## _wp09149

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---

### I. Introduction
- Tunisia has undertaken reforms over the last two decades that:
  - allowed access to international capital markets on favorable terms;
  - established a good macroeconomic policy track record;
  - strengthened the prudential framework for the financial sector;
  - liberalized the foreign exchange system;
  - and developed monetary instruments at the Central Bank of Tunisia (BCT) in line with best practices.
- Authorities intend to strengthen Tunisia’s integration into the global economy and the BCT is contemplating a move to an inflation targeting (IT) framework in the medium term.
- Paper scope:
  - requirements for using interest rates as the operating target for monetary policy;
  - roadmap for establishing other building blocks of an IT framework.

### II. Overview of economic and financial reforms
- Historical evolution and sequencing:
  - 1970s–mid-1980s: inward-looking strategies with heavy state role, tariffs, and exchange controls; administratively set interest rates often negative in real terms.
  - Mid-1980s onward reforms aimed to correct banking imbalances, curtail direct government intervention, strengthen market allocation of savings, and increase competition and financial soundness.
  - Key milestones:
    - 1993: acceptance of Article VIII obligations (current account convertibility).
    - 1994: introduction of a spot interbank foreign exchange market.
    - Late 1996: lifting of restrictions on lending rates and elimination of lending requirements to priority sectors.
    - Early 1997: money market operations became the main monetary policy instrument.
- Financial sector reforms and market development:
  - Privatization of most state-owned banks and strengthening of prudential regulations.
  - Stock market modernization and greater foreign investor participation in government securities markets.

### III. Exchange arrangements and monetary policy framework (Box 2 & Box 3)
- Exchange arrangements (position as of end-2007)
  - Managed floating exchange regime with BCT intervention to achieve a slight pace of depreciation of the real exchange rate against a basket of currencies.
  - Since 1994 the dinar exchange rate is determined in the interbank market; banks may provide forward contracts and other financial operations.
- Foreign currency accounts and capital transaction rules (selected items)
  - Residents: comptes spéciaux, comptes professionnels (exporters may keep up to 100 percent of export proceeds), comptes devises bénéfices exports (may keep 15 percent of foreign currency earnings).
  - Nonresidents: may bring foreign exchange into the country and keep it in foreign currency accounts and take it out at any time.
  - Nonresident investments in domestic debt instruments restricted except through mutual funds, bonds listed on the stock exchange, or government securities (up to 20 percent of each issue).
  - Commercial banks may borrow abroad up to the equivalent of TD 10 million per year; required to transfer 80 percent of their foreign currency holdings to BCT foreign correspondents at end of day.
- Monetary policy legal and operational features
  - Under Article 33 of the May 2006 Central Bank Law the priority objective is to safeguard price stability.
  - May 2006 law amendments eliminated monetary financing and laid two key features of an IT framework.
  - Interim operational stance:
    - BCT derives annual targets for M3 from the government’s financial program, with monthly targets for M3 and base money growth.
    - BCT calibrates monetary operations based on liquidity forecasts and aims at keeping short-term interbank rates within a desired range.
  - BCT intends to adopt interest rates as the operational target of monetary policy.

### IV. Money market structure, liquidity management, and prerequisites for interest-rate targeting
- Money market structure and usage
  - RTGS introduced in 2006 enabling real-time knowledge of account balances; intraday repo facility introduced.
  - 95 percent of interbank transactions are overnight or for maturities of less than one month.
  - Term transactions beyond one month and short-term swaps are virtually nonexistent.
  - 80 percent of banks’ loans, irrespective of their duration, are indexed on the TMM.
  - Government securities (Treasury bonds at 2, 5, and 10 years) account for 2/3 of negotiable domestic debt instruments.
  - Bid cover ratio has been in the 300 percent region.
  - Secondary market is virtually nonexistent; repo market underdeveloped though Master Repo Contract in place since 2006.
- Operational weaknesses and consequences
  - Tight management of the overnight interbank rate by the BCT has limited term transactions and interest risk management.
  - Short-term repo-type operations (“ventes à réméré”) suffer from lack of legal certainty over collateral and may have rates above the money market.
  - Forward exchange transactions generate sizeable FX open positions for banks that cannot be hedged in the money market, indicating poor integration between money and FX markets.
  - BCT liquidity management has often provided banks with all required liquidity at no penal cost, and monetary targeting has been used more as a reference than a strict operational path.
- Preconditions for effective use of interest rates as operating target (explicit)
  - a liquid and deep money market across maturities so policy rate changes affect the yield curve;
  - commercial banks’ liquidity management and funding policies must allow gradual adjustment of lending rates to money market conditions;
  - monetary management must ensure money market conditions remain in line with the policy stance while allowing development of risk management instruments.
- Recommended operational changes for liquidity management
  - target a small given amount of excess reserves at the end of the reserve maintenance period;
  - regular monetary operations should adjust provision of reserves to changes in autonomous factors over the reserve period;
  - fine-tuning operations should smooth short-term unanticipated liquidity changes through volume adjustments;
  - standing facilities should only correct discrepancies that cannot be corrected by fine-tuning operations.
- Suggested instruments and market-deepening measures (selected)
  - establish an unconditional overnight deposit and lending facility to create a corridor for interbank rates, provided corridor is wide enough;
  - conduct fine-tuning on market terms (variable rate auctions with min/max rates if necessary);
  - use purchases/sales of government securities on the secondary market for structural liquidity management and repos for fine-tuning;
  - give the TRE the role of a floor rate and develop benchmark rates (BOR-type);
  - encourage money market mutual funds and develop interest rate hedging instruments such as short-term interest rate swaps.

