account transparency remain.
- Recommended PFM reforms to contain SFA and improve discipline
  - Accelerate implementation of regional directives, especially internal expenditure controls and transparency.
  - Legal frameworks restricting use of exceptional/simplified procedures; streamline expenditure controls under normal chains to reduce incentives for ad hoc procedures.
  - Adopt automated Financial Management Information System tools.
  - Upgrade member state capacity in macro-fiscal forecasting and move toward accrual accounting where feasible.
  - Improve public access to budgetary information.

### Fiscal coordination and risk-sharing mechanisms
- Tax coordination
  - De jure framework advanced but ineffective de facto due to incomplete implementation of directives.
  - 2021 tax-to-GDP ratio estimated at 13.2 percent of GDP—well below the 20 percent floor.
  - June 2019 Council action plan to raise tax revenue and standardize VAT, excise, direct tax collection; implement digitalization and reduce tax competition.
  - Recommendation: WAEMU Commission to review tax coordination framework and undertake detailed legislative review to promote adherence.
- Mechanisms to manage large idiosyncratic shocks
  - Escape clauses: compensation via additional efforts by unaffected countries; operational and political challenges exist.
  - Regional stabilization fund:
    - Temporary transfers to affected countries financed by annual contributions.
    - Basdevant and others (2015) suggested transfers between 0.75 to 1.25 percent of GDP for WAEMU.
    - Transfers proportional to shock size, country size, and accumulated resources; no disbursement when no negative shocks.
    - Regional bonds could complement financing but require fiscal integration.
  - Small common budget:
    - WAEMU budget in 2019: 0.2 percent of region’s GDP (CFAF 205 billion).
    - EU budget for comparison: 1 percent of EU GDP.
  - Fiscal coordination mechanisms are critical to address asymmetric shocks and contagion.

### Conclusions and reform priorities
- Main conclusions
  - Calibration exercise supports retaining pre-suspension ceilings: 70 percent of GDP for debt and 3 percent of GDP for the deficit as appropriate targets balancing growth and sustainability.
  - Headline nominal deficit rule preferred over structural or cyclically-adjusted rules given WAEMU capacity and implementation constraints.
- Priority reforms across the three pillars
  - Strengthen fiscal governance design and enforcement:
    - Bolster WAEMU Commission’s independent enforcer role.
    - Define precise escape clause triggers and timelines; strengthen procedures to revert to rules.
    - Redefine correction mechanisms and sanctions; increase reputational costs.
  - Enhance PFM to contain SFA and prevent fiscal imbalances:
    - Accelerate regional directive implementation; improve internal expenditure controls and transparency.
    - Restrict exceptional procedures and streamline expenditure chains; adopt automated FMIS tools.
  - Strengthen fiscal coordination mechanisms:
    - Improve tax coordination implementation and consider revising directives to curb tax incentives.
    - Enhance fiscal risk sharing (regional stabilization fund or targeted transfers).
    - Consider longer-term development of a small union budget.

*Source: IMF Working Paper “Strengthening the WAEMU Regional Fiscal Framework” (wpiea2022049-print-pdf).*

### Introduction............................................................................................................

### Introduction

### Background and context
- The West African Economic and Monetary Union (WAEMU) is one of four currency unions in the world, consisting of eight countries.
- The Central Bank of West African States (BCEAO):
  - issues a common currency, the CFA Franc, pegged to the euro,
  - conducts a single regional monetary policy,
  - pools foreign exchange reserves of members,
  - contributes to the supervision of the financial system of the WAEMU.
- A “Growth, Stability, Convergence and Solidarity Pact” adopted in 1996 aimed at ensuring “consistency between national fiscal policies and the common monetary policy” and a “sustainable balance of payment position” through gradual convergence by member countries to numerical ceilings on the fiscal deficit and debt to GDP ratios.
- The members of the WAEMU are Benin, Burkina Faso, Côte d'Ivoire, Guinea-Bissau, Mali, Niger, Senegal, and Togo.

### Key concerns with the existing fiscal surveillance framework
- The WAEMU regional surveillance framework aims to ensure sustainability of national fiscal policies and consistency with the common monetary policy, including preserving the fixed exchange rate regime.
- In practice, the framework has shown weaknesses:
  - Fiscal rules have been weakly enforced over the years, contributing to weak compliance with the convergence criteria by member states (Féler and Simard, 2019).
  - Repeated fiscal slippages since 1996 led to successive postponements of the Pact’s convergence deadlines.
  - Regional convergence was temporarily achieved at the aggregate level in 2019, but the fiscal framework was suspended in 2020 in the context of the Covid crisis (WAEMU, 2020a).
  - Debt has accumulated significantly over the past decade due to high fiscal deficits and prevalence of debt-creating operations not captured by fiscal deficits (Féler and Simard, 2019; Nguyen-Duong and Selim, 2021).
  - Ad hoc unorthodox procedures and other below-the-line and off-budget operations persisted and often escaped official scrutiny in national budgets (Imbert and others, 2022; Versailles, 2018).
  - The framework lacks formal fiscal-sharing mechanisms, complicating stabilization for countries subject to idiosyncratic shocks (for example, security problems in Burkina Faso, Mali and Niger) without support from other members or pressure to loosen the common monetary policy stance.

