## 1.  Potential Income Shortfalls over the Medium-Term Under Current Policies

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### Introduction: key issues and proposed approach
- The Fund needs to generate income to cover operational expenses and build reserves to protect against key financial risks.
- Under current arrangements, the Fund is heavily dependent on credit outstanding for its income; the margin on the basic rate of charge is set each year on a cost-plus basis.
- Reserves have built to around SDR 6 billion under the current system.
- GRA credit outstanding has fallen to its lowest level in 25 years: currently just over SDR 20 billion, less than a third of its peak of over SDR 70 billion reached three years ago.
- The current system for setting the rate of charge is not sustainable in a low-credit environment.
- Options discussed for broadening the Fund’s income base include:
  - establishing an Investment Account,
  - reducing remuneration,
  - introducing user fees,
  - increasing third-party financing,
  - selling part of the Fund’s gold and investing the proceeds.
- Proposed approach in the paper:
  - Update projections of the Fund’s income position in FY07 and the medium term.
  - Revisit available options.
  - Consider current policies, necessary policy adjustments, and precautionary balances.
- Precautionary balances are held primarily to mitigate credit and income risk; a pause in the Board’s agreed strategy for accumulating reserves is suggested while additional income options are developed.
- The paper presents measures that would eliminate the income gap in FY07 but notes a large financing gap remains moving forward; further work is required.

### Income outlook under current policies (structure and mechanics)
- The rate of charge margin is set to cover expenses and meet the net income target (Rule I-6(4)); the net income target equals 5 percent of the Fund’s reserves at the beginning of the financial year unless the Executive Board decides otherwise.
- The margin was set at 108 basis points for FY06, projected to achieve a net income target of SDR 188 million after paying administrative expenses of SDR 646 million.
- Surcharges:
  - 100 and 200 basis points apply on credit outstanding in the credit tranches and the Extended Fund Facility (EFF) above 200 and 300 percent of quota, respectively;
  - the Supplemental Reserve Facility carries an initial surcharge of 300 basis points, rising to a maximum of 500 basis points.
  - Surcharge income is excluded from the calculation of net income for determining whether the net income target has been achieved.
- Fund cost of financing is broadly given by the SDR interest rate; remuneration is paid at the SDR interest rate on reserve tranche positions.
- Lending-related income components:
  - Margin (after financing cost),
  - Annual commitment fee (25 basis points on amounts up to 100 percent of quota, and 10 basis points on amounts in excess of 100 percent of quota),
  - 50 basis point service charge on purchases.
- Implicit return on precautionary balances: balances are held with creditor members, reducing reserve tranche positions and saving the Fund remuneration costs.
- PRGF administrative expenses historically reimbursable from PRGF Trust; in recent years paid from surcharge income to maximize subsidized financing.

### Key findings and projections (selected figures preserved verbatim)
- Table 1 headline figures (In millions of SDRs, except where indicated):
  - A. Administrative expenses 1/: 646679 708 735
  - B. Income sources under current policies: 754520 498 471
    - B.1. Margin for the rate of charge 2/: 410208 159 110
    - B.2. Implicit return on reserves and the SCA-1 3/: 210254 279 298
    - B.3. Payment of PRGF expenses 4/: 5858 60 63
    - B.4. Payment for SRP funding 5/: 76-- -- --
  - C. Net income (B-A): 108-159 -210 -264
  - D. Net income target (current rules) 6/: 188283 220 232
  - E. Income shortfall (C-D): -80-442 -430 -496
- Memorandum items (from Table 1):
  - Fund credit outstanding (average): 35,80017,800 13,700 10,200
  - External financing by donors 7/: 2728 29 30
  - Surcharge income (after payment of PRGF expenses): 23866 20 1
  - SDR interest rate path (in percent) 8/: 2.73.3 3.7 3.9
  - Required margin under current rule (in basis points): 108356 422 594
  - Burden sharing adjustments (average, in basis points): 1934 45 61
    - Deferred charges: 48 11 15
    - SCA-1: 1526 34 46
- Central scenario assumptions and outlook:
  - Projections assume current borrowing member countries continue to repay as scheduled (expectations basis) and remaining scheduled disbursements take place under existing arrangements.
  - Under this central scenario, Fund credit could decline to SDR 15 billion by end-FY07, and less than SDR 8 billion by end-FY09.
  - At the current margin of 108 basis points, total income from regular sources in FY07 would decline from SDR 755 million to SDR 520 million under the central scenario.
  - Administrative expenses projected at about SDR 680 million on preliminary budget estimates would result in a loss under current policies.
  - Total shortfall vis-à-vis net income target in the order of SDR 440 million in FY07.
  - Covering the FY07 shortfall under the existing rule would require a margin of about 360 basis points.
  - By FY09, regular income from the margin could be as low as SDR 110 million (about 15 percent of the administrative budget, compared with about 65 percent at present).
  - Overall shortfall vis-à-vis net income target could be as high as SDR 500 million by FY09; income could fall short of expenses by about SDR 265 million.
  - Burden-sharing adjustments alone would rise from around 20 basis points currently to over 60 basis points in FY09 under current policies.

### Rule on the Rate of Charge and Surcharge Income (Box 1) — highlights
- Rate of Charge:
  - Basic rate of charge is set at a margin over the SDR interest rate, determined at the beginning of each financial year based on estimated income and expenses and the net income target.
  - Net income target equal to 5 percent of the Fund’s reserves at the beginning of the financial year, unless the Executive Board decides otherwise.
  - Semi-annual midyear reviews to determine corrective measures, such as adjustment to the rate of charge; shortfalls are typically added to the following year’s net income target.
- Surcharge Income:
  - Surcharges of 100 and 200 basis points apply on credit outstanding in the credit tranches and the EFF above 200 and 300 percent of quota, respectively.
  - The Supplemental Reserve Facility surcharge schedule described above.
  - Surcharge income is excluded from net income calculations for determining the net income target.

### Assessing medium-term sustainability: scenarios of credit outstanding and precautionary balances
- The Fund’s two main income sources under current policies: the margin on GRA lending operations and implicit earnings on interest-free reserves.
- Table 2 (Income Generated Under Different Scenarios of Credit Outstanding and Precautionary Balances 1/) (In millions of SDRs) — assumes a margin for the rate of charge of 108 basis points and an SDR rate of 3.5 percent; excludes service charges and surcharge income:
  - Precautionary Balances × Fund Credit Outstanding
    - 2,500:
      - 10,000 → 195
      - 20,000 → 305
      - 30,000 → 410
      - 40,000 → 520
    - 5,000:
      - 10,000 → 285
      - 20,000 → 390
      - 30,000 → 500
      - 40,000 → 605
    - 7,500:
      - 10,000 → 370
      - 20,000 → 480
      - 30,000 → 585
      - 40,000 → 695
    - 10,000:
      - 10,000 → 460
      - 20,000 → 565
      - 30,000 → 675
      - 40,000 → 780

### Implications and near-term steps
- The current policy framework is likely to produce substantial financing gaps over the medium term under plausible credit scenarios.
- Policy adjustments will be needed to close these gaps; given required voting majorities, broad membership support will be necessary.
- Time lags in generating additional income sources argue for initiating work on options now.
- A pause in reserve accumulation is suggested while additional income options are developed.
- Further work is required to identify medium-term mechanisms that ensure the Fund can operate without relying on sharp growth in lending.