### V. Empirical assessment of transmission channels (VAR evidence, 2001:01–2006:09)
- Data and methodology highlights
  - Monthly frequency; start date 2001 due to data constraints; monthly GDP proxied using industrial output via Chow and Lin (1971).
  - Variables logged and seasonally adjusted except Tunisian and European interest rates (expressed in levels and not seasonally adjusted).
  - VAR(2) selected by Akaike and Schwartz criteria; models estimated in levels with a constant and deterministic trend.
  - Structural identification via Cholesky decomposition; impulse responses computed at 20 lags.
- Model specifications (selected)
  - Model 1: Y′t = [yTUNt  pTUNt  mTUNt  xTUNt] and variants replacing mTUNt with money base hTUNt or M3 m3TUNt.
  - Model 2: Y′t = [yTUNt  pTUNt  m3TUNt  tmmTUNt  xTUNt] (adds TMM).
  - Exogenous foreign variables X′t = [1−toil  EUty 1−EUTs  EUTs] where toil = Brent price, EUty = EU real activity, EUTs = EU short-term interest rate.
- Main empirical findings (impulse responses and correlations)
  - General: responses are muted relative to industrial countries but broadly consistent with theory; return to equilibrium typically within twelve months for monetary shocks (not significant).
  - Model 1 (money aggregate shock): temporary unanticipated increase in money supply:
    - triggers a temporary increase in activity;
    - triggers a depreciation of the exchange rate;
    - inflationary impact on prices manifests with a longer delay.
  - Model 2 (interest rate included):
    - a monetary shock has a rapid but temporary impact on activity; price impact more persistent but not significant.
    - an interest rate shock (temporary unanticipated increase in TMM):
      - triggers a decline in activity with effects tending to dissipate after nine months;
      - deflationary impact on prices begins after six months and is long-lasting;
      - exchange rate impact is rapid and temporary and weakly significant.
  - Comparative stylized facts:
    - Tunisian responses show (i) more moderate amplitude; (ii) weaker or insignificant price responses; (iii) stronger responses to interest rate shocks than monetary shocks; (iv) typically weak exchange rate responses.
  - Correlations and money demand diagnostics:
    - 12-month rolling correlation between annual inflation and annual growth of the money base = 0.45 at end-2000 and = 0.29 at end-2006.
    - Correlation between inflation and M3 = 0.35 at end-2000 and = 0.52 at end-2006.
    - Correlation between money base (year on year) and M3: 58 percent over 1996–2001 and 51 percent over 2001–06.
    - Correlation between year-on-year total credit and annual money growth: with M3 ~ 34 percent; with money base ~ 24 percent.
    - Money demand regressions (2001:01–2006:12, real terms m_t - p_t on y_t and π_t):
      - When m_t - p_t = monetary base: y_t = 0.22 (0.02) and π_t = -0.20 (0.20).
      - When m_t - p_t = M3: y_t = 0.10 (0.005) and π_t = -0.15 (0.06).
    - Structural breaks detected: 2003 for monetary base equation; 2004 for M3 equation.
  - Reaction function estimates (TMM as dependent variable):
    - Pre-2003 and over longer samples: estimation quality poor and unstable.
    - Post-2003: parameter signs more in line with expectations; coefficient on inflation > 1 but only marginally significant; output gap coefficient not significantly different from zero.
    - Gradual adjustment present (ρ significantly different from zero); correction parameter γ low and weakly significant.
    - Stability tests reject coefficient stability even in the recent period; residual heteroskedasticity present.
  - Conclusion: evidence supports an increased recent role for interest-rate policy but results remain fragile due to limited observations and omitted variables.

### VI. Assessment of compliance with inflation-targeting building blocks (Box 4, Appendix Table 4)
- Institutional features (selected)
  - 1. Price stability as primary objective — Compliance: High.
  - 2. De facto and de jure autonomy of the CB — Compliance: Intermediate.
    - Numeric indices: political autonomy index = 0.63 (MCD countries = 0.45); operational autonomy index = 0.75 (MCD countries = 0.63).
  - 3. CB is transparent and accountable — Compliance: Intermediate.
- Operational features (selected)
  - 4. Stable macroeconomic framework — Compliance: Intermediate.
    - 4a. Absence of fiscal dominance — Compliance: Intermediate.
    - 4b. Robust external position — Compliance: Low.
  - 5. Efficient and stable financial sector — Compliance: Intermediate.
    - 5a. Financial market — Compliance: Low.
    - 5b. Money market — Compliance: Low.
    - 5c. Forex market — Compliance: Intermediate.
    - 5e. Banking sector — Compliance: Intermediate (volume of NPLs is high; performance of certain state-owned banks needs strengthening).
  - 6. Monetary and forex operations are efficient — Compliance: High.
  - 7. Efficient interest rate transmission channel — Compliance: High (potentially, given indexation).
- Technical and organizational features (selected)
  - 8. Infrastructure required for IT — Compliance: Low (including subitems on inflation measurement, setting targets, forecasting tools, understanding transmission channels).
  - 9. Publication of inflation reports — Compliance: Low.
  - 10. Well-established analytical capacities — Compliance: Intermediate (recommend recruiting at least two econometricians and two economists).
  - 11. Transparent decision-making process — Compliance: Low (monthly targets and factors for deviations not publicly disseminated).
  - 12. CB organization suited to IT needs — Compliance: Low.

### VII. Policy recommendations and staged actions to strengthen IT readiness
- Immediate actions
  - Strengthen the monetary policy framework and intensify cooperation among public agencies involved in macroeconomic policy and research to leverage existing analytical skills.
- Short term (1–2 years)
  - Develop an autonomous central bank research capability in monetary, financial, and inflation forecasting issues.
  - Establish an action plan for eliminating administered prices.
  - De-index banking transactions from the TMM (through appropriate incentives).
- Medium term (3–5 years)
  - Achieve BCT capacity to forecast inflation and growth.
  - Ensure exchange rate flexibility.
  - Eliminate administered prices.
  - Make markets more efficient.
  - Liberalize the capital account, subject to prudential measures and preceded by strengthening the banking sector (significant reduction in nonperforming loans) and reduction in external debt.
- Operational specifics for transition to IT
  - Increase transparency of the monetary programming process: public disclosure of methodology for current monetary targets and rationale for using monetary base and broad money as leading indicators.
  - Choice of leading inflation indicator: retain M3 given stable correlation with inflation over 2001–2006.
  - Future operating target: drop base money as operating target and adopt short-term interest rate as operating target.
  - Liquidity management: adopt “neutral” liquidity management so overnight market rate can reach equilibrium around the policy rate and operations compensate in real time for autonomous factor changes.
- Preconditions and cautions
  - Firm commitment by monetary and fiscal authorities and public adherence to the inflation target are critical; transparency is especially important.
  - Assess corporate vulnerability to interest-rate fluctuations and identify measures to reduce indexation practices before relying on short-term interest rate operational targeting.
  - Define role of the exchange rate in the monetary strategy; assess effects of exchange rate liberalization and set a rule for FX intervention consistent with IT.
  - Note: combining IT with exchange rate targeting has produced conflicts in other countries (examples cited in source).

### VIII. Appendices — operational details and diagnostics (selected)
- Appendix I: Monetary targeting framework
  - Annual M3 target determined from IEQ macro framework and money demand function prepared by BCT.
  - Monthly M3 profile derived from annual target and used to estimate monthly monetary base profile via observed monthly multipliers.
  - Monthly monetary base target used as a control variable; intrayear revisions of projections inform BCT assessment but do not revise the initial annual target publicly announced.
- Appendix Table 5: Unit root tests (monthly data 2001:01–2006:12)
  - Augmented Dickey-Fuller p-values for levels and 1st differences reported for key series; 1st differences uniformly have p-values = 0 for both c and c+t specifications (rejecting unit root in differences).
  - Selected level p-values (c specification): tTUNLy = 0.99; tTUNLp = 0.07; tTUNLx = 0.99; tTUNLh = 0.94; tTUNLm3 = 0.97; tTUNtmm = 0.15; tLoil = 0.99; EUtLy = 0.66; EUts = 0.25.

*Source: _wp09149 (IMF Working Paper excerpts provided in the source PDF).*

### References..............................................................................................................

### _wp09149 - References..............................................................................................................

### I. Introduction
- Tunisia has undertaken economic reforms over the last two decades that:
  - allowed access to international capital markets on favorable terms;
  - established a good macroeconomic policy track record;
  - strengthened the prudential framework for the financial sector;
  - liberalized the foreign exchange system;
  - and developed monetary instruments at the Central Bank of Tunisia (BCT) in line with best practices.
- Authorities intend to strengthen Tunisia’s integration into the global economy and the BCT is contemplating a move to an inflation targeting (IT) framework in the medium term.
- The paper discusses:
  - requirements for using interest rates as the operating target for monetary policy;
  - roadmap for establishing the other building blocks of an IT framework.
- Paper structure:
  - Section II: summarizes Tunisia’s program of economic reforms.
  - Section III: focuses on the use of interest rates as the operating target for monetary policy.
  - Section IV: looks at the transmission channels of monetary policy and offers empirical evidence for the interest rate channel in Tunisia.
  - Section V: analyses Tunisia’s compliance with the building blocks of an IT framework, in light of other emerging countries moving towards IT.
  - Section VI: concludes.