### Purpose, scope, and analytic focus of the paper
- The Covid crisis and current suspension of the framework provide an opportunity to evaluate the existing fiscal surveillance framework in the WAEMU and rethink components related to:
  - fiscal rules (ceilings, design, enforcement),
  - regional public financial management (PFM) systems,
  - fiscal coordination mechanisms.
- The WAEMU Commission is conducting a review of the framework and the convergence path, with a view of submitting reform proposals to the WAEMU Council of Ministers in 2022.
- The paper assesses the adequacy and effectiveness of the WAEMU fiscal framework, focusing on three main pillars considered the fiscal foundation of a currency union:
  - common fiscal rules (including adequacy of current numerical ceilings and other elements of design and enforcement),
  - shared public financial management systems,
  - fiscal coordination mechanisms.
- The paper examines fiscal rules in the WAEMU using several methods to calibrate regional debt and deficit ceilings to assess whether previous numerical ceilings (in place before the Pact’s suspension) remain suitable for the region, taking into account large development spending needs and the objective of fiscal prudence to preserve fiscal sustainability.
- The analysis expands on previous work (Hitaj, 2016; Basdevant and others, 2015; Féler and Simard, 2019; Eyraud, 2019; Nguyen-Duong and Selim, 2021; Bebee and others, 2022) and focuses on design and implementation of the most critical fiscal criteria (fiscal and debt rules), leaving aside other criteria (on taxes and wages) and non-fiscal ones (inflation).

### Structure of the paper
- Section II: brief literature review on theoretical underpinnings for fiscal discipline and coordination in currency unions, with a focus on the WAEMU region.
- Section III: background on the WAEMU fiscal surveillance framework including institutional aspects and implementation track record.
- Section IV: explores issues related to fiscal rules calibration, design, and underlying enforcement mechanisms.
- Section V: provides a brief assessment of the common PFM systems in the WAEMU.

*Source: Introduction, IMF Working Paper “Strengthening the WAEMU Regional Fiscal Framework” (wpiea2022049-print-pdf).*

### section VI suggests possible reforms to improve fiscal coordination mechanisms in the region. Section VII

### wpiea2022049-print-pdf - section VI suggests possible reforms to improve fiscal coordination mechanisms in the region. Section VII

### Literature Review: Fiscal Coordination in Currency Unions
- Common monetary policy in a currency union ensures automatic coordination of responses to symmetric shocks (Canzoneri and Gray, 1985).
- Fiscal policy remains the only tool to stabilize national business cycles when they diverge from the common monetary policy and when factor mobility is imperfect (Mundell, 1961; McKinnon, 1963).
- Fiscal coordination (including fiscal discipline) among member states is recommended to prevent excessive budget deficits that would undermine long-term credibility of the common currency (De Grauwe, 1992).
- “Deficit bias” can arise because countries in a currency union access a common pool of resources and may overspend, overborrow, free-ride, or shift tightening to other members or the central bank (Buiter et al., 1993; Kenen, 1995; Chari and Kehoe, 2004).
- Fiscal coordination helps members internalize spillovers and align national fiscal stance with common monetary policy (Hamada, 1985).

### Three Pillars of Fiscal Coordination
- The literature proposes three mechanisms to achieve fiscal coordination (Eyraud, 2019):

  1. Fiscal rules
     - Purpose: enforce fiscal prudence, limit “deficit bias”, facilitate coordination.
     - Functions: commitment device (Alesina and Tabellini, 1990; Eyraud and others, 2018) and signaling device (Debrun and Kumar, 2007).
     - Design considerations:
       - Poorly designed rules (e.g., procyclical or imprecise) can be self-defeating.
       - Rules are more effective when supported by strong enforcement: greater automaticity, credible sanctions, better monitoring (Eyraud and others, 2018).

  2. Public Financial Management (PFM) systems
     - PFM covers formulation, approval, and execution of the budget and processes for public expenditure management.
     - Strong PFM fosters fiscal discipline; fiscal consolidations are more durable when supported by strong institutions (Tsibouris and others, 2006; Kumar and others, 2007; IMF 2011).
     - Medium-term expenditure frameworks (MTEFs) help set multi-year priorities and build credibility.
     - Effective expenditure controls prevent spending outside approved budgets and limit unbudgeted liabilities (Doe and Pattanayak, 2008; Corbacho and Ter-Minassian, 2013).

  3. Fiscal coordination mechanisms
     - Purpose: internalize cross-border spillovers through channels such as trade, inflation, and contagion.
     - Examples:
       - Frameworks to avoid excessive tax competition (Wilson, 1986).
       - Insurance or fiscal risk-sharing schemes: “rainy day fund” with permanent contributions and transfers linked to country-level shocks (Allard and others, 2013).
       - A common budget for the union to allow risk sharing through revenues and spending (Allard and others, 2013).