### Income resilience and precautionary balances
- Recent build up in reserves has significantly increased the resilience of the Fund’s income position.
- Implicit contribution of precautionary balances to the Fund’s income is currently projected at about SDR 250 million in FY07 and to increase further in subsequent years.
- Counterfactuals:
  - If precautionary balances were in the SDR 2-3 billion range, the Fund’s present income position would be significantly more serious.
  - If precautionary balances were at the agreed target level of SDR 10 billion, the Fund could cover operating expenses around their current size at credit levels of SDR 30 billion, and the income shortfall at significantly lower credit levels would be much smaller than currently projected.
- Note on remuneration floor: current decision limits adjustments to a floor on the rate of remuneration of 85 percent of the SDR rate; Fund Articles set the floor at 80 percent of the SDR rate.

### Sustainability of the budget under varying credit scenarios
- With precautionary balances around SDR 7.5 billion, a Fund budget in the order of SDR 700–750 million (Table 1) is not sustainable unless credit expands substantially from current levels.
- Required credit base to sustain a budget of SDR 700–750 million: about SDR 40 billion.
- If credit declines to around SDR 10 billion (central scenario), the sustainable budget would be about SDR 370 million.
- Surcharge income assumption: surcharge income continues to be used to accumulate reserves as at present; at low credit levels surcharge income would likely decline to very low levels and would not significantly alter the picture.

### Trends in Fund credit outstanding (Box 2)
- Over the past twenty-five years, Fund credit outstanding followed a rising upward trend, with variability increasing in the 1990s.
- Recent sharp decline in credit has taken it well below the range normally associated with the prior trend (to well below two standard deviations).
- Uncertainty on whether recent decline is:
  - A temporary cyclical development (e.g., better macro policies, more flexible exchange rates, member reserve accumulation leading to structural decline in demand), or
  - The beginning of a new and lower trend (e.g., outcome of long period of accommodative global monetary policy and growing international imbalances).
- Observations from past experience:
  - Even with an upward trend, actual credit can remain below trend line for an extended period.
  - Exceptional access could cause rapid rise in Fund credit if a major crisis affects a few large economies.
  - Given extent of recent decline, a major event would likely be needed for credit to return near previous longer-term trend over a medium-term horizon.
- Data note: Fund Outstanding Credit, January 1980–December 2005 (figure); end-December 2005 data adjusted to reflect early repayment by Argentina on January 3, 2006.

### Options to ensure sustainable income if long-term credit ~ SDR 10 billion
- A different financing structure would be required if SDR 10 billion in credit outstanding becomes the central scenario.
- Options (would require changes in the Articles):
  - (i) an annual levy or assessment in proportion to quotas;
  - (ii) expanding the unremunerated reserve tranche positions (e.g., through the uniform adjustable norm);
  - (iii) reducing the floor under the Articles for the rate of remuneration;
  - (iv) amending the Fund’s investment authority.

### Broadening the income base — Investment Account
- Articles allow establishment of an Investment Account; total transferable amount equivalent to the Fund’s reserves (currently close to SDR 6 billion, excluding SCA-1 balances of SDR 1.7 billion).
- Current treatment: these reserves are part of currency balances kept with creditor members, implicitly earning the three-month SDR interest rate.
- Proposed approach: invest these balances in a portfolio of government securities to extend maturities beyond three-month SDR rate.
- Estimated additional income: about 50 basis points per annum ≈ additional average annual income of about SDR 30 million.
- Board status: Board discussed establishment in September 2005; most Directors supportive though some concerned about return prospects.

### Broadening the income base — Gold sales
- Articles permit sale of gold and investment of proceeds to generate additional income (e.g., Special Disbursement Account or Investment Account).
- Example approach: sell enough gold within an agreed timeframe to hold investments equivalent to the SDR 10 billion target for precautionary balances.
- At current market prices, this could require a gold sales program of about 11–12 million ounces, or roughly 11 percent of the Fund’s total holdings.
- Operationally feasible but would require an 85 percent majority decision and careful design to limit market impact.

### Broadening the income base — Increase the margin on GRA lending
- Current margin over the SDR rate charged on GRA lending: 108 basis points (a new high).
- Since 2002 (when Fund credit peaked at SDR 70 billion), the margin has more than doubled.
- At the current SDR interest rate, implies borrowing rate of about 4 ½ percent, excluding surcharges on exceptional access.
- Qualifications/constraints on further increases:
  - Cooperative limits on how far borrowing costs can be raised; very large increases would be out of line with past experience.
  - Borrowing members have already borne part of the income decline via past margin increases.
  - Large access cases subject to surcharges (currently Turkey and Uruguay) pay surcharges of 100–200 basis points on credit in the credit tranches over 200 percent of quota; marginal borrowing cost around 310 basis points over SDR interest rate before burden-sharing adjustments.
  - Further margin increases could encourage early repayment by large access cases before sustainable footing is achieved, which could be counter-productive.
  - Uncertainties in future margin fluctuations could make Fund credit less attractive to borrowers.
- Income estimates from margin increases (Table 3):
  - Additional income from increase in margin of about 10 percent (i.e., to 119 basis points):  
    - Credit outstanding SDR 10,000 → 11 (In millions of SDRs)  
    - SDR 20,000 → 22  
    - SDR 30,000 → 33  
    - SDR 40,000 → 44
  - Additional income from increase in margin of about 20 percent (i.e., to 130 basis points):  
    - SDR 10,000 → 22  
    - SDR 20,000 → 44  
    - SDR 30,000 → 66  
    - SDR 40,000 → 88

### Broadening the income base — Reduce remuneration
- Articles permit remuneration between 80 and 100 percent of the SDR interest rate; since FY88 remuneration has been 100 percent (before burden-sharing adjustments).
- Reducing the coefficient below 100 percent increases creditor members’ effective contribution to operations.
- Risks/constraints:
  - Would reduce burden-sharing capacity and could adversely affect the attractiveness of maintaining reserve tranche positions to central banks and auditors.
  - Effective rate of remuneration is already less than 100 percent because of unremunerated positions.
- Estimated savings from reductions in remuneration (Table 4; assumes SDR interest rate of 3.5 percent and constant difference of SDR 6.6 billion between Fund credit outstanding and remunerated reserve tranche positions):
  - Savings from reduction to 95 percent of the SDR rate: SDR 10,000 → 6; 20,000 → 23; 30,000 → 41; 40,000 → 58 (In millions of SDRs)
  - Savings from reduction to 90 percent of the SDR rate: SDR 10,000 → 12; 20,000 → 47; 30,000 → 82; 40,000 → 117
  - Savings from reduction to 85 percent of the SDR rate: SDR 10,000 → 12; 20,000 → 70; 30,000 → 123; 40,000 → 175
    - Note: Because of need to maintain a cushion for burden-sharing of estimated deferred charges (SDR 12 million), under a scenario of SDR 10 billion in credit outstanding, there are no additional savings from reducing the rate of remuneration below 90 percent of the SDR rate.
  - Savings from reduction to 80 percent of the SDR rate (after allowing for assumed SDR 12 million in burden-sharing for deferred charges): SDR 10,000 → 12; 20,000 → 82; 30,000 → 152; 40,000 → 222