### Box 1 — Objectives of the 11th Economic Plan (period 2007–2016)
- Primary objectives:
  - double per capita income;
  - reduce unemployment by four percentage points.
- Policy implications:
  - increase overall productivity, requiring enhanced effectiveness of economic policies;
  - enhance the efficiency of the financial sector as a key pillar.
- Financial and external objectives:
  - full convertibility of the currency to facilitate foreign investment, requiring:
    - a sound and efficient financial sector to facilitate long-term saving mobilization;
    - a strong external position to ensure stability of the dinar;
    - availability of hedging instruments against financial market risks.
  - adoption of a floating exchange rate regime to aid integration into the global economy, requiring:
    - enhanced financial intermediation;
    - reliance on market mechanisms in the conduct of monetary policy;
    - adoption of an exchange rate policy to enhance competitiveness and mitigate external vulnerability.
- Monetary policy objective:
  - focus on inflation control, requiring:
    - optimizing the utilization of economic information;
    - enhancing transparency of monetary and fiscal policy;
    - promoting financial stability.

### II. Overview of Tunisia’s Program of Economic Reforms
- Historical context:
  - 1970s–mid-1980s: inward-looking development strategies with heavy state role, tariffs, and exchange controls.
  - Financial sector functioned to collect savings at low cost and redirect them to government, public enterprises, and priority sectors; interest rates set administratively and usually negative in real terms.
  - Money markets underdeveloped; bond and equity markets virtually nonexistent.
- Mid-1980s onward reforms aimed to:
  - correct banking sector imbalances;
  - curtail direct government intervention;
  - strengthen role of market forces in allocation of savings;
  - enhance capacity of financial institutions to mobilize savings;
  - increase competition and financial soundness of banks.
- Key milestones:
  - Initial phase (1987–1993): gradual dismantling of direct monetary policy controls; culminated with current account convertibility when Tunisia accepted the obligations of Article VIII of the IMF’s Articles of Agreement in 1993.
  - Post-1993: further liberalization and development of financial markets.

### A. Financial Sector Reforms
- Reforms pursued to:
  - relax regulatory constraints on banks’ balance sheets;
  - allow greater freedom in foreign currency operations;
  - introduce and strengthen prudential regulations consistent with international best practices;
  - restructure public enterprises and privatize most state-owned banks.
- Market development steps:
  - stock market modernization;
  - foreign investor participation in government securities market;
  - banks and firms with ratings or listed on the stock exchange allowed greater leeway for foreign borrowing.
- Specific sequencing:
  - 1994: introduction of a spot interbank foreign exchange market.
  - Late 1996: lifting of restrictions on lending rates and elimination of lending requirements to priority sectors.
  - Early 1997: money market operations became the main monetary policy instrument.

### B. External Sector and Policies
- Exchange rate regime:
  - managed floating exchange regime where the BCT intervenes to achieve a slight pace of depreciation of the real exchange rate against a basket of currencies weighted according to main trading partners and competitors.
  - policy aims at periodic nominal exchange rate adjustments to support Tunisian competitiveness.
  - BCT has begun using a broader set of indicators to gauge competitive position of producers and guide exchange rate policy.
- Capital flows and controls:
  - extensive restrictions on capital inflows and outflows were maintained historically to permit an independent monetary policy.
  - BCT focused on targeting the rate of expansion in credit to the economy around the rate of nominal GDP growth (effectively targeting growth in broad money).
  - capital controls were used to ensure domestic savings financed domestic investment and to limit reliance on short-term external financing.
- Liberalization progress for nonresidents:
  - good progress in liberalizing capital transactions for nonresidents:
    - inward foreign direct investments largely liberalized;
    - nonresidents allowed to bring foreign exchange into the country and keep it in bank accounts denominated in foreign currency or in convertible dinar.
  - remaining restrictions:
    - nonresidents are not allowed to invest in domestic money- or capital market-debt instruments, except:
      - through mutual fund shares invested in such securities;
      - through the purchase of bonds listed in the stock exchange;
      - or the purchase of government securities (up to 20 percent of each issue).
    - regulatory framework for outward capital transactions remains fairly restrictive except for export-oriented activities.

### Appendices, Tables, Figures, and Boxes (as listed)
- Appendices listed:
  - I. Tunisia: Monetary Targeting Framework
  - II. Inflation Targeting in Emerging Economies
- Appendix Tables listed include:
  - 3. Tunisia: Reforms in the Monetary, Financial and External
  - 4. Detailed Compliance with the Building Blocks
  - 5. Unit Root Tests
- Paper includes Tables, Figures, and Boxes referenced in the text (titles listed in source content).

*Source: _wp09149 - References..............................................................................................................*

### Box 2. Tunisia: Summary of Exchange Arrangements

### Box 2. Tunisia: Summary of Exchange Arrangements (Position as of end-2007)

### Exchange rate structure and market
- Since 1994, the exchange rate of the dinar is determined in the interbank market, with BCT intervention aimed at keeping it at its targeted level.
- Banks are allowed to provide forward contracts to exporters, importers, and service providers, and for financial operations.

### Foreign currency bank accounts
- Residents are allowed to open:
  - comptes spéciaux: open to new or returning residents who wish to repatriate assets from abroad and keep the proceeds in foreign currency.
  - comptes professionnels: open to exporters; account holders may keep up to 100 percent of export proceeds without BCT authorization.
  - comptes devises bénéfices exports: open to individuals and businesses with income in foreign currency other than export proceeds; account holders may keep 15 percent of foreign currency earnings without BCT authorization.
- Nonresidents may bring foreign exchange into the country and keep it in bank accounts denominated in foreign currency, and take it out at any time.
- 50 percent of earnings from work must be deposited in nonconvertible dinar-denominated accounts.

### Capital transactions
- Stock purchases in Tunisian companies by nonresidents do not require prior approval unless a controlling share or voting rights are acquired; in that case, prior approval is required; investment proceeds can be freely repatriated.
- Investments by nonresidents in domestic debt instruments are restricted except through:
  - the purchase of shares issued by mutual funds,
  - the purchase of bonds listed in the stock exchange,
  - the purchase of government securities (up to 20 percent of each issue).
- The accumulation of assets abroad by residents requires prior authorization; exporters may transfer limited amounts annually to finance business-related expenses.
- Commercial credits to nonresidents by residents require BCT approval.
- Corporations may freely contract foreign currency loans from nonresidents up to an annual limit; limits were further liberalized for credit institutions and firms which have a rating or which are listed in the stock exchange.

### Provisions specific to financial institutions
- Commercial banks may:
  - borrow abroad up to the equivalent of TD 10 million equivalent per year;
  - open correspondent accounts with foreign banks but are required to transfer 80 percent of their foreign currency holdings to BCT foreign correspondents [nivellement] at the end of the day;
  - provide forward cover for trade-related and financial operations (up to 12 months). 1/
  - engage in foreign currency/dinar swap operations and in forward rate agreements to hedge against interest rate risk.
- BCT authorization is required to grant loans to nonresidents.
- Institutional investors are not allowed to purchase assets abroad.
- Offshore banks are not subject to exchange controls.
- Note: 1/ At the end of 2007 the BCT announced that the limit will be extended beyond 12 months.