### WAEMU-Specific Literature: Key Findings
- Research on rules, PFM arrangements, and coordination mechanisms is less extensive for WAEMU than for the Euro Area.
- Fiscal rules
  - Compliance with convergence criteria has been considered weak.
  - Recommendations: simpler rules and more effective enforcement mechanisms (Nguyen-Duong and Selim, 2021; Basdevant and others, 2015).
  - The deficit rule from the 1990s was associated with procyclical fiscal policy, especially absent fiscal sharing mechanisms (Guillaumont and Tapsoba, 2009; Coulibaly, 2015; Dessus and others, 2013).
  - Dessus and others (2013) explored alternative rules allowing more cyclical flexibility for sustained growth.
  - Basdevant and others (2015) recommended reducing the 70 percent debt ratio ceiling to 50 percent based on debt sustainability exercises.
  - Bebee and others (2022) provided quantitative analysis of medium-term regional debt and deficit ceilings using econometric estimates and a structural model.

- Public Financial Management (PFM)
  - Emphasis on better PFM to control sources of debt accumulation, especially below-the-line and off-budget operations (Imbert and others, 2022; Nguyen-Duong and Selim, 2021; Féler and Simard, 2019; Versailles, 2018; Hitaj, 2016).
  - Uneven implementation of PFM directives across member states noted (Assemien, 2008; Imbert, 2014; Sarr, 2014; Bonherbe, 2016).

- Risk-sharing mechanisms
  - Recommendations include (i) improving national tax harmonization to enhance WAEMU Commission’s surveillance, and (ii) establishing centralized risk-sharing mechanisms and enhancing financial integration to smooth asymmetric shocks (Dessus and others, 2013; Basdevant and others, 2015; World Bank, 2019).

### Background: The WAEMU System of Fiscal Rules
- The WAEMU Treaty (post-1994 devaluation of the CFA Franc) reinforced fiscal discipline and coordination and introduced the “Growth, Stability, Convergence and Solidarity Pact”.
- A regional fiscal surveillance framework was formally adopted in 1996; the WAEMU Commission was mandated with regional fiscal surveillance.
- Additional expected coordination measures included harmonizing budget laws and reducing disparities in national tax policies (Kireyev, 2016).

### The Initial Pact: 1996-2015 — Design and Compliance
- 1994 convergence path defined eight rules (“criteria”):
  - First-order criteria: ceilings on fiscal deficit and debt to GDP ratios, CPI inflation ceiling, and prohibition to accumulate arrears. The deficit rule was based on the basic fiscal balance (excluding grants and externally financed capital expenditure). Debt ceiling set at 70 percent of GDP.
  - Second-order criteria: ceilings on wages and salaries, floors on tax revenue, investment-expenditure-to-revenue ratios, limits on current account deficits (Kireyev, 2016).

- Compliance outcomes:
  - Repeated breaches in deficit and debt ceilings observed in majority of WAEMU countries since 1998, notably between 2001 and 2012 (Hitaj, 2016; Doré and Masson, 2002).
  - By 2015, several countries remained noncompliant with the fiscal deficit criterion.

- Root causes of slippages (mid-2010s assessments):
  1. Excessively complex rules; too many criteria and some difficult to understand, implement, and monitor (Basdevant and others, 2015). The basic fiscal balance excluded foreign-financed capital expenditure and was insufficiently linked to public debt dynamics (Hitaj, 2016; Coulibaly, 2015).
  2. Absence of fiscal sharing mechanisms made the deficit rule procyclical, with adjustments mainly via public spending and asymmetric responses across the cycle (Guillaumont and Tapsoba, 2009; Coulibaly, 2015; Dessus and others, 2013).
  3. Limited effectiveness of monitoring and enforcement mechanisms.

### The 2015 Revised Criteria and Convergence Phase: 2015-2019
- Conference of WAEMU Heads of States adopted a revised surveillance framework in 2015 (Additional Act no. 01/2015/ CCEG/UEMOA).
- Deadlines and progression:
  - Member countries expected to meet convergence criteria by end-2019; if fewer than half of members accounting for at least 65 percent of regional GDP met criteria sustainably, convergence phase could be extended by one year.
  - Stability phase would begin only when first-order criteria observance was “durable” (maintained for two years and expected to hold for two future years).

- 2015 Convergence Criteria (as adopted)
  - First-order criteria (Ceiling/Floor):
    - Overall fiscal balance (including grants) to nominal GDP  ≥ -3 percent
    - Average consumer price inflation per year ≤ 3 percent
    - Total public debt to nominal GDP  ≤ 70 percent
  - Second-order criteria (Ceiling/Floor):
    - Wages and salaries to tax revenue  ≤ 35 percent
    - Tax revenue to nominal GDP  ≥ 20 percent

- Key changes in 2015 reform:
  - Simplified rules: main fiscal rule measured by overall fiscal balance; number of criteria reduced from 8 to 6 (criteria on arrears, current account, and public investment dropped).
  - Debt ceiling retained at 70 percent of GDP.
  - Gradual reduction of arrears toward elimination by 2019.