### Medium-term strategy and other income sources
- Medium-Term Strategy Review suggests exploring additional income sources as part of the Fund’s strategic orientation.
- Options mentioned:
  - External Financing: Fund already receives over SDR 25 million annually in external financing from donors; potential to increase such financing (management-chaired task force examining framework).
    - Possibility: trust fund for donor support to technical assistance; deposits in administered account at below market rates to mobilize subsidy resources.
  - User Fees: charge fees for certain services/products where permissible under the Articles; mechanisms needed to defray costs for low-income members (e.g., subsidies).
  - Commitment Fees: at current fee structure, precautionary arrangements of SDR 10 billion could generate up to SDR 25 million per annum in fees; adaptations to financial instruments could yield additional charges.

### Precautionary balances: composition and functions
- Precautionary balances comprise reserves and the Special Contingent Account (SCA-1).
- The Fund’s reserves comprise the Special Reserve and the General Reserve.
- Main functions of reserves:
  - (i) to protect the Fund’s financial position against credit risk and risk of operational losses;
  - (ii) to demonstrate, through the achievement and retention of net income, the soundness and prudence of the institution’s financial management;
  - (iii) to augment the Fund’s liquidity.
- Special Reserve:
  - Established in 1957 with proceeds from a gold investment program to provide safeguards against deficits.
  - Additions financed out of net income (other than income derived from surcharges).
  - The Fund may use the Special Reserve for any purpose for which it may use the General Reserve, except distribution.
- General Reserve:
  - Term used since 1958 for reserves contemplated in Article XII, Section 6 (a).
  - Available to meet losses of a capital character or administrative deficits.
  - Additions since FY 1998 have been made from income derived from surcharges under the Supplemental Reserve Facility, in the credit tranches, and under the Extended Fund Facility.
- SCA-1:
  - Set up in 1987 to protect the Fund against the risk of loss arising from the ultimate failure of members to settle their overdue principal obligations in the GRA.
  - Allocations: initially funded with excess FY87 income; until FY01 allocated annually an amount equal to 5 percent of reserves; since then additions set at SDR 94 million (representing the reduction in the net income target from the gold mitigation).
  - Uses: losses from ultimate failure to repay overdue GRA principal would first be charged against the SCA-1; contributors bear losses in proportion to cumulative contributions to SCA-1.
  - Dissolution and refunds: SCA-1 would be dissolved and resources distributed to members in proportion to cumulative contributions when there are no overdue GRA charges or principal balances; early distribution possible.

### Reserve accumulation strategy and quantified near-term adjustments
- Current strategy for reserve accumulation involves annual placement to reserves of two income sources:
  - (i) net surcharge income placed to the General Reserve;
  - (ii) net income (i.e., the net income target, if achieved) placed to the Special Reserve.
- In 2002 the Board adopted a target for precautionary balances of SDR 10 billion; reaffirmed in 2004.
- Precautionary balances increased from SDR 4.5 billion at adoption of the target to around SDR 7.5 billion currently.
- Two changes in computation of the net income target that could be considered within current rules (Table 5):
  - Rebasing: exclude the General Reserve from the base for the net income target would reduce the net income target by about SDR 160 million.
  - Eliminate carryovers: excluding carryover of the FY06 shortfall (current estimate of the FY06 income shortfall is SDR 80 million) could reduce the FY07 net income target by a further SDR 80 million.
- Suspending the net income target: existing rules could allow setting the target at a token nominal amount (Rule I-6(4) requires the net income target to set as a “percent of reserves” which would preclude a net income target of zero).
- Use surcharge income to pay administrative expenses:
  - Example net surcharge income after PRGF administrative expenses: SDR 66, 20, 1 (table rows).
- Table 5 summary (selected figures, in millions of SDRs):
  - Projected income shortfall (A): FY07 -442; FY08 -430-496.
  - Changing the net income target (B): FY07 237; FY08 161162.
  - Suspend the remaining net income target (C): FY07 45; FY08 5869.
  - Use net surcharge income to pay for administrative expenses (D): FY07 66; FY08 201.
  - Remaining income gap (E = A+B+C+D): FY07 -94; FY08 -191-264.
- Footnote on Rule I-6(4): does not require carryover of an income shortfall—the Executive Board has discretionary power to determine subsequent net income target “in light of the results in the previous financial year.”

### Suspending SCA-1 accumulations and gold mitigation considerations
- Current practice implies annual accumulation of SDR 94 million to SCA-1, shared equally between creditor and debtor members (SDR 47 million each).
- Declining credit base accentuates necessary burden-sharing adjustments, which could be as high as 60 basis points over the medium term.
- Capacity of burden-sharing via remuneration (floor on remuneration of 80 percent of the SDR rate) would likely prove insufficient to generate SDR 47 million by FY09 under the baseline credit scenario.
- One approach: suspend gold mitigation — would increase effective rate of remuneration for creditors and reduce effective rate of charge for borrowers, at expense of corresponding accumulation of precautionary balances; could be combined with offsetting adjustments in the rate of remuneration and rate of charge.

### Drawing down reserves and combined policy approach
- The Fund has met temporary losses in the past by drawing down capital and reserves and could do so again, though this is not desirable.
- Possible combined approach to cover income shortfall for FY07 and potentially medium term:
  - (i) activation of the Investment Account;
  - (ii) suspension of gold mitigation, a slowing or pause in reserve accumulation via a notional net income target, and possibly temporary use of surcharge income to cover operating expenses;
  - (iii) at least offsetting reductions in the rate of remuneration and increases in the rate of charge;
  - (iv) steps to explore possible introduction of alternative income-broadening mechanisms.
- The last option becomes particularly important if credit continues to decline, as other measures would not be sufficient in outer years under that scenario.