### Trade regime
- Tunisia joined the WTO in 1994.
- The Association agreement with the European Union will result in the elimination of tariffs imposed on European goods by 2008.
- Regional and bilateral trade agreements have been signed with Middle Eastern countries; they are expected to lead to the creation of a regional free-trade zone.

### Monetary policy framework
- Tunisia operates monetary policy in the context of a managed float based on an undisclosed basket of currencies with no preannounced path for the exchange rate.
- The value of the dinar is determined on the interbank market, guided by daily indicative buying and selling exchange rates against major currencies in a 1 percent range.
- The BCT publishes the weighted-average rate for interbank transactions for the previous day and may intervene in the spot foreign exchange market at levels that do not necessarily correspond to the published mid-point range.
- Under Article 33 of the May 2006 Central Bank Law, the priority objective of monetary policy is to safeguard price stability; the amendment removed ambiguity regarding domestic versus external stability.
- The May 2006 BCT law amendments eliminated all forms of monetary financing and laid two key features of an IT framework.
- The BCT intends to adopt interest rates as the operational target of monetary policy; in the interim, monetary policy has been anchored on a monetary program:
  - The BCT derives annual targets for M3 from the government’s financial program, as well as monthly targets for M3 and base money growth.
  - The BCT calibrates monetary operations based on liquidity forecasts and aims at keeping short-term interbank rates within a desired range.
- Monetary targeting has de facto been used rather as a reference value than as a normative path for the monetary base; in 2006 outturn figures generally surpassed monthly targets.
- The BCT does not proceed to a critical analysis of the macroeconomic forecasts provided by the Institut d’Études Quantitatives (IEQ).
- BCT liquidity management implicitly provides banks with all the liquidity they need to comply with required reserves and at no penal cost.

### Using interest rates as the operating target: prerequisites and challenges
- Preconditions for effective use of interest rates as the operating target:
  - a liquid and deep money market across maturities so changes in the central bank’s policy rate affect the yield curve;
  - commercial banks’ liquidity management and funding policies must allow gradual adjustment of lending rates to money market conditions;
  - monetary management must ensure money market conditions remain in line with the monetary policy stance while allowing development of risk management instruments.
- Meeting these conditions in Tunisia will take time and require adjustments to strengthen financial markets.

### Interbank money market and liquidity management in Tunisia
- The overnight interbank market has advanced technical characteristics:
  - Introduction in 2006 of a Real-Time Gross Settlement System (RTGS) enabled real-time knowledge of account balances at the BCT.
  - Introduction of an intraday repo facility permitted by the integration of the securities settlement system and the RTGS.
- The tight management of the overnight interbank market rate by the BCT has limited development of term transactions:
  - 95 percent of interbank transactions are overnight or for maturities of less than one month.
  - Term transactions beyond one month and short-term swaps are virtually nonexistent.
- The lack of volatility of the overnight rate (TMM) has been a deterrent to active liquidity management by bank treasurers and prevented development of interest risk management; consequences include:
  - 80 percent of banks’ loans, irrespective of their duration, are indexed on the TMM.
  - An increase in the central bank’s policy rate has an immediate impact on the cost of most loans (i.e., not only on new ones).
- The repo market is underdeveloped despite a Master Repo Contract in place since 2006; repo transactions are only used by the BCT for liquidity provision.
- Market segmentation and limited term interbank activity have led to pricing aberrations and anti-competitive behavior:
  - Large institutional customers sometimes secure above-market remuneration for large deposits from banks with tight liquidity.
- Forward exchange transactions generate sizeable foreign exchange open positions for banks which cannot be hedged on the money market, reflecting poor integration between money and foreign exchange markets.
- Tunisia’s increased reliance on domestic debt:
  - Government securities (Treasury bonds at 2, 5, and 10 years account for 2/3 of negotiable domestic debt instruments).
  - Bid cover ratio has been in the 300 percent region.
  - The secondary market is virtually nonexistent; active portfolio management hampered by lack of a genuine repo market.
- Short-term repo-type operations (“ventes à réméré”) carry shortcomings:
  - No legal certainty regarding ownership of the collateral.
  - They encourage market segmentation.
  - Rates sometimes above those in the money market, reflecting inconsistencies in deposit mobilization and inefficiency of market segments.

### Monetary management: assessment and way forward
- The BCT has monetary instruments in line with international best practices, but implementation suffers from weaknesses due to simultaneous focus on quantities and prices.
- The BCT can implement policy in structural surpluses or deficits of liquidity; operations are based on efficient infrastructures (RTGS, securities DVP system).
- “Window guidance” and fine-tuning operations have allowed the BCT to keep the overnight interbank market rate within a range of +/- 12 basis points around the policy rate, but such practices have undermined market signals and limited the role of interest rates.
- The liquidity forecasting framework is weakened by the volatility of the Treasury’s end-of-the-day balances with the BCT; other autonomous factors contribute only marginally to forecasting errors.
- Greater exchange rate flexibility will further reduce uncertainty of projections associated with foreign assets.
- To allow flexibility in the overnight interbank rate and give a greater role to interest rates, liquidity management should focus on achieving a small given amount of excess reserves at the end of the reserve maintenance period:
  - Regular monetary operations should adjust provision of reserves to changes in autonomous factors over the reserve period.
  - Fine-tuning operations should smooth short-term unanticipated changes in liquidity through volume adjustments.
  - Standing facilities should only correct discrepancies from forecasts that could not be corrected by fine-tuning operations.
- Adopting this operating environment will require several adjustments to the current operational framework.

*Source: Box 2. Tunisia: Summary of Exchange Arrangements (Position as of end-2007).*

### Box 3. Tunisia: Monetary Policy

### Box 3. Tunisia: Monetary Policy

### Instruments
- Required reserves ranging from 0 to 5 percent based on maturity of deposits. They are non-interest-bearing, and full averaging during the monthly reserve maintenance period is allowed.
- Standing lending facility involves 1–7 day reverse repo operations at the policy rate + 100 basis points.
- Discretionary operations include:
  - 7-day deposit/credit auctions;
  - three-month tenders for repos;
  - outright sales/purchases of government securities; and
  - overnight fine-tuning operations.

### Liquidity management and short-term rate guidance
- Establishing a corridor for short-term interbank market rates by allowing banks to have access to an unconditional overnight deposit and lending facility at the BCT would foster market development provided the corridor is wide enough.
- Conduct fine-tuning operations on market terms (using variable rate auctions for instance, with a minimum or maximum rate if deemed necessary), so that a balanced amount of central bank reserves ultimately make it possible for market rates to converge toward the BCT policy rate.
- Use purchases/sales of government securities on the secondary market for structural liquidity management via the setting-up of an outright open-market portfolio, for example by ensuring that these assets are backed by a stable monetary liability (currency in circulation or required reserves), and using repo operations for fine-tuning operations.