- Compliance outcomes at end-2019 (WAEMU Commission assessment, WAEMU, 2019):
  - First-order convergence criteria met at the regional (aggregate) level at end-2019 but not for every country.
  - All WAEMU countries except Guinea-Bissau and Senegal met all first-order criteria.
  - Regional fiscal deficit estimated at 2.5 percent of GDP at end-2019.
    - Fiscal consolidation was backloaded with slippages in 2016 and 2017 and improved momentum since 2018 due mainly to better revenue mobilization.
  - Public debt remained below the 70 percent of GDP ceiling but did not decline toward 40 percent of GDP as expected in 2015; debt ratio increased by about almost 17 percentage points of GDP between end-2012 and end-2019 to about 45 percent of GDP even though the deficit declined.
  - CPI inflation converged to the regional criterion and was estimated at -0.7 percent.
  - Second-order criteria: neither met at the regional level by end-2019. Only Senegal and Mali met the wages and salaries criterion. All countries breached the revenue criterion despite enhanced revenue mobilization in 2019.

- COVID-19 impact:
  - WAEMU Heads of States Declaration in April 2020 suspended the Pact (including fiscal rules) to allow accommodative responses to the shock. The suspension voided convergence and stability considerations pending new reforms.

### Reforming the System of Fiscal Rules in WAEMU — Assessment Agenda
- Ongoing WAEMU Commission review of the fiscal framework provides opportunity to reassess:
  - (i) Adequacy of previous ceilings (debt at 70 percent of GDP and deficit at 3 percent of GDP) for long-term fiscal sustainability.
  - (ii) Design aspects: whether to change the deficit rule definition or introduce alternative rules.
  - (iii) Effectiveness of enforcement mechanisms.

- Assessment structure (as presented):
  1. Calibrate regional fiscal ceilings (debt and deficit) to test suitability.
  2. Analyze fiscal rule design aspects.
  3. Analyze enforcement mechanisms of fiscal rules.

### Fiscal Rules Calibration — Concepts and Approach
- Distinction made between:
  - Medium-term fiscal anchor (often the debt-to-GDP ratio) as the guide for medium-term expectations and upper limit for repeated slippages.
  - Operational rule (short-term fiscal aggregate under policymakers’ control), commonly a budget balance rule or an expenditure rule.

- Calibration sequence:
  - First calibrate the debt ceiling (debt anchor), then use the debt anchor to guide calibration of the budget balance ceiling.

- Trade-off in debt ceiling calibration:
  - Not too high: avoids vulnerability to shocks, preserves market confidence, limits fiscal distress.
  - Not too low: allows space for debt-financed spending on infrastructure and development to meet SDG goals.

- Two approaches considered to calibrate the debt ceiling:
  1. “Safe” debt approach (precautionary)
     - Defines the “safe” debt-to-GDP ratio that keeps debt dynamics under control under adverse shocks.
     - Steps:
       - Estimate a maximum debt limit (point beyond which debt dynamics may spiral out of control).
       - Estimate required safety margin.
       - Infer debt anchor = debt limit minus safety margin.
     - Safety margin estimated via stochastic simulations:
       - Estimate distribution of historical macroeconomic and fiscal shocks.
       - Simulate future debt trajectories under these shocks over a 6-year horizon to create a fan chart of debt realizations.
       - Use the fan chart to calibrate the debt anchor and calculate probability that public debt would exceed the maximum debt limit in the medium-term.

  2. Growth-oriented approach
     - Emphasizes economic growth considerations and space for borrowing to finance large development spending (described in the text as the second approach to be considered after the “safe” debt approach).

*Source: IMF Working Paper — Strengthening the WAEMU Regional Fiscal Framework (excerpts from sections VI and preceding background and calibration discussion).*

### Appendix 1 presents the details of the steps followed to obtain estimates of the maximum debt limit for the

### wpiea2022049-print-pdf - Appendix 1: Steps to obtain estimates of the maximum debt limit for the region

### Debt-limit estimates and recommended ceiling
- Two approaches were used to estimate the maximum debt limit: concepts of “fiscal fatigue” and preservation of debt servicing capacity.
- The results indicate that a debt limit of around 80 percent of GDP for the WAEMU seems appropriate.
- Recommended operational debt anchor: around 70 percent of GDP, corresponding to a safety buffer of 10 percent of GDP relative to the 80 percent debt limit.

### Simulations, safety buffers, and contingent liabilities
- Safety buffer should reflect:
  - i) the history of macroeconomic shocks for countries in the region;
  - ii) contingent liabilities, estimated at 3 percent of GDP every 6-years based on evidence discussed in Bova et al. (2019).
- Macroeconomic and fiscal shocks drawn from a multivariate normal distribution for regional annual data on: real GDP growth, the primary balance, real interest rates and the real exchange rate.
- Simulations use the standard debt dynamics equation and a fiscal reaction function; results shown as fan charts across shock scenarios.
- Calibration objective: set the debt anchor so the fan chart stays below the maximum debt limit over a 6-year horizon with a high probability.
- Key simulation outcomes:
  - A debt anchor of around 70 percent of GDP if policymakers accept a 10 percent probability of breaching the maximum debt limit by year 6.
  - Accounting for an expected contingent liability realization of 3 percent of GDP over 6 years implies a debt anchor of 68 percent of GDP.
- Evidence on contingent liability realizations (Bova et al. (2019)):
  - On average a country experienced a contingent liability realization every 12 years with a fiscal cost of 6.1 percent of GDP per episode.
- Stock-flow adjustments (SFAs) can disconnect deficits and debt evolution due to contingent liabilities, off-budget operations, or large financial asset operations.