### One policy package example to close the FY07 income gap (Table 6)
- Table 6 summary (in millions of SDRs):
  - Projected income gap (A): FY07 -94; FY08 -191-264.
  - Policy options (B) aggregate examples:
    - Establish the Investment Account: FY07 30; FY08 30; FY09 30. (Assumes average annual incremental return of 50 basis points.)
    - Increase the margin: FY07 30; FY08 23; FY09 17. (Increase in the margin and reduction in remuneration offset by suspension of further accumulations in the SCA-1.)
    - Reduce remuneration: FY07 30; FY08 23; FY09 8.
    - Total policy options B: FY07 90; FY08 8160.
  - Remaining income gap (C = A+B): FY07 -4; FY08 -110-204.
  - Memorandum items:
    - Remaining income gap as a percent of administrative expenses: --; 1628.
    - Remaining income gap as a percent of reserves: --; 1.93.5.
- Example package described:
  - Maintain effective rate of charge and rate of remuneration at current level while establishing and funding the Investment Account.
  - Suspension of SCA-1 accumulations could facilitate a nominal increase in the margin to 125 basis points generating around SDR 30 million in FY07.
  - SCA-1 burden-sharing adjustments to rate of remuneration could help close projected income gap by SDR 30 million.
  - Such package, with Investment Account, could bring FY07 income outlook into broad balance on current projections.
- Limitation: package would not on current projections be sufficient over the medium term; further work needed on revenue mechanisms, use of Fund’s own resources (including gold), adequacy of precautionary balances, medium-term strategy and budget linked to income framework, and reconsideration of rules for setting the margin and net income target.

### Next steps and issues for Board discussion
- Immediate priority: generate income for FY07; decision on rate of charge needed by end-April.
- Options for Board consideration could include combination of:
  - Establishment and funding of the Investment Account,
  - Reformulation of the computation of the net income target,
  - Adjustments to the rate of remuneration and the margin,
  - Temporary slowdown or suspension in the pace of accumulation of reserves and the SCA-1.
- Key discussion questions for Directors highlighted:
  - Need for a stable and durable source of financing and proposals for low-demand-for-credit environment?
  - Need to avoid a sharp increase in the rate of charge for FY07 and modify rules for setting the rate of charge?
  - Views on implementing measures to close FY07 financing gap: establishment of Investment Account; reduction in remuneration with suspension of SCA-1 accumulations; scope for increasing the margin in FY07?
  - Feasibility of generating income through user fees, scope for increased external financing by donors, and charges on new financing instruments (e.g., commitment fees)? Other opportunities for additional revenue?

*Source: _021706 - 1.  Potential Income Shortfalls over the Medium-Term Under Current Policies ...............6*

### 1.  Potential Income Shortfalls over the Medium-Term Under Current Policies ...............6

### 1.  Potential Income Shortfalls over the Medium-Term Under Current Policies ...............6

### Introduction: key issues and proposed approach
- The Fund needs to generate income to cover operational expenses and build reserves to protect against key financial risks.
- Under current arrangements, the Fund is heavily dependent on credit outstanding for its income; the margin on the basic rate of charge is set each year on a cost-plus basis.
- Reserves have built to around SDR 6 billion under the current system.
- GRA credit outstanding has fallen to its lowest level in 25 years: currently just over SDR 20 billion, less than a third of its peak of over SDR 70 billion reached three years ago.
- The current system for setting the rate of charge is not sustainable in a low-credit environment.
- Options discussed for broadening the Fund’s income base include:
  - establishing an Investment Account,
  - reducing remuneration,
  - introducing user fees,
  - increasing third-party financing,
  - selling part of the Fund’s gold and investing the proceeds.
- Proposed approach in the paper:
  - Update projections of the Fund’s income position in FY07 and the medium term.
  - Revisit available options.
  - Consider current policies, necessary policy adjustments, and precautionary balances.
- Precautionary balances are held primarily to mitigate credit and income risk; a pause in the Board’s agreed strategy for accumulating reserves is suggested while additional income options are developed.
- The paper presents measures that would eliminate the income gap in FY07 but notes a large financing gap remains moving forward; further work is required.

### Income outlook under current policies (structure and mechanics)
- The rate of charge margin is set to cover expenses and meet the net income target (Rule I-6(4)); the net income target equals 5 percent of the Fund’s reserves at the beginning of the financial year unless the Executive Board decides otherwise.
- The margin was set at 108 basis points for FY06, projected to achieve a net income target of SDR 188 million after paying administrative expenses of SDR 646 million.
- Surcharges: 100 and 200 basis points apply on credit outstanding in the credit tranches and the Extended Fund Facility (EFF) above 200 and 300 percent of quota, respectively; the Supplemental Reserve Facility carries an initial surcharge of 300 basis points, rising to a maximum of 500 basis points. Surcharge income is excluded from the calculation of net income for determining whether the net income target has been achieved.
- Fund cost of financing is broadly given by the SDR interest rate; remuneration is paid at the SDR interest rate on reserve tranche positions.
- Lending-related income components:
  - Margin (after financing cost),
  - Annual commitment fee (25 basis points on amounts up to 100 percent of quota, and 10 basis points on amounts in excess of 100 percent of quota),
  - 50 basis point service charge on purchases.
- Implicit return on precautionary balances: balances are held with creditor members, reducing reserve tranche positions and saving the Fund remuneration costs.
- PRGF administrative expenses historically reimbursable from PRGF Trust; in recent years paid from surcharge income to maximize subsidized financing.

### Key findings and projections (selected figures preserved verbatim)
- Table 1 headline figures (In millions of SDRs, except where indicated):
  - A. Administrative expenses 1/: 646679 708 735
  - B. Income sources under current policies: 754520 498 471
    - B.1. Margin for the rate of charge 2/: 410208 159 110
    - B.2. Implicit return on reserves and the SCA-1 3/: 210254 279 298
    - B.3. Payment of PRGF expenses 4/: 5858 60 63
    - B.4. Payment for SRP funding 5/: 76-- -- --
  - C. Net income (B-A): 108-159 -210 -264
  - D. Net income target (current rules) 6/: 188283 220 232
  - E. Income shortfall (C-D): -80-442 -430 -496
- Memorandum items (from Table 1):
  - Fund credit outstanding (average): 35,80017,800 13,700 10,200
  - External financing by donors 7/: 2728 29 30
  - Surcharge income (after payment of PRGF expenses): 23866 20 1
  - SDR interest rate path (in percent) 8/: 2.73.3 3.7 3.9
  - Required margin under current rule (in basis points): 108356 422 594
  - Burden sharing adjustments (average, in basis points): 1934 45 61
    - Deferred charges: 48 11 15
    - SCA-1: 1526 34 46
- Central scenario assumptions and outlook:
  - Projections assume current borrowing member countries continue to repay as scheduled (expectations basis) and remaining scheduled disbursements take place under existing arrangements.
  - Under this central scenario, Fund credit could decline to SDR 15 billion by end-FY07, and less than SDR 8 billion by end-FY09.
  - At the current margin of 108 basis points, total income from regular sources in FY07 would decline from SDR 755 million to SDR 520 million under the central scenario.
  - Administrative expenses projected at about SDR 680 million on preliminary budget estimates would result in a loss under current policies.
  - Total shortfall vis-à-vis net income target in the order of SDR 440 million in FY07.
  - Covering the FY07 shortfall under the existing rule would require a margin of about 360 basis points.
  - By FY09, regular income from the margin could be as low as SDR 110 million (about 15 percent of the administrative budget, compared with about 65 percent at present).
  - Overall shortfall vis-à-vis net income target could be as high as SDR 500 million by FY09; income could fall short of expenses by about SDR 265 million.
  - Burden-sharing adjustments alone would rise from around 20 basis points currently to over 60 basis points in FY09 under current policies.