### Money Market Deepening — obstacles and recommended measures
- Main obstacle: indexation to the TMM rate of most banks’ operations, which removes incentives for treasurers to mobilize longer-term funding since they are not exposed to interest rate risks.
- Additional constraint: indexation of longer-term resources, such as the administered saving (Taux Réglementaire de l’Épargne-TRE) remunerated at TMM minus 200 basis points.

Recommended measures:
- Give the TRE the role of a floor rate and develop benchmark rates (BOR-type) which would allow banks to mobilize term deposits at a fixed rate, and price their loans using these benchmark references.
- Encourage the creation of money market mutual funds to boost competition for resources, encourage enhanced asset/liability management, diversify the market, and stimulate the use of repo-based money market operations.
- Allow greater variability in short-term interest rates in order to encourage banks to manage their overall asset-liability positions in a more market-oriented perspective.
- Rely on repo operations in the management of government cash balances so as to encourage banks to expedite the required preparations for using repo operations.
- Develop interest rate risk hedging instruments such as short-term interest rate swaps, so that banks can provide hedging instruments should interest rates become flexible.

### The interest rate transmission: theoretical background
- Purpose: assess to what extent, according to what time scale, and through which economic variables monetary policy decisions influence the economic cycle and inflation.
- General empirical findings summarized:
  - A temporary and unanticipated change in the monetary policy stance has a transitory but small-scale impact on real activity.
  - Impact on price levels seems permanent but takes a longer time to materialize.
  - Monetary policy effects frequently differ depending on the state of the economic cycle, often having a more pronounced impact in periods of economic slowdown than during growth periods.
  - Sectoral variation: effects more substantial in capital-intensive sectors (e.g., fabricated metal products, transport equipment) than in agriculture.

Transmission channels listed:
- Interest rate channel: modification of the real interest rate affects consumption and investment decisions via financing costs.
- Exchange rate channel: changes in interest rates can reallocate financial portfolios, affect exchange rates, and thereby foreign trade.
- Bank credit channel: policy affects potential volume of credit by modifying deposits and reserves; especially powerful where banks are primary finance sources.
- Balance sheet channel: policy-induced changes in collateral values and net worth affect borrowing, with stronger effects on small-scale enterprises.
- Financial asset price channel: policy can alter prices of financial assets, influencing investment (Tobin’s q) and household consumption via wealth/liquidity effects.

Methodological note on empirical estimation:
- In practice, transmission channels are generally estimated by structural macro-econometric or short-term econometric models.
- Short-term models such as vector autoregression (VAR) models are preferred in settings subject to structural shifts because they rest on short-term dynamics while leaving open longer-term relationships.
- For emerging countries like Tunisia, benchmarked VAR models are considered more appropriate to test reactions to monetary policy shocks, ensuring maximum flexibility in variable dynamics.

### Review of the literature on Tunisia (selected findings)
- Treichel (1997): preconditions for a monetary base targeting framework were in place as far back as 1995, but stressed reassessing money functions given reforms.
- Boughrara (2002): analyzing 1987–2000 finds an inverse causal relationship between narrow aggregates (M2) and inflation and that M2 is not perfectly controllable in the short term.
- Benbouziane and Benamar (2004): support the argument that M2 is not perfectly controllable in the short term.
- Daly (2003): variations in the monetary base account for only a minimal portion of fluctuations in M3.
- Boughrara (2003): comparative analysis for 1988–2001 shows the monetary channel is the most important in Tunisia, low exogeneity of base money, and the exchange rate channel minimally significant during that period; exchange rate and base money are leading indicators of inflation.
- Boughrara et al. (2007): nominal exchange rate may be an important transmission channel and determinant of nonperforming loans (NPLs) in the recent period; effectiveness of inflation targeting (IT) is sensitive to the state of the banking system and significant NPLs could dampen IT effectiveness when a policy rate rise coincides with a negative supply shock.

### Assessment of transmission mechanisms in Tunisia — empirical approach
- Two benchmark vector autoregression (VAR) models are used to detect the impact of a monetary policy shock on economic activity and prices.
- VAR representation considered: VAR(p) of the form (1) X(L)B(L)Y_t + ... (see source for exact notation).
- Estimation focuses on the period January 2001–September 2006, with a monthly frequency.
- Given the limited number of years and the temporary nature of economic developments in Tunisia, the analysis of long-term relationships in the economy has not been adopted nor imposed in the estimations.
- Each estimated VAR model contains a constant and a deterministic trend and is estimated in levels.

*Source: Box 3. Tunisia: Monetary Policy (excerpts) — IMF working paper content provided in the source PDF.*

### introduction of implicit cointegration relationships among the data. The structure of the lags

### _wp09149 - introduction of implicit cointegration relationships among the data. The structure of the lags

### Data, frequency, and preprocessing
- Monthly frequency chosen given constraints setting the starting date at 2001; GDP only available at annual and quarterly intervals and monthly GDP established using industrial output via Chow and Lin (1971) because of a nearly 60 percent correlation between annual GDP growth and industrial output growth.
- Data were expressed in natural logarithms and seasonally adjusted, except for Tunisian and European interest rates which were expressed in levels and not seasonally adjusted.
- Seasonal adjustment: X11 method used; potential imperfect correction of seasonal factors (e.g., Islamic holidays) is noted.
- Lag selection: Akaike and Schwartz Information Criteria suggested a two-lag VAR(2) in each case.
- Standard specification and estimate-quality tests: LM and White tests indicate residuals of the VAR models are not correlated and are homoskedastic.

### VAR model specifications and identification
- Model 1 endogenous vector:
  - (2) Model 1: Y′t = [yTUNt  pTUNt  mTUNt  xTUNt]
  - (2a) Model 1′: Y′t = [yTUNt  pTUNt  hTUNt  xTUNt]  (money base h)
  - (2b) Model 1′′: Y′t = [yTUNt  pTUNt  m3TUNt  xTUNt]  (broad aggregate M3)
- Model 2 endogenous vector:
  - (3) Model 2: Y′t = [yTUNt  pTUNt  m3TUNt  tmmTUNt  xTUNt]  (adds money market overnight interest rate tmm)
- Exogenous foreign variables vector X′t = [1−toil  EUty 1−EUTs  EUTs]:
  - Brent price: toil
  - Real activity in the European Union: EUty (industrial production index used)
  - Short-term interest rate in the European Union: EUTs (and lags)
- Exogeneity assumption: Tunisian variables do not feedback to the EU variables.
- Structural identification: Cholesky decomposition applied to residuals ηt to obtain orthogonal shocks et and estimate impulse response functions.
- Impulse responses computed at 20 lags (roughly four weeks of trading days).
- Ordering sensitivity: results can depend on ordering; different sequences tested did not change overall picture of transmission channels.

### Implicit identification assumptions across models
- Model 1 implicit assumption: monetary shocks do not simultaneously influence activity and prices but may affect the exchange rate.
- Model 2 implicit assumption: interest rate responds simultaneously to activity, price, and monetary shocks but not to exchange-rate shocks; exchange rate is immediately affected by all shocks.