### Sensitivity and uncertainty around the anchor
- Historical-estimate-based safety buffer of 10 percent of GDP could need widening due to risks and structural trends (example: monetary policy normalization in Advanced Economies raising global interest rates).
- Robustness check: a 100 basis points increase in interest rates relative to recent levels would increase the size of the buffer to over 16 percent of GDP, bringing the debt anchor below 65 percent of GDP if a debt limit of 80 percent of GDP is considered.
- Conversely, factors that could support a higher debt limit:
  - If revenues excluding grants to GDP ratio increase from 14.8 to 16 percent of GDP, the debt limit would be revised upward to 95 percent of GDP, keeping other things equal.

### Approach 2 — Growth-maximizing debt level (theoretical calibration)
- Methodology: theoretical model (Checherita-Westphal and others, 2014) that derives the debt-to-GDP ratio maximizing growth assuming public debt finances public capital (golden rule).
- Production function includes labor (L), private capital (K), and public capital (Kg); output elasticity of public capital denoted α.
- Optimal debt-to-GDP ratio D* depends on α via:
  - D* = ( (α/(1−α))^2 )^(1−α)   [expression as presented in source]
- Empirical estimation:
  - Data sources: Penn-World Tables version 10.0 and IMF’s Investment and Capital Stock Dataset, pooled data for WAEMU countries over 1960-2015.
  - Two model specifications used (shares of private capital; per capita terms) and specifications with/without deterministic trend.
  - All regressions yield point estimates for α of around 0.31, implying an optimal debt-to-GDP ratio target of about 74 percent.
  - Considering a 90 percent confidence interval for α (upper bound 0.34, lower bound 0.28) yields optimal debt-to-GDP ratios ranging from 65 percent to 84 percent.
- Conclusion from growth-maximizing approach: consistent with simulation-based anchor; suggests no strong case for changing current regional debt ceiling.

### Overall conclusion on the debt ceiling
- The analysis indicates the current regional ceiling of 70 percent of GDP is appropriate, striking a balance between fiscal prudence and growth considerations.
- The 70 percent ceiling corresponds to a debt limit of 80 percent of GDP minus a safety buffer of 10 percent of GDP, deemed appropriate given historical shocks and expected contingent liabilities.

### Setting the deficit ceiling (operational rule implications)
- Current WAEMU rule: nominal headline overall deficit capped below 3 percent of GDP as part of convergence criteria.
- Debt stabilization relationship used to derive overall deficit (OB) that makes debt converge to a target in absence of shocks:
  - OB = ((−θ)/(1 + θ)) D   [formula as presented in source]
- Assumptions and implications:
  - Potential medium-term real growth: between 5 to 6 percent (in line with current IMF projections).
  - BCEAO inflation objective: 2 percent (+/− 1 percent band).
  - Implied nominal potential growth rate: between 6 and 9 percent.
  - Under these assumptions, the 3 percent of GDP ceiling would stabilize debt between 40 to 50 percent of GDP.
- Alternative ceilings and implications:
  - A 4 percent deficit ceiling would stabilize debt at around 70 percent of GDP if nominal growth rate is assumed at 6 percent.
  - Considering nominal growth rate of 8 percent, a 4 percent of GDP deficit would stabilize debt at 54 percent of GDP.
- Risks from raising the deficit ceiling to 4 percent of GDP:
  - Deficit ceilings often become focal points; experience suggests convergence toward the ceiling over time could raise regional deficit paths.
  - External stability risks: wider fiscal deficits could undermine the currency peg by draining international reserves and affecting competitiveness via real exchange rate appreciation.
  - Market absorptive capacity and crowding-out: limited liquidity in the regional sovereign bond market could create financial pressures and crowd out private sector financing.

### Fiscal rules design: options and trade-offs
- Rule options considered:
  - Retain nominal deficit ceiling (current rule): easy to communicate, compute, monitor, and enforce; close link to debt dynamics; downside: procyclicality and drift of public debt.
  - Cyclically-adjusted balance (CAB) rule: limits overall balance after correcting for business cycle effects; advantages in stabilization and countercyclicality; challenges: technical difficulty in timely and reliable output gap estimation.
  - Structural balance rule (SBR): extends CAB by correcting for one-off measures and other cycles; can reduce spending volatility but has a poor track record due to optimistic potential output estimates and implementation complexity.
  - Expenditure rule: limits total, primary, or current spending (levels or growth rates); easier to monitor and enforce; can reduce deficit bias but may discourage revenue mobilization unless paired with revenue guidance.
- Recommendation: on balance, a rule focusing on the nominal headline deficit appears most appropriate for WAEMU given its advantages outweigh drawbacks.
- Differentiation of rules across countries:
  - Potentially justified by differing repayment capacities and initial conditions, but historical precedent within a currency union is limited.
  - Differentiation would complicate fiscal coordination and monitoring and may be difficult to calibrate given data constraints.