### Box 1 (Rule on the Rate of Charge and Surcharge Income) — preserved highlights
- Rate of Charge:
  - Basic rate of charge is set at a margin over the SDR interest rate, determined at the beginning of each financial year based on estimated income and expenses and the net income target.
  - Net income target equal to 5 percent of the Fund’s reserves at the beginning of the financial year, unless the Executive Board decides otherwise.
  - Semi-annual midyear reviews to determine corrective measures, such as adjustment to the rate of charge; shortfalls are typically added to the following year’s net income target.
- Surcharge Income:
  - Surcharges of 100 and 200 basis points apply on credit outstanding in the credit tranches and the EFF above 200 and 300 percent of quota, respectively.
  - The Supplemental Reserve Facility surcharge schedule described above.
  - Surcharge income is excluded from net income calculations for determining the net income target.

### Assessing medium-term sustainability: scenarios of credit outstanding and precautionary balances
- The Fund’s two main income sources under current policies: the margin on GRA lending operations and implicit earnings on interest-free reserves.
- Table 2 (Income Generated Under Different Scenarios of Credit Outstanding and Precautionary Balances 1/) (In millions of SDRs) — assumes a margin for the rate of charge of 108 basis points and an SDR rate of 3.5 percent; excludes service charges and surcharge income:
  - Precautionary Balances × Fund Credit Outstanding
    - 2,500:
      - 10,000 → 195
      - 20,000 → 305
      - 30,000 → 410
      - 40,000 → 520
    - 5,000:
      - 10,000 → 285
      - 20,000 → 390
      - 30,000 → 500
      - 40,000 → 605
    - 7,500:
      - 10,000 → 370
      - 20,000 → 480
      - 30,000 → 585
      - 40,000 → 695
    - 10,000:
      - 10,000 → 460
      - 20,000 → 565
      - 30,000 → 675
      - 40,000 → 780

### Implications and near-term steps
- The current policy framework is likely to produce substantial financing gaps over the medium term under plausible credit scenarios.
- Policy adjustments will be needed to close these gaps; given required voting majorities, broad membership support will be necessary.
- Time lags in generating additional income sources argue for initiating work on options now.
- A pause in reserve accumulation is suggested while additional income options are developed.
- Further work is required to identify medium-term mechanisms that ensure the Fund can operate without relying on sharp growth in lending.

*Source: _021706 - 1.  Potential Income Shortfalls over the Medium-Term Under Current Policies ...............6*

### 19.      The first point to note is that the build up in reserves in recent years has significantly

### _021706 - 19.      The first point to note is that the build up in reserves in recent years has significantly

### Income resilience and precautionary balances
- Recent build up in reserves has significantly increased the resilience of the Fund’s income position.
- Implicit contribution of precautionary balances to the Fund’s income is currently projected at about SDR 250 million in FY07 and to increase further in subsequent years.
- Counterfactuals:
  - If precautionary balances were in the SDR 2-3 billion range, the Fund’s present income position would be significantly more serious.
  - If precautionary balances were at the agreed target level of SDR 10 billion, the Fund could cover operating expenses around their current size at credit levels of SDR 30 billion, and the income shortfall at significantly lower credit levels would be much smaller than currently projected.
- Note on remuneration floor: current decision limits adjustments to a floor on the rate of remuneration of 85 percent of the SDR rate; Fund Articles set the floor at 80 percent of the SDR rate.

### Sustainability of the budget under varying credit scenarios
- With precautionary balances around SDR 7.5 billion, a Fund budget in the order of SDR 700–750 million (Table 1) is not sustainable unless credit expands substantially from current levels.
- Required credit base to sustain a budget of SDR 700–750 million: about SDR 40 billion.
- If credit declines to around SDR 10 billion (central scenario), the sustainable budget would be about SDR 370 million.
- Surcharge income assumption: surcharge income continues to be used to accumulate reserves as at present; at low credit levels surcharge income would likely decline to very low levels and would not significantly alter the picture.

### Trends in Fund credit outstanding (Box 2)
- Over the past twenty-five years, Fund credit outstanding followed a rising upward trend, with variability increasing in the 1990s.
- Recent sharp decline in credit has taken it well below the range normally associated with the prior trend (to well below two standard deviations).
- Uncertainty on whether recent decline is:
  - A temporary cyclical development (e.g., better macro policies, more flexible exchange rates, member reserve accumulation leading to structural decline in demand), or
  - The beginning of a new and lower trend (e.g., outcome of long period of accommodative global monetary policy and growing international imbalances).
- Observations from past experience:
  - Even with an upward trend, actual credit can remain below trend line for an extended period.
  - Exceptional access could cause rapid rise in Fund credit if a major crisis affects a few large economies.
  - Given extent of recent decline, a major event would likely be needed for credit to return near previous longer-term trend over a medium-term horizon.
- Data note: Fund Outstanding Credit, January 1980–December 2005 (figure); end-December 2005 data adjusted to reflect early repayment by Argentina on January 3, 2006.

### Options to ensure sustainable income if long-term credit ~ SDR 10 billion
- A different financing structure would be required if SDR 10 billion in credit outstanding becomes the central scenario.
- Options (would require changes in the Articles):
  - (i) an annual levy or assessment in proportion to quotas;
  - (ii) expanding the unremunerated reserve tranche positions (e.g., through the uniform adjustable norm);
  - (iii) reducing the floor under the Articles for the rate of remuneration;
  - (iv) amending the Fund’s investment authority.

### Broadening the income base — Investment Account
- Articles allow establishment of an Investment Account; total transferable amount equivalent to the Fund’s reserves (currently close to SDR 6 billion, excluding SCA-1 balances of SDR 1.7 billion).
- Current treatment: these reserves are part of currency balances kept with creditor members, implicitly earning the three-month SDR interest rate.
- Proposed approach: invest these balances in a portfolio of government securities to extend maturities beyond three-month SDR rate.
- Estimated additional income: about 50 basis points per annum ≈ additional average annual income of about SDR 30 million.
- Board status: Board discussed establishment in September 2005; most Directors supportive though some concerned about return prospects.

### Broadening the income base — Gold sales
- Articles permit sale of gold and investment of proceeds to generate additional income (e.g., Special Disbursement Account or Investment Account).
- Example approach: sell enough gold within an agreed timeframe to hold investments equivalent to the SDR 10 billion target for precautionary balances.
- At current market prices, this could require a gold sales program of about 11–12 million ounces, or roughly 11 percent of the Fund’s total holdings.
- Operationally feasible but would require an 85 percent majority decision and careful design to limit market impact.