### Main empirical results — VAR impulse responses
- General:
  - Impulse responses computed with 95 percent confidence intervals.
  - Responses generally muted in Tunisia but consistent with theory.
  - Return to equilibrium typically within twelve months for monetary shocks (not significant).
- Model 1 (money base or M3 as policy instrument):
  - Temporary unanticipated increase in money supply:
    - Triggers a temporary increase in activity.
    - Triggers a depreciation of the exchange rate.
    - Inflationary impact on prices manifests with a longer delay.
  - Difference between money base (model 1′) and M3 (model 1′′):
    - Transitory depreciation is weakly significant only with the money base (model 1′).
- Model 2 (includes money market rate TMM):
  - Monetary shock:
    - Impact on activity is rapid but temporary.
    - Impact on prices appears more persistent but not significant.
  - Interest rate shock (temporary and unanticipated increase in TMM):
    - Triggers a decline in activity with effects tending to dissipate after nine months.
    - Deflationary impact on prices begins after six months and is long-lasting (contrast: price impact more persistent than activity).
    - Exchange rate impact is rapid and temporary; weakly significant when interest rate is the policy instrument.
  - If M3 is replaced by the money base in model 2, lagged variables for the latter are often insignificant in most equations.

### Comparative magnitudes and stylized facts
- Compared with industrial countries, Tunisian responses show:
  - (i) amplitude of responses is more moderate;
  - (ii) price responses are clearly weaker or even insignificant in some cases;
  - (iii) responses are stronger in the case of an interest rate shock than in the case of a monetary shock;
  - (iv) impact on the exchange rate is usually weak and often insignificant.
- Other empirical observations:
  - Balance sheet channel may exist but cannot be verified with available data; survey evidence (IEQ 2005) indicates required collateral volume is a main impediment to investment.
  - Administered prices and exchange rate controls likely dampen price and exchange-rate channels.
  - Financial structure: combination of M3 and short-term interest rate importance may reflect shallow financial markets and bank-oriented investment financing (95 percent of investment financed by bank credit).
  - Correlations over time (rolling and sample comparisons):
    - At end-2000: 12-month rolling correlation between annual inflation rate and annual growth of money base = 0.45; with M3 = 0.35.
    - At end-2006: correlation with money base = 0.29; with M3 = 0.52.
    - Correlation between money base (year on year) and M3 moved from 58 percent over 1996–2001 to 51 percent over 2001–06.
    - Correlation between year-on-year total credit and credit to private sector and annual money growth: with M3 ~ 34 percent and 33 percent respectively; with money base ~ 24 percent and 18 percent respectively.
    - Correlation between annual growth in credit and inflation: ~18 percent and 7 percent respectively for total credit to the economy and credit to the private sector.
- Money demand (long-term) estimations (monthly frequency 2001:01-2006:12), real terms m_t - p_t regressed on y_t and π_t:
  - When m_t - p_t = monetary base: y_t = 0.22 (0.02) and π_t = -0.20 (0.20).
  - When m_t - p_t = M3: y_t = 0.10 (0.005) and π_t = -0.15 (0.06).
  - Structural breaks: estimated relationships record a structural change (2003 for monetary base equation; 2004 for M3 equation), introducing instability into long-term relationships.
  - Conclusion: estimation underscores a more important role for M3 in inflation targeting than for the monetary base.

### Reaction function estimation and interpretation
- Interest-rate reaction function estimated with TMM as dependent variable:
  - Estimation 1: pure inflation-targeting specification (annual inflation rate as unique explanatory variable).
  - Estimation 2: standard specification (annual inflation rate and output gap).
- Estimation findings:
  - Over long period starting before 2003, estimation quality is poor and highly unstable.
  - Post-2003: instability persists but of lesser magnitude; parameter signs are as expected (not the case before 2003).
  - Coefficient of inflation > 1 as expected but only marginally significant in both estimations.
  - Coefficient for output gap not significantly different from zero.
  - Gradual adjustment process present (coefficient ρ significantly different from zero).
  - Correction mechanism parameter γ is low and of weak significance — possibly due to high stability of TMM over the regression period.
  - Stability tests reject coefficient stability even in the recent period; misspecification tests reveal poor explanatory power and heteroskedastic residuals.
- Overall interpretation:
  - Results should be interpreted with caution given limited observations.
  - Evidence broadly supports that the use of the interest rate has become more active recently, but TMM still reacts to other omitted variables.
  - Omitted variables and limited observations likely contribute to instability and poor fit.

*Source: IMF staff estimates.*

### Box 4. Reaction Function of Central Banks: Between Theory and Practice

### Box 4. Reaction Function of Central Banks: Between Theory and Practice

### Background and motivation
- Taylor (1993) proposes a simple rule summarizing the Fed funds rate behavior by stabilizing the output gap and inflation around its target.
- Taylor (1993) finds that the specification fits the Fed funds rate over 1987–1992 on a quarterly basis when "imposing arbitrarily *r* and *π* both equal to 2% and 5.0 21 ==ββ."  
- Empirical literature finds time variation in the relative weight on output gap versus inflation, but stable estimates can emerge when estimating on sub-periods corresponding to different chairmen (Judd and Rudesbusch (1998); Clarida et al. (2000)).
- Goodhart (1999) notes that adding lagged dependent variables is required empirically; the sum of lag coefficients is generally close to, or greater than, one, implying gradual adjustment of rates in practice.

### Model specification: standard approach and ECM representation
- Taylor-style representative rule (equation (1) in source):
  - (1) tttt gap r rff 2 * 1 ** )(βππβπ+−++=  
    where *t ff is the nominal Federal funds rate recommended by the rule, *rr the equilibrium real Federal funds rate, t π and *π denote respectively the current annual inflation rate and its target, and t gap is the output gap.
- Empirical adjustment via lagged dynamics (Judd and Rudebusch (1998)):
  - (2) ttttt ffffff εργ+Δ+−=Δ −−11 *)( 
- Error-correction mechanism when substituting (1) into (2) (equation (3) in source):
  - (3) tttttt ffffgapffεργδλπα+Δ++++=Δ −−11  
    - α = )( *1 * πβγ−rr (as defined in source)
    - λ and δ are expected to be positive from estimation
    - t ε are white noise errors
    - relations: )1( 1 βγλ += and γβδ 2 = (as specified)

### Empirical estimates for Tunisia (BCT sample: 2003:1–2006:8)
- Estimates of an interest rate reaction function (Equation (3))
  - Estimation 1:
    - λ = 1.64 (1.37)
    - δ = -
    - γ = -0.01 (0.00)
    - ρ = 0.29 (0.14)
  - Estimation 2:
    - λ = 1.89 (1.27)
    - δ = -0.16 (0.17)
    - γ = -0.01 (0.00)
    - ρ = 0.26 (0.15)
- Misspecification tests:
  - R2 = 0.15
  - Breusch-Godfrey LM test: F-stat = 1.16
  - ARCH test: F-stat = 22.55
- Estimation notes:
  - Heteroskedasticity and autocorrelation consistent estimators (Andrews (1991)).
  - Standard errors reported in parentheses.
  - Given limited observations and non-rejection of the null hypothesis, intercept α removed to improve dynamics.