### Fiscal rules enforcement: monitoring, escape clauses, correction mechanisms, and sanctions
- Rule monitoring:
  - Commission monitors compliance via multilateral surveillance; members regularly transmit required information; two reports published per year (June and December).
  - Since 2015 reforms, WAEMU Commission’s administrative capacity enhanced and voluntary compliance encouraged, but scope remains to strengthen the Commission as an independent enforcer—which would require increased capacity and potential treaty amendments.
- Escape clauses:
  - Commission can propose activation of escape clauses in exceptional circumstances; Council of Ministers may lift first-order criteria temporarily; Commission can propose directives defining size and duration; member government must propose corrective measures within 30 days.
  - Improvements needed:
    - More precise and quantitative triggers (current wording “exceptional circumstances” is vague).
    - Clear activation process, timelines, and procedures to revert to rules (the April 2020 suspension did not follow a well-defined escape clause process).
    - Institutional safeguards to limit political influence over activation (EU practice provides a reference where the Commission confirms conditions).
  - Caution: escape clauses for persistent security problems are problematic if they permit repeated deviations rather than structural fiscal adjustments.
- Correction mechanisms and sanctions:
  - Current WAEMU procedures: during convergence a breach requires corrective measures proposed by the Commission and approved by Council by two-thirds majority; in stability phase corrective measures for observed breaches required, only recommendations for projected breaches.
  - Framework lacks detailed guidance on pace of correction, milestones, deadlines, and supervisory requirements.
  - Enforcement authority resides with the Council of Ministers; reforms could tilt the balance toward the Commission by:
    - Granting the Commission authority to determine non-compliance;
    - Requiring the Commission to submit enforcement recommendations to the Council;
    - Ensuring recommendations are adopted unless rejected by qualified majority.
  - Sanctions under Article 74: declarative or financial (publication, withdrawal of positive measures, recommendation to West African Development Bank to review interventions, suspension of Union’s assistance). In practice, financial sanctions have never been applied.
  - Evidence shows financial sanctions often lack credibility and can be counter-productive; reputational sanctions are generally more effective but WAEMU’s current reputational sanctions are relatively weak.
  - Recommendation to raise reputational costs: establish independent national fiscal councils to conduct public independent assessments and monitoring of public finances; options include eight national councils or a single regional fiscal council; in resource-constrained countries, national councils could be hosted by existing independent institutions (e.g., national BCEAO offices).

### Public Financial Management (PFM) reforms and implementation gaps
- Regional PFM harmonization began in the late 1990s; 2015 fiscal framework revision emphasized continuing work on budget laws and procedures.
- 2009 regional directives (6 directives, plus 2 in 2011) aimed to align practices with GFSM 2001, strengthen results-based budgeting, and internal controls; directives do not provide guidance on fiscal risk management.
- Transposition and implementation:
  - By end-2019 all WAEMU countries had transposed the six PFM directives into national legislation.
  - Implementation progress was slow and uneven; WAEMU Commission had set a five-year implementation period to January 2017 which was missed.
  - 2021 evaluation showed improved progress but gaps remained in internal expenditure controls and transparency of accounts.
- Harmful PFM practices undermining de jure reforms:
  - Stock-flow adjustments averaged more than 1 percent of GDP between 2013 and 2019, contributing to a disconnect between deficits and debt.
  - Some SFAs reflect good practices, but others stem from PFM deficiencies: spending outside normal expenditure chains, abuse of exceptional procedures, circumvention of expenditure controls and approved appropriations.
  - These irregularities can conceal the true scale of public expenditure and lead to underestimated fiscal deficits on a commitment basis.

*Source: Appendix 1 of the IMF Working Paper “Strengthening the WAEMU Regional Fiscal Framework” (wpiea2022049-print-pdf).*

### Box 1. Public Debt Dynamics and Stock-Flow Adjustments (SFA) over 2012-19

### Box 1. Public Debt Dynamics and Stock-Flow Adjustments (SFA) over 2012-19

### Debt dynamics and contribution of Stock-Flow Adjustments (SFA)
- WAEMU public debt levels have increased significantly since 2012.
- Accounting decomposition of main drivers of debt dynamics:
  - About two-thirds of the debt increase was due to cumulated fiscal deficits.
  - About a third arose from cumulative SFA (abstracting from automatic debt dynamics of growth and exchange rate).
- SFA averaged about 1.3 percent of GDP per year between 2013 and 2019.
- SFA peaked in 2017 at 3.3 percent of GDP due to a one-off operation related to the expansion of the debt perimeter in Senegal.
- The debt ratio increased by about 17 percentage points of GDP between end-2012 and end-2019.
- At the time of the October 2014 WEO vintage, the debt ratio was projected by staff to increase slightly (by 2 percent of GDP) over the same period.
- Analysis of sources of forecast errors:
  - Errors came mostly from an underestimation of SFA.
  - Underestimation of SFA was the main factor behind forecast errors on debt projections.