### Broadening the income base — Increase the margin on GRA lending
- Current margin over the SDR rate charged on GRA lending: 108 basis points (a new high).
- Since 2002 (when Fund credit peaked at SDR 70 billion), the margin has more than doubled.
- At the current SDR interest rate, implies borrowing rate of about 4 ½ percent, excluding surcharges on exceptional access.
- Qualifications/constraints on further increases:
  - Cooperative limits on how far borrowing costs can be raised; very large increases would be out of line with past experience.
  - Borrowing members have already borne part of the income decline via past margin increases.
  - Large access cases subject to surcharges (currently Turkey and Uruguay) pay surcharges of 100–200 basis points on credit in the credit tranches over 200 percent of quota; marginal borrowing cost around 310 basis points over SDR interest rate before burden-sharing adjustments.
  - Further margin increases could encourage early repayment by large access cases before sustainable footing is achieved, which could be counter-productive.
  - Uncertainties in future margin fluctuations could make Fund credit less attractive to borrowers.
- Income estimates from margin increases (Table 3):
  - Additional income from increase in margin of about 10 percent (i.e., to 119 basis points):  
    - Credit outstanding SDR 10,000 → 11 (In millions of SDRs)  
    - SDR 20,000 → 22  
    - SDR 30,000 → 33  
    - SDR 40,000 → 44
  - Additional income from increase in margin of about 20 percent (i.e., to 130 basis points):  
    - SDR 10,000 → 22  
    - SDR 20,000 → 44  
    - SDR 30,000 → 66  
    - SDR 40,000 → 88

### Broadening the income base — Reduce remuneration
- Articles permit remuneration between 80 and 100 percent of the SDR interest rate; since FY88 remuneration has been 100 percent (before burden-sharing adjustments).
- Reducing the coefficient below 100 percent increases creditor members’ effective contribution to operations.
- Risks/constraints:
  - Would reduce burden-sharing capacity and could adversely affect the attractiveness of maintaining reserve tranche positions to central banks and auditors.
  - Effective rate of remuneration is already less than 100 percent because of unremunerated positions.
- Estimated savings from reductions in remuneration (Table 4; assumes SDR interest rate of 3.5 percent and constant difference of SDR 6.6 billion between Fund credit outstanding and remunerated reserve tranche positions):
  - Savings from reduction to 95 percent of the SDR rate: SDR 10,000 → 6; 20,000 → 23; 30,000 → 41; 40,000 → 58 (In millions of SDRs)
  - Savings from reduction to 90 percent of the SDR rate: SDR 10,000 → 12; 20,000 → 47; 30,000 → 82; 40,000 → 117
  - Savings from reduction to 85 percent of the SDR rate: SDR 10,000 → 12; 20,000 → 70; 30,000 → 123; 40,000 → 175
    - Note: Because of need to maintain a cushion for burden-sharing of estimated deferred charges (SDR 12 million), under a scenario of SDR 10 billion in credit outstanding, there are no additional savings from reducing the rate of remuneration below 90 percent of the SDR rate.
  - Savings from reduction to 80 percent of the SDR rate (after allowing for assumed SDR 12 million in burden-sharing for deferred charges): SDR 10,000 → 12; 20,000 → 82; 30,000 → 152; 40,000 → 222

### Medium-term strategy and other income sources
- Medium-Term Strategy Review suggests exploring additional income sources as part of the Fund’s strategic orientation.
- Options mentioned:
  - External Financing: Fund already receives over SDR 25 million annually in external financing from donors; potential to increase such financing (management-chaired task force examining framework).
    - Possibility: trust fund for donor support to technical assistance; deposits in administered account at below market rates to mobilize subsidy resources.
  - User Fees: charge fees for certain services/products where permissible under the Articles; mechanisms needed to defray costs for low-income members (e.g., subsidies).
  - Commitment Fees: at current fee structure, precautionary arrangements of SDR 10 billion could generate up to SDR 25 million per annum in fees; adaptations to financial instruments could yield additional charges.

*Source: Finance Department*

### 36.      Precautionary balances (i.e., reserves and the SCA-1) are held to mitigate the Fund’s

### 36.      Precautionary balances (i.e., reserves and the SCA-1) are held to mitigate the Fund’s

### Precautionary balances: composition and functions
- Precautionary balances comprise reserves and the Special Contingent Account (SCA-1).
- The Fund’s reserves comprise the Special Reserve and the General Reserve.
- Main functions of reserves:
  - (i) to protect the Fund’s financial position against credit risk and risk of operational losses;
  - (ii) to demonstrate, through the achievement and retention of net income, the soundness and prudence of the institution’s financial management;
  - (iii) to augment the Fund’s liquidity.
- Special Reserve:
  - Established in 1957 with proceeds from a gold investment program to provide safeguards against deficits.
  - Additions financed out of net income (other than income derived from surcharges).
  - The Fund may use the Special Reserve for any purpose for which it may use the General Reserve, except distribution.
- General Reserve:
  - Term used since 1958 for reserves contemplated in Article XII, Section 6 (a).
  - Available to meet losses of a capital character or administrative deficits.
  - Additions since FY 1998 have been made from income derived from surcharges under the Supplemental Reserve Facility, in the credit tranches, and under the Extended Fund Facility.
- SCA-1:
  - Set up in 1987 to protect the Fund against the risk of loss arising from the ultimate failure of members to settle their overdue principal obligations in the GRA.
  - Allocations: initially funded with excess FY87 income; until FY01 allocated annually an amount equal to 5 percent of reserves; since then additions set at SDR 94 million (representing the reduction in the net income target from the gold mitigation).
  - Uses: losses from ultimate failure to repay overdue GRA principal would first be charged against the SCA-1; contributors bear losses in proportion to cumulative contributions to SCA-1.
  - Dissolution and refunds: SCA-1 would be dissolved and resources distributed to members in proportion to cumulative contributions when there are no overdue GRA charges or principal balances; early distribution possible.

### Reserve accumulation strategy and targets
- Current strategy for reserve accumulation involves annual placement to reserves of two income sources:
  - (i) net surcharge income placed to the General Reserve;
  - (ii) net income (i.e., the net income target, if achieved) placed to the Special Reserve.
- Balances are also accumulated in the SCA-1 through the burden-sharing mechanism, notably an annual amount of SDR 94 million representing the estimated annual cost of the 1999–2000 off-market gold transactions.
- In 2002 the Board adopted a target for precautionary balances of SDR 10 billion; reaffirmed in 2004.
- Precautionary balances increased from SDR 4.5 billion at adoption of the target to around SDR 7.5 billion currently.