### Assessment of Tunisia’s monetary framework and IT building blocks
- Current structural shifts:
  - Monetary aggregate remains important, but the very short-term interest rate (TMM) has gained importance; base money importance has decreased.
  - Tunisia’s money market is concentrated at the short end and lacks term depth, complicating monetary transmission assessment.
- Building blocks of Inflation Targeting (IT) grouped as institutional, operational, technical, organizational (as enumerated in source).
- Tunisia’s compliance summary (Table 2 as evaluated in source):
  - Institutional features:
    - 1. Price stability is the primary objective — High
    - 2. Sufficient autonomy of the CB — Intermediate
    - 3. CB is transparent and accountable — Intermediate
  - Operational features:
    - 4. Stable macroeconomic framework — Intermediate
      - 4a. Absence of fiscal dominance — Intermediate
      - 4b. Robust external position — Low
    - 5. Efficient and stable financial sector — Intermediate
      - 5a. Efficient financial market — Low
      - 5b. Efficient money market — Low
      - 5c. Efficient exchange market — Intermediate
      - 5d. Efficient and stable banking sector — Intermediate
    - 6. Efficient monetary/forex operations — High
    - 7. Strong interest rate channel — High
  - Technical features:
    - 8. Infrastructure required for IT — Low
      - 8a. Good measure of inflation — Low
      - 8b. Process for setting the target — Low
      - 8c. Good Inflation indices — Low
      - 8d. Forecasting tools — Low
      - 8e. Understand transmission channels — Low
    - 9. Publication of inflation reports — Low
    - 10. Robust analytical capacities — Intermediate
  - Organizational features:
    - 11. Transparent decision-making — Low
    - 12. CB organization suited to IT needs — Low
  - Source: Authors’ evaluation and Appendix Table 4.

### Key diagnostic findings for Tunisia
- Compliance with institutional building blocks improved by May 2006 amendment establishing price stability as primary objective.
- Operational capabilities: BCT has robust operational frameworks for monetary and foreign-exchange operations; interest rate transmission channel potentially strong due to indexation of most banks’ lending on money market rates.
- Constraints and weaknesses:
  - Residual fiscal dominance risks due to weight and adjustment mechanisms of administered prices, which can create a tradeoff between inflation control and fiscal policy.
  - Technical and organizational capacities are relatively weak; external position robustness is low.
  - Indexation of bank transactions to TMM may deter dynamic use of policy interest rate and complicate adoption of short-term rate operational target.
  - Lack of data on private institutions’ credit conditions prevents quantifying corporate sensitivity to interest-rate changes.

### Policy recommendations and staged actions to strengthen IT readiness
- Immediate:
  - Strengthen the monetary policy framework and intensify cooperation among public agencies involved in macroeconomic policy and research to leverage existing analytical skills.
- Short term (1–2 years):
  - Develop an autonomous central bank research capability in monetary, financial, and inflation forecasting issues.
  - Establish an action plan for eliminating administered prices.
  - De-index banking transactions from the TMM (through appropriate incentives).
- Medium term (3–5 years):
  - Achieve BCT capacity to forecast inflation and growth.
  - Ensure exchange rate flexibility.
  - Eliminate administered prices.
  - Make markets more efficient.
  - Liberalize the capital account, subject to prudential measures and preceded by strengthening the banking sector (significant reduction in nonperforming loans) and reduction in external debt.
- Operational specifics for a move toward IT:
  - Transparency of the monetary programming process: public disclosure of methodology for current monetary targets and rationale for use of monetary base and broad money as leading indicators.
  - Choice of leading inflation indicator: retain M3 given stable correlation with inflation over 2001–2006; correlation between inflation and base money declined while correlation with M3 remained strong and relatively stable.
  - Future operating target: drop base money as operating target and adopt short-term interest rate, reflecting declining correlation between inflation and base money over 2001–2006.
  - Liquidity management: adopt “neutral” liquidity management to allow overnight market rate to reach equilibrium around the policy rate; operations should compensate in real time for autonomous factor changes.
- Preconditions and caution:
  - Firm commitment by monetary and fiscal authorities and public adherence to inflation target are critical; transparency is especially important.
  - Assess corporate vulnerability to interest rate fluctuations and identify measures to reduce indexation practices before relying on short-term interest rate operational targeting.
  - Define the role of the exchange rate in the monetary strategy; assess effects of exchange rate liberalization and set a rule for foreign-exchange intervention consistent with IT.
  - Recognize that combining IT with exchange rate targeting has often produced conflicts (examples cited: Chile, Israel, Poland, Hungary), sometimes leading to widening or discontinuation of exchange rate bands.

### Anticipated evolution of transmission channels in Tunisia
- Likely strengthening of the interest-rate channel given importance of bank credit and high business indebtedness; capital-intensive sectors expected to be most sensitive; large self-financing enterprises less sensitive.
- Potential increase in importance of the balance sheet channel.
- With full capital account liberalization, exchange rate channel likely to strengthen; risks include real appreciation of the dinar harming exports and favoring imports, creating sectoral adjustment pressures.
- Under IT with short-term interest rate as main instrument, the monetary channel is expected to diminish over time; the credit channel (including M3 relationships) may weaken with financial market development, though M3 should remain informative for medium- and long-term inflation dynamics.

*Source: IMF staff (Box 4, _wp09149)._

### Appendix I. Tunisia: Monetary Targeting Framework

### Appendix I. Tunisia: Monetary Targeting Framework

### Monetary programming objectives and annual target setting
- The monetary programming exercise aims at setting a target for M3 as follows:
  - Determining an annual target for M3 on the basis of the macro framework received from the Institut d’Économie Quantitative (IEQ), which is integrated into a money demand function prepared by the BCT41.
  - The macroeconomic forecasts by the IEQ are obtained by means of the macro econometric model used for preparing the Plan.
  - In tandem with the publication of the economic budget, the annual target for M3 for the following year is disseminated through the dispatch of summary economic indicators sent to financial transactors.42

### Monthly profiling and monetary base estimation
- Based on the annual target, a monthly profile is determined for M3 on the basis of estimates of its cyclical trends and seasonal components, as well as of an irregular component (residuals).
- Based on the monthly profile for M3, a monthly profile for the monetary base is estimated at the end of the month of December by applying the monthly multipliers observed between M3 and the monetary base throughout the current year.43

### Operational use of the monetary base target and intrayear revisions
- The monthly target for the monetary base serves as a control variable, throughout the year, to assess any overshooting of the target.
- If macroeconomic forecasts are revised in the course of the year in connection with the financial programming for the budget:
  - A new estimation of optimal growth for M3 and the monetary base is carried out in order to determine their anticipated growth and evaluate any overshooting of the target previously set for M3.
  - This estimation does not mean a revision of the initial target announced at the end of the preceding year. It serves as an information tool within the BCT to determine the magnitude of the overshooting attributable to the revision of the macroeconomic framework.

### Footnotes and operational clarifications
- 41: The annual target for the monetary aggregate M3 consists in a target to be achieved at year-end, i.e., a year-on-year figure for the month of December for each year.
- 42: Apart from the target increase in M3 and the macroeconomic projections (for GDP and its internal components), these indicators also contain likely outturn figures for the current year and the anticipated annual growth in other monetary aggregates (except for monetary base), credit, national saving, foreign debt, and government finance.
- 43: In the month of December in year t, the monthly target for the monetary base for year t+1 is determined on the basis of the monthly increase computed for M3 to which the monthly money multiplier observed between the two money aggregates during year t is applied. As the exercise is conducted at end-December of year t, it is thus talking about the money multipliers observed during the eleven months of year t and one provisional multiplier for the month of December. Accordingly, a re-estimation of the monthly profile of the target for the monetary base for year t+1 is carried out at the end of the month of January in year t+1 once the money multiplier for the month of December in year t is available.