### Nature and drivers of SFA (examples and assessment)
- SFA reflect a mix of sound and poor budget management practices.
  - Sound practices:
    - Arrears clearance in Côte d’Ivoire in 2018 is consistent with best PFM standards.
    - Extension of the debt perimeter in Senegal in 2017 is consistent with best PFM standards.
  - Poor or off-budget practices contributing to SFA:
    - Prefinancing schemes in Benin, Togo and Senegal.
    - Treasury financing of persistent deficits of SOEs in Senegal.
- Irregularities in fiscal accounting can lead to differences between above-the-line fiscal balance and below-the-line net financing data and large stock-flow discrepancies between government debt and deficits.

### Public Financial Management (PFM) weaknesses and reform imperatives
- To ensure that the 3 percent deficit rule remains an effective tool to constrain the debt trajectory, enhancing the PFM system should be a priority.
- Critical actions and constraints:
  - Expedite implementation of the directives at the national level.
  - Reasons for implementation delays include:
    - PFM reforms may have been highly ambitious and required a longer implementation period.
    - Enhanced budget transparency entailed by directives may be difficult to enforce given increased security spending in response to terrorism (subject to military secrecy and confidentiality).
    - Delays in technical assistance needed to help officials complete the implementation process.
  - Importance of upgrading member state capacity in macro-fiscal forecasting to ensure reliable and timely data provision.
    - Reliable forecasts would mitigate risks that large deviations from the announced policy stance undermine the credibility of the fiscal rule (IMF, 2009).
    - Reliable forecasts would allow some degree of internal monitoring of adherence to the rule and foster ownership of the rule at the national level.
  - Additional practical difficulties:
    - Limitations of national budgetary and accounting systems.
    - Challenges in implementing accrual accounting.
    - Limited access to budgetary information by the general public.

### Specific PFM reform recommendations to contain SFA and improve fiscal discipline
- Member countries must accelerate implementation of the regional directives on PFM reforms, especially those related to:
  - Improving internal expenditure controls.
  - Improving transparency of accounts.
- Complementary national-level measures to minimize deviations from approved budget appropriations and tighten link between fiscal and debt targets:
  - Establish clear legal frameworks for budget execution that restrict the use of exceptional and other simplified procedures to very limited cases (these procedures have often been a source of below-the-line operations).
  - Streamline expenditure controls under the normal chain of expenditure so they become less cumbersome and less redundant, reducing incentives to use less stringent and ad hoc procedures.
  - Adopt automated tools in the Financial Management Information System of fiscal reporting (Imbert and others, 2022).

### Fiscal coordination and fiscal risk-sharing mechanisms
- The third pillar of fiscal discipline in a currency union is the introduction of explicit coordination mechanisms covering taxes, expenditures, and financing to internalize cross-country spillovers.
- Tax coordination:
  - Case for enhancing tax coordination in the WAEMU.
  - The WAEMU Treaty emphasizes reducing excessive disparities in tax structure among member states.
  - The framework of tax coordination is advanced de jure but ineffective de facto due to incomplete implementation of directives.
  - Some regional tax directives may need revision to curb use of tax incentives and raise minimum rates of excises.
  - Regional framework could be strengthened with effective monitoring and sanctioning mechanisms.
    - To date, no WAEMU country fully adheres to the tax directives.
    - The WAEMU Court of Justice has never heard a single case on public finances, suggesting monitoring and sanctions are not being enforced.
  - Recommendation: WAEMU Commission could initiate a review of the tax coordination framework in collaboration with national authorities and undertake a detailed review of member countries’ legislation to identify gaps and promote greater adherence.
- Tax revenue convergence challenge:
  - The 2021 tax to GDP ratio at the WAEMU level is estimated at 13.2 percent of GDP—well below the 20 percent of GDP floor.
  - In June 2019, the Council of Ministers adopted an action plan to help countries reach the convergence criterion on tax revenue and increase fiscal space for investment spending.
  - The action plan aims at improving and standardizing VAT collection, excise duty, and direct tax collection, and defines actions to reduce tax competition and strengthen information exchange and digitalization.
- Managing large idiosyncratic shocks with contagion effects:
  - Three main approaches considered:
    - Use of escape clauses: Compensate temporary deviations from the deficit rules in countries affected by shocks with additional fiscal efforts in unaffected countries; challenges include operational and political implementation, quantification, and potential weakening of aggregate credibility.
    - A regional stabilization fund:
      - Would provide temporary transfers to countries affected by negative asymmetric macroeconomic shocks.
      - Could be financed by annual contributions from member states.
      - Basdevant and others (2015) suggested a simple, automatic, and non-regressive system of transfers ranging between 0.75 to 1.25 percent of GDP for the WAEMU to smooth income similarly to federal states.
      - Transfers would be proportional to: (1) the size of the shocks, (2) the relative size of each economy compared with the rest of the union, and (3) the resources accumulated in the fund each year.
      - If no country is affected by a negative shock, no disbursement would take place and contributions would be saved.
      - Regional bonds issuance could be an additional financing source but would need to be complemented by carefully designed fiscal integration.
    - Work towards a larger union budget:
      - Pool risks through a small and targeted common budget, deployable for health emergencies, for instance.
      - The WAEMU budget is small, representing only 0.2 percent of the region’s GDP (CFAF 205 billion in 2019).
      - By comparison, the European Union budget amounts to 1 percent of EU GDP.
  - Fiscal coordination mechanisms are critical to allow WAEMU countries to address shocks, especially asymmetric ones.