### Slowing reserve accumulation — options and quantified impacts
- Rationale: some income-broadening options take time and would only provide additional income over the medium term; a short-term pause in reserve accumulation may be appropriate.
- Two changes in computation of the net income target that could be considered within current rules (Table 5):
  - Rebasing: exclude the General Reserve from the base for the net income target would reduce the net income target by about SDR 160 million.
  - Eliminate carryovers: excluding carryover of the FY06 shortfall (current estimate of the FY06 income shortfall is SDR 80 million) could reduce the FY07 net income target by a further SDR 80 million.
- Suspending the net income target: existing rules could allow setting the target at a token nominal amount (Rule I-6(4) requires the net income target to set as a “percent of reserves” which would preclude a net income target of zero).
- Use surcharge income to pay administrative expenses:
  - Surcharge income and PRGF administrative expense examples:
    - Surcharge income: SDR 124 (mem.), 80, 64 (years implied in table);
    - Less: PRGF administrative expenses: SDR -58, -60, -63.
  - Net available shown: e.g., use net surcharge income to pay for administrative expenses could yield SDR 66, 20, 1 (table rows).
- Table 5 summary (selected figures, in millions of SDRs):
  - Projected income shortfall (A): FY07 -442; FY08 -430-496.
  - Changing the net income target (B): FY07 237; FY08 161162. (Rebasing: 157; 161162. Eliminating carryover of FY06 shortfall: 80.)
  - Suspend the remaining net income target (C): FY07 45; FY08 5869.
  - Use net surcharge income to pay for administrative expenses (D): FY07 66; FY08 201.
  - Remaining income gap (E = A+B+C+D): FY07 -94; FY08 -191-264.
- Footnote on Rule I-6(4): does not require carryover of an income shortfall—the Executive Board has discretionary power to determine subsequent net income target “in light of the results in the previous financial year.”

### Suspending SCA-1 accumulations and gold mitigation considerations
- Current practice implies annual accumulation of SDR 94 million to SCA-1, shared equally between creditor and debtor members (SDR 47 million each).
- Considerations for slowing or abandoning SCA-1 accumulation:
  - Declining credit base accentuates necessary burden-sharing adjustments, which could be as high as 60 basis points over the medium term.
  - For borrowing members, the SDR 47 million collected through the rate of charge is borne by only a few countries; the SDR 47 million collected through the rate of remuneration is shared by the much larger number of countries in the Financial Transactions Plan.
  - Capacity of burden-sharing via remuneration (floor on remuneration of 80 percent of the SDR rate) would likely prove insufficient to generate SDR 47 million by FY09 under the baseline credit scenario.
  - Current approach uses a refundable mechanism (related to arrears clearance) to cover a permanent increase in the Fund’s costs; recent use of proceeds of the 1999–2000 off-market gold transactions (held in the SDA) in context of the MDRI strengthens case for a more permanent, simpler, transparent arrangement.
- One approach: suspend gold mitigation — would increase effective rate of remuneration for creditors and reduce effective rate of charge for borrowers, at expense of corresponding accumulation of precautionary balances; could be combined with offsetting adjustments in the rate of remuneration and rate of charge.

### Drawing down reserves and overall possible approach
- The Fund has met temporary losses in the past by drawing down capital and reserves and could do so again, though this is not desirable.
- Possible combined approach to cover income shortfall for FY07 and potentially medium term:
  - (i) activation of the Investment Account;
  - (ii) suspension of gold mitigation, a slowing or pause in reserve accumulation via a notional net income target, and possibly temporary use of surcharge income to cover operating expenses;
  - (iii) at least offsetting reductions in the rate of remuneration and increases in the rate of charge;
  - (iv) steps to explore possible introduction of alternative income-broadening mechanisms.
- The last option becomes particularly important if credit continues to decline, as other measures would not be sufficient in outer years under that scenario.

### One policy package example to close the FY07 income gap (Table 6)
- Table 6 summary (in millions of SDRs):
  - Projected income gap (A): FY07 -94; FY08 -191-264.
  - Policy options (B) aggregate examples:
    - Establish the Investment Account: FY07 30; FY08 30; FY09 30. (Assumes average annual incremental return of 50 basis points.)
    - Increase the margin: FY07 30; FY08 23; FY09 17. (Increase in the margin and reduction in remuneration offset by suspension of further accumulations in the SCA-1.)
    - Reduce remuneration: FY07 30; FY08 23; FY09 8.
    - Total policy options B: FY07 90; FY08 8160.
  - Remaining income gap (C = A+B): FY07 -4; FY08 -110-204.
  - Memorandum items:
    - Remaining income gap as a percent of administrative expenses: --; 1628.
    - Remaining income gap as a percent of reserves: --; 1.93.5.
- Example package described:
  - Maintain effective rate of charge and rate of remuneration at current level while establishing and funding the Investment Account.
  - Suspension of SCA-1 accumulations could facilitate a nominal increase in the margin to 125 basis points generating around SDR 30 million in FY07.
  - SCA-1 burden-sharing adjustments to rate of remuneration could help close projected income gap by SDR 30 million.
  - Such package, with Investment Account, could bring FY07 income outlook into broad balance on current projections.
- Limitation: package would not on current projections be sufficient over the medium term; further work needed on revenue mechanisms, use of Fund’s own resources (including gold), adequacy of precautionary balances, medium-term strategy and budget linked to income framework, and reconsideration of rules for setting the margin and net income target.

### Next steps and issues for Board discussion
- Immediate priority: generate income for FY07; decision on rate of charge needed by end-April.
- Options for Board consideration could include combination of:
  - Establishment and funding of the Investment Account,
  - Reformulation of the computation of the net income target,
  - Adjustments to the rate of remuneration and the margin,
  - Temporary slowdown or suspension in the pace of accumulation of reserves and the SCA-1.
- Key discussion questions for Directors highlighted:
  - Need for a stable and durable source of financing and proposals for low-demand-for-credit environment?
  - Need to avoid a sharp increase in the rate of charge for FY07 and modify rules for setting the rate of charge?
  - Views on implementing measures to close FY07 financing gap: establishment of Investment Account; reduction in remuneration with suspension of SCA-1 accumulations; scope for increasing the margin in FY07?
  - Feasibility of generating income through user fees, scope for increased external financing by donors, and charges on new financing instruments (e.g., commitment fees)? Other opportunities for additional revenue?

### Annex note (linking analytical presentation with income statement)
- The paper presents a new analytical format focusing on net contribution of main income-earning assets (Fund credit and interest-free resources, essentially precautionary balances).
- The projected net regular income position is the same in both traditional and new formats: SDR 108 million.
- For analytical purposes, gross flows closely related have been netted (e.g., netting remuneration against income generated from Fund credit and GRA’s SDR holdings).

*Source: Excerpt from IMF staff paper on the Fund’s finances (content unit 36–49, Annex I) contained in the provided PDF content.*

### 2.74 percent against the associated remuneration expense (i.e., SDR 981 million).

### _021706 - 2.74 percent against the associated remuneration expense (i.e., SDR 981 million).

### Reconciliation adjustments and analytical presentation
- Adjustment (i): Netting of interest earned on SDR holdings against associated remuneration expense (example: SDR 981 million reflected against periodic charges).
- Adjustment (ii): Reclassification of service and stand-by charges to reflect this income together with the net contribution from charges on Fund credit.
- Adjustment (iii): Reclassification of SRP funding costs as administrative expenses to reflect the gross impact of the administrative and capital budgets. The SRP funding cost of SDR 76 million had been excluded from administrative expenses for rate-of-charge setting but is reflected in IAS 19 expenses.
- Adjustment (iv): Removal of burden-sharing adjustments to reflect the net position.
- After adjustments: The negative balance for remuneration reflects the implicit contribution of the Fund’s interest-free resources to savings in remuneration expense. In FY06, these balances are estimated at an average of SDR 7.6 billion, resulting in remuneration savings of SDR 210 million at the average SDR rate of 2.74 percent.