*Source: Appendix I. Tunisia: Monetary Targeting Framework (text provided).*

### Appendix Table 4. Tunisia: Detailed Compliance with the Building Blocks

### Appendix Table 4. Tunisia: Detailed Compliance with the Building Blocks of an IT Framework

### Institutional features
- 1. Price stability as primary objective
  - Description: The general goal of the BCT is to safeguard price stability. This amendment provides the institutional basis for adopting IT.
  - Compliance: High
- 2. De facto and de jure autonomy of the central bank (CB)
  - Description: The de jure autonomy of the BCT is high, but has not been fully utilized so far. It is not clear that active interest rate management would be properly understood and accepted by the government and the public.1/ Public sector officials account for a sizable share of the BCT Board (4 out of 8 members, not including the governor).2/
  - Compliance: Intermediate
  - Numeric details from notes:
    - The BCT has high de jure indices of autonomy: its index of political autonomy was 0.63 compared to 0.45 for MCD countries; the index of operational autonomy was 0.75, against 0.63 for MCD countries.
    - Of the 24 IT central banks, the government is not represented on the monetary policy decision-making bodies for 10 of them; when represented, it is involved in the voting on monetary policy decisions in only four of them.
- 3. CB is transparent and accountable
  - Description: The rules in place at the BCT are generally less stringent than those in place at IT central banks.3/
  - Compliance: Intermediate
  - Note detail:
    - The BCT is required to inform the President of the Republic of any fact which could prove harmful to monetary stability (Article 34). The governor reports to the President of the Republic (Article 70) and is required to publish the BCT’s annual balance sheet in the official journal. The BCT is required to send a statement of its accounts to the Minister of Finance every ten days. Of the 24 IT central banks, only seven are not required to account for their performance to Parliament; all publish an inflation report, most often quarterly and at least semiannually.

### Operational features
- 4. Stable macro framework
  - Description: The stability of the macroeconomic framework benefits from capital controls.
  - Compliance: Intermediate
  - 4a. Absence of fiscal dominance
    - Description: The mechanisms for adjusting administered prices introduce a fiscal bias into the control of inflation and the implementation of the monetary program may lead to an implicit accommodation of budgetary slippages.
    - Compliance: Intermediate
  - 4b. Robust external position
    - Description: The external position benefits from capital controls, and external indebtedness is high.
    - Compliance: Low
- 5. Efficient and stable financial sector
  - Description: The institutional framework is broadly adequate, yet financial markets lack depth.
  - Compliance: Intermediate
  - 5a. Financial market
    - Description: The financial market infrastructure appears adequate but the market is shallow.
    - Compliance: Low
  - 5b. Money market
    - Description: The development of the money market has been hampered by the BCT’s daily interventions through mid-2006 as well as by the fragile financial performance of certain state-owned banks.
    - Compliance: Low
  - 5c. Forex market
    - Description: The development of the exchange market has been impeded by capital controls and the underdevelopment of the money market.
    - Compliance: Intermediate
  - 5e. Efficient and stable banking sector
    - Description: The volume of NPLs is high and the performance of certain state-owned banks needs to be significantly strengthened.
    - Compliance: Intermediate
- 6. Monetary and forex operations are efficient
  - Description: The BCT has monetary instruments and infrastructures in line with best international practices. Their implementation is well in hand.
  - Compliance: High
- 7. Efficient interest rate transmission channel
  - Description: Potentially high given the indexation of interest rates. However, indexation may deter dynamic use of the interest rate and, hence, affect the feasibility of IT.
  - Compliance: High

### Technical features
- 8. Infrastructure required for IT
  - Description: A core infrastructure is in place but it is not optimally used by the BCT, and certain tools essential for IT need to be established.
  - Compliance: Low
  - 8a. Have an inflation measurement for targeting
    - Description: The weight of administered prices in the CPI is high (which creates a tradeoff between inflation and fiscal policy) and the basket does not reflect the composition of household expenditures.
    - Compliance: Low
  - 8b. Set the inflation target and its maturity
    - Description: Discussions are at a preliminary stage.4/
    - Compliance: Low
  - 8c. Inflation indices that are rapid, leading and lagged
    - Description: Such indices are being developed.
    - Compliance: Low
  - 8d. Statistical tools for producing inflation forecasts
    - Description: Such tools are being developed.
    - Compliance: Low
  - 8e. Good understanding of transmission channels
    - Description: The assessment of transmission channels has not been the focus of in-depth studies.
    - Compliance: Low
- 9. Publication of inflation reports
  - Description: Given the current status of the economic and analytical capacity at the BCT, the preparation of such a report is not yet possible.
  - Compliance: Low
- 10. Well-established analytical capacities
  - Description: Potential exists in some public agencies but it is poorly utilized by the BCT. It is therefore advisable to:
    - (i) strengthen technical cooperation with agencies that have analytical capacities; and
    - (ii) recruit at least two econometricians and two economists to strengthen the capacity of the Research Unit.
  - Compliance: Intermediate

### Organizational features
- 11. Transparent decision-making process
  - Description: The annual targets of the monetary program are published; however, neither the monthly targets nor the factors accounting for deviations and revisions throughout the year are disseminated to the public.
  - Compliance: Low
- 12. Organization of the CB’s work units suited to the needs of an IT framework
  - Description: In the short term, a higher degree of cooperation between the BCT units involved is essential in the preparation of the monetary policy meetings and in the setting of research priorities on IT. In the longer term, changes in the BCT organization chart should be considered.
  - Compliance: Low

### Appendix Table 5. Unit Root Tests — key points
- Dataset: Monthly data for 2001:01–2006:12.
- Variables tested (ADF p-values reported; columns indicate inclusion of constant (c) and constant plus trend (c+t); results for level and 1st difference):
  - tTUNLy: Level p-values: c = 0.99, c+t = 0.22; 1st difference p-values: c = 0, c+t = 0
  - tTUNLp: Level p-values: c = 0.07, c+t = 0.29; 1st difference p-values: c = 0, c+t = 0
  - tTUNLx: Level p-values: c = 0.99, c+t = 0.91; 1st difference p-values: c = 0, c+t = 0
  - tTUNLh: Level p-values: c = 0.94, c+t = 0.05; 1st difference p-values: c = 0, c+t = 0
  - tTUNLm3: Level p-values: c = 0.97, c+t = 0.72; 1st difference p-values: c = 0, c+t = 0
  - tTUNtmm: Level p-values: c = 0.15, c+t = 0.42; 1st difference p-values: c = 0, c+t = 0
  - tLoil: Level p-values: c = 0.99, c+t = 0.96; 1st difference p-values: c = 0, c+t = 0
  - EUtLy: Level p-values: c = 0.66, c+t = 0.46; 1st difference p-values: c = 0, c+t = 0
  - EUts: Level p-values: c = 0.25, c+t = 0.64; 1st difference p-values: c = 0, c+t = 0
- Note: P-values refer to the null hypothesis of a unit root in the given series. IMF staff estimates.

*Source: Appendix Table 4 and Appendix Table 5, _wp09149 - Appendix Table 4. Tunisia: Detailed Compliance with the Building Blocks*

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