## _wp12136

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---

### Overview and methodology
- Uses a fully updated calibration of the DMP model (Debrun, Masson, and Pattillo) to assess net gains from the Common Monetary Area (CMA) and hypothetical expansions.
- DMP simulations compare costs of losing monetary sovereignty to gains in terms of greater policy credibility, emphasizing dilution of individual governments' ability to extract an inflation tax from a regional central bank.
- Focuses on welfare impacts under counterfactuals: (i) membership of the CMA, (ii) expanding the CMA, (iii) establishing a regional central bank conducting union-wide monetary policy, and (iv) combinations of (ii) and (iii).
- Simulations are partial and positive (not normative); they do not capture political factors, institutional preparedness, or all dimensions of monetary integration.

### Key empirical context and calibration inputs
- Data and indicators spanning at least 1994–2010 and selected indicators for 2008–2010 (as reflected in the tables listed).
- Builds on prior DMP calibrations applied to Africa (Masson and Pattillo, 2005; Debrun, Masson and Pattillo, 2008 and 2011).
- Seigniorage and inflation tax revenues in simulations are allocated according to GDP shares (not current rules-based allocation); induced discrepancies are small (about ½ percentage point of GDP for Lesotho, per text).

### Main findings on welfare effects and monetary arrangements
- Being a member of the CMA:
  - Significant benefits of CMA membership, particularly for Lesotho and Swaziland.
- Quantified permanent per capita income gains owing to the CMA:
  - Lesotho: 6.1 percent
  - Swaziland: 2.1 percent
  - Namibia: 1.8 percent
  - South Africa: 0.5 percent
- Interpretation notes:
  - Costs from shock asymmetry imply a permanent decline of per capita income equal to 0.3 to 0.5 percent for affected countries (text).
  - The monetary externality (credibility gain) is 0.46 percent (same for all countries by construction).
  - For LNS countries, a much larger benefit arises from insulation from pressures to finance budgets via inflation tax; model finds very high equilibrium inflation tax rates under monetary sovereignty.
- Expanding the CMA to include all current SADC members:
  - A larger CMA including all current SADC members is desirable for all except Mauritius and Tanzania (fiscally conservative), and possibly Angola (terms of trade very volatile and uncorrelated with neighbors).
  - Block expansion (all SADC members join simultaneously): only Mauritius remains a net loser; credibility effect becomes a sizable gain in excess of 1.3 percent of permanent per capita consumption for SADC candidates and about 0.9 percent for existing CMA members.
- Single-country accession:
  - Countries that would lose if joining alone: Angola, Mauritius, Tanzania (losses driven by low or negative TOT correlations with South Africa and, in some cases, high TOT volatility).
  - Largest hypothetical winners among potential entrants (joining individually): Botswana, Zambia, Zimbabwe — significant gains mainly from lower inflation via reduced fiscal pressures on monetary policy.
- Establishing a genuine CMA-wide monetary union with a regional central bank (CCB):
  - Would carry some costs in terms of foregone anti-inflationary credibility because fiscally profligate countries could extract a higher inflation tax despite small size.
  - Under current calibration and past data, no CMA member would benefit from replacing SARB leadership with a CCB. Gains from better stabilization for LNS countries would be offset by pressures on a CCB to raise the inflation tax.
  - Differences between a hegemonic SARB and a regional CCB are small and fall within plausible calibration margins.
- Creating an SADC-wide currency union under a regional CCB:
  - Continues to be beneficial for all except Mauritius.
  - Gains for existing CMA members—compared to the existing arrangement—are likely limited and fall well within plausible margins of error.

### Drivers of gains and costs
- Credibility gains are the main driver of benefits from monetary unification in the model: larger unions dilute individual governments' capacity to raise inflation for fiscal purposes.
- Costs emphasized by traditional Optimum Currency Area (OCA) literature—owing to asymmetric shocks—are relatively small in the DMP framework.
- Costs rise with lower correlation of terms-of-trade (TOT) shocks with South Africa and with larger TOT volatility.
- Benefits increase with intensity of intraregional trade and with greater fiscal “financing need” (FN), via anti-inflationary credibility and insulation from pressures to monetize deficits.
- Financing needs (FN) substantially shape a country’s willingness to join; large dispersion of FN across SADC matters.