### Reconciled projected income and expense (FY 2006, in millions of SDRs)
- 1. Operational Income
  - a. Periodic charges, including burden sharing: 1,363; adjustment netting (981); other adjustments 21; further items 7; revised component 410.
  - b. Interest on SDR holdings: (25).
  - c. Service and stand-by charges: (21); adjustment (0).
  - Total operational income: 1,409.
- 2. Operational Expense
  - Remuneration, including burden sharing: 789; adjustment (1,006); other adjustments 7; net remuneration savings (210).
- 3. Net operational income: 620.
- 4. Administrative expense: 570; SRP funding reclassified 76; resulting administrative expense 646.
  - Less: estimated cost of administering the PRGF Trust: (58); net administrative related subtotal 512.
- 5. Regular net income: 108.
- Payment of SRP funding out of special reserve: (76); resulting regular net income shown as 108 after reserve payment.

Notes:
- 1/ As reported in Table 1 of The Fund's Income Position for FY 2006--Update to the Midyear Review.
- 2/ As reported in Table 1 of the main body of this paper.

### Cost of credit: markets and the Fund (1994–2005) — key findings
- Comparison caveats: differences in currency denomination, interest-rate type (fixed vs. flexible), maturities, Fund charge structure (including non-linear high access surcharges), burden-sharing mechanism, and Fund preferred creditor status complicate direct comparisons.
- Trend: Costs of borrowing from the market and the Fund for an average emerging market economy have come closer over the last decade due to lower emerging market rates and the introduction of level-based surcharges by the Fund in 2000.
- Specific observations:
  - The differential between market rates and the maximum credit tranches rate has narrowed.
  - The average U.S. dollar-denominated market rate that members face on average has fallen below the maximum SRF Fund rate.
  - The euro-denominated market rate has fallen below the maximum cost of credit from the Fund under both the SRF and the credit tranches.
- Data and indices used:
  - U.S. dollar market rate approximated by EMBIG Perform yield to maturity (Stripped EMBIG Perform is a subindex).
  - Euro market rate approximated by Euro EMBIG yield to maturity.
  - Fund cost based on rate of charge (adjusted for burden-sharing) plus Fund surcharges.
- Surcharge policy note: After November 28, 2000, holdings arising from purchases that exceed 200 percent of quota are subject to a surcharge of 100 basis points; holdings above 300 percent of quota are subject to a surcharge of 200 basis points.

### Precautionary balances, reserves, and related ratios (selected end-period figures)
- Precautionary balances (end-period series shown): 1.6, 4.0, 6.4, 7.2, 5.2, 7.6 (series across years listed in source).
- Reserves (series shown): 1.4, 2.8, 4.9, 5.6, 3.8, 6.0 (series across years listed in source).
  - General reserves: 0.4, 0.9, 2.7, 3.3, 1.7, 3.5.
  - Special reserves: 1.0, 1.9, 2.2, 2.4, 2.2, 2.5.
- SCA-1 and SCA-10 series: SCA-1 = 0.2, 1.1, 1.5, 1.6, 1.4, 1.7.
- Free reserves: -1.0, 3.1, 5.6, 6.5, 4.5, 7.0.
- Memorandum items (selected):
  - Credit capacity: 60.2, 150.8, 164.1, 170.1, 162.6, 170.5.
  - Credit outstanding: 22.1, 43.9, 62.2, 49.9, 63.6, 21.8.
  - Credit in good standing: 19.5, 43.0, 61.4, 49.1, 62.9, 21.2.
  - Arrears: 3.4, 1.9, 1.8, 1.8, 1.7, 1.7.
    - Principal arrears: 2.6, 0.9, 0.8, 0.7, 0.7, 0.6.
    - Charges arrears: 0.8, 1.0, 1.0, 1.0, 1.0, 1.0.
- Ratios (selected):
  - Precautionary balances to credit capacity: 2.7, 2.6, 3.9, 4.3, 3.2, 4.5.
  - Precautionary balances to credit outstanding: 7.2, 9.0, 10.2, 14.5, 8.1, 35.0.
  - Free reserves to credit capacity: -1.6, 2.0, 3.4, 3.8, 2.8, 4.1.
  - Free reserves to credit in good standing: -5.0, 7.1, 9.1, 13.2, 7.2, 33.1.

### Historical General Resources Account (GRA) indicators (selected series)
- Use of Fund credit, average SDR interest rate, average rate of charge, average rate of remuneration, annual net income, annual administrative expenses presented across FY series from 1946 through FY 2006.
- FY 2006 (note): Balances are based on actual results to November 2005 and projections for the remainder of the year, except for credit outstanding updated to reflect advance repurchases by Brazil and Argentina.
- Example snapshot for FY 2006 from the series:
  - Credit outstanding: 20,312 (in millions of SDRs).
  - Average SDR interest rate: 2.74 percent.
  - Average rate of charge: 3.82 percent.
  - Average rate of remuneration: 2.74 percent.
  - Annual net income: 210 (in millions of SDRs).
  - Annual administrative expenses: 706 (in millions of SDRs).
- Note: Administrative expenses from FY 01 include the impact of IAS 19 accounting, increasing volatility.

### Options for adjusting to a low credit environment (policy options and comments)
- Slow reserve growth; drawdown reserves
  - Temporary palliative. Erodes income generating capacity. Reserves would need to be rebuilt in event of renewed demand for Fund credit. Prolonged recourse raises reputation risks.
- Suspend mitigation of off-market gold transaction
  - Method of permanently mitigating impact of the 1999–2000 gold transaction on the GRA would need to be identified.
- Reduce rate of remuneration
  - Scope limited because rate of remuneration must be at least 80 percent of SDR interest rate. Yield is a function of credit outstanding.
- Reduce administrative expenditures
  - Would need to be considered in context of Fund’s medium-term strategy; outside scope of present review.
- Invest profits of gold sales
  - Would increase income generating capacity; converts illiquid asset into liquid one whose preservation would need to be safeguarded. Sales require approval by 85 percent of total voting power and should be phased to limit market impact.
- Investment Account
  - Potential to boost and diversify income over time, with risk of year-to-year volatility. Investment income potential currently a function of reserve level and investment performance. Gold sales would boost income potential.
- Increase rate of charge margin
  - Scope limited by Fund’s cooperative role and cost of alternative funding. Yield depends on credit outstanding.
- Fees for services
  - Scope limited by public good aspect of Fund services and members' capacity to pay.
- Third-party financing
  - Increasing donor financing of technical assistance could take forms of grants or an endowed trust/administered account. Donor response unknown. Potential loss of independence and conflicts with public good aspects.
- Commitment fees
  - Charging fees on new precautionary arrangements could boost income, but such arrangements first need to be designed and popularized.

*Source: IMF Finance Department (excerpts and tables as presented in the provided content).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2006/_021706.pdf_