### Conclusions and reform priorities
- Two main conclusions:
  - The calibration exercise concludes that the debt and deficit ceilings that prevailed before the suspension of the rule (70 percent of GDP for debt and 3 percent of GDP for the deficit) remain adequate targets balancing growth, development, and fiscal sustainability.
  - Keeping the deficit ceiling in headline nominal terms seems more suitable than structural or cyclically-adjusted balance rules in the WAEMU context, given practical difficulties in implementing, monitoring, and communicating such rules.
- Going forward, fiscal consolidation during the coming years is needed and would require a well-designed fiscal framework including better fiscal discipline and coordination.
- Priority reforms across the three pillars:
  - Strengthen the design and enforcement of the WAEMU fiscal governance framework:
    - Strengthen monitoring by bolstering the independent enforcer role of the WAEMU Commission.
    - Enhance credibility of escape clauses by clearly defining triggers and timelines/procedures to revert to the rule.
    - Redefine correction mechanisms and sanctions for unauthorized deviations, including increasing reputational costs.
  - Enhance PFM to contain stock-flow adjustments and prevent buildup of fiscal imbalances:
    - Accelerate implementation of regional directives on PFM reforms, improve internal expenditure controls and transparency.
    - Improve national discipline to minimize deviations from approved budget appropriations and impose stricter compliance with expenditure controls.
    - Implement the national actions listed above (legal frameworks, streamlined controls, automated FMIS tools).
  - Strengthen fiscal coordination mechanisms:
    - Enhance tax coordination via implementation and compliance with directives and revise directives to curb tax incentives.
    - Enhance fiscal risk sharing to manage idiosyncratic shocks.
    - Consider a longer-term project to work towards a small union budget.

*Box 1. Public Debt Dynamics and Stock-Flow Adjustments (SFA) over 2012-19 — wpiea2022049-print-pdf*

### Appendix 1. Thinking about the Maximum Debt

### Appendix 1. Thinking about the Maximum Debt Limit for the WAEMU

### Fiscal Fatigue
- Concept: estimates the limit above which debt cannot be stabilized in times of fiscal stress because policymakers cannot generate sufficient primary surpluses to offset unfavorable macroeconomic conditions (Gosh et al., 2013).
- Maximum debt level approximation:
  - D* = PO_max / (r − g)_stress
- Empirical inputs (April 2021 WEO vintage):
  - 95th percentile of the distribution of the interest-growth differential (based on effective interest rates on debt) for countries in the region: 3.3 percent.
  - 95th percentile of the distribution of primary balances for WAEMU countries (historical WEO data since 1996): 2.7 percent of GDP.
- Resulting implication:
  - This maximum primary surplus (2.7 percent of GDP) divided by the interest-growth differential (3.3 percent) implies a debt limit of 80 percent of GDP.

### Preserving Debt Servicing Capacity
- Concept: focuses on preserving debt carrying capacity by monitoring the ratio of interest expenses to revenues (excluding grants) as an indicator of the ability to repay debt.
- Rationale:
  - For sub-Saharan African countries with low revenue mobilization, the interest-to-revenue ratio may be more relevant for sustainability than the debt level per se.
  - Empirical evidence links the interest-to-revenue ratio tightly to fiscal stress in emerging markets and developing economies (Bentum, David, Slavov, and Sode, 2022).
  - Econometric models suggest thresholds for the interest-to-revenue ratio that would signal upcoming fiscal stress range from 16 to 19 percent.
- Relationship to derive debt limit:
  - D* = τ × (Revenue/GDP) / (Effective interest rate)
    - (Presented in the source as D* = τ × [Revenue/GDP] / [Effective interest rate], with τ denoting the interest-to-revenue threshold.)
- Empirical inputs (WAEMU averages 2015–2019):
  - Revenue/GDP (excluding grants): 14.9%
  - Effective interest rate: 3.3%
- Resulting debt limits (Appendix Table estimates):
  - For τ = 16%:
    - Debt Limit = 72%
  - For τ = 19%:
    - Debt Limit = 86%

### Key Findings and Numerical Summary
- Fiscal-fatigue approach:
  - 95th percentile r−g: 3.3 percent
  - 95th percentile maximum primary balance: 2.7 percent of GDP
  - Implied debt limit: 80 percent of GDP
- Debt-servicing-capacity approach (using 2015–2019 WAEMU averages):
  - Revenue/GDP: 14.9%
  - Effective interest rate: 3.3%
  - Debt limits:
    - τ = 16% → 72%
    - τ = 19% → 86%
- Overall conclusion from the appendix:
  - A debt limit of around 80 percent of GDP for the WAEMU seems appropriate (simple average of the limits obtained under the different approaches).

*Source: Appendix 1. Thinking about the Maximum Debt Limit, Strengthening the WAEMU Regional Fiscal Framework, Working Paper No. WP/22/49*

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_Source: https://www.imf.org/-/media/files/publications/wp/2022/english/wpiea2022049-print-pdf.pdf_