### Limitations and excluded dimensions
- Model omits:
  - Political factors essential for monetary unions to work (e.g., solidarity, risk sharing).
  - Intrinsic benefits from exchange rate stability (investment and intraregional trade effects).
  - The creation of a common money market.
  - Institutional building requirements (a central bank, regional financial supervisor, common accounting standards) and broader coordination of fiscal, structural, and regulatory policies.
- Cannot resolve normative questions about acceptable losses of sovereignty or political costs required for union sustainability (e.g., lessons from the recent euro area crisis).
- Estimates are broad welfare estimates, not precise country-by-country prescriptions; more precise estimation would require capturing country-specific factors and data up to 2011.

### Policy-relevant implications and recommendations
- Maintain the existing asymmetric CMA arrangement (South Africa setting monetary policy) rather than moving to a CMA-wide central bank, to preserve anti-inflationary credibility.
- Consider enlargement benefits cautiously: expansions are generally beneficial but depend critically on the fiscal behavior, size, and trade linkages of prospective members.
- Institutional development and political arrangements (solidarity mechanisms, fiscal coordination, supervisory frameworks) remain essential complements to any monetary integration effort but are outside the model’s quantitative assessment.
- Mechanisms that alleviate stabilization costs—more countercyclical fiscal policies and effective risk-sharing/transfer systems—would be important, especially for an expanded CMA; agreeing and implementing such transfer systems in a heterogeneous group like SADC would be challenging.

### CMA history, institutional arrangements, and economic convergence (selected facts)
- Key dates and milestones:
  - 1921: South African currency became medium of exchange in South Africa, Bechuanaland, Lesotho, Namibia, and Swaziland.
  - 1974: Rand Monetary Area (RMA) agreement institutionalized on December 5.
  - 1975: Botswana left the RMA; continued to use rand until August 1976.
  - April 1986: RMA revamped into the Common Monetary Area (CMA) composed of Lesotho, Swaziland, and South Africa.
  - 1992: Namibia joined CMA formally; 1993: Namibia launched the Namibian dollar.
  - 2003: Swaziland reauthorized use of the rand as legal tender.
- Exchange rate and legal tender arrangements:
  - Lesotho, Namibia, and Swaziland (LNS countries) have pegged their domestic currencies at par to the South African rand.
  - South African rand is legal tender throughout the CMA; the three other currencies are legal tender only in their own country.
  - In each LNS country, local currency and rand are perfect substitutes, with no conversion cost, and no restrictions on funds transfers for current or capital transactions.
  - SARB has adopted an inflation targeting framework.
- Institutional limitations relative to full currency union:
  - No common central bank; no pooling of external reserves; no formal regional surveillance of domestic policies; no fiscal transfers to cushion asymmetric shocks.
  - 1-to-1 parities are not backed by irrevocable commitments such as mutual assistance promises; SARB may make foreign exchange available to other CMA members.
  - Swaziland can adjust its exchange rate unilaterally with six month notice to SARB; Swaziland is not required to hold foreign exchange at the SARB to cover its currency in circulation (unlike Lesotho and Namibia).
- Size and weight:
  - South Africa accounts for more than 90 percent of the region’s GDP and trade.
- Fiscal positions and public debt (selected figures 2008–2011):
  - Swaziland posted deficits: 5.6 percent of GDP on average over 2008–10, with 13.8 percent, on a commitment basis, during the fiscal year 2010/11.
  - Lesotho’s public debt was 41.5 percent of GDP.
- Trade and capital mobility:
  - All four CMA members (together with Botswana) belong to the Southern African Customs Union.
  - Capital and goods are highly mobile across CMA; in crises, sharp reversals in net capital flows can strain smaller economies because of absence of conversion cost between local currency and rand.

### Key macroeconomic indicators (memo table, selected entries preserved exactly)
- Countries listed in order: Lesotho, Namibia, South Africa, Swaziland, CMA Total, Botswana
- Nominal GDP (millions of US dollars): 1,939 9,947 307,743 3,167 322,795 13,323
- Real GDP growth rate (percent): 3.7 2.8 1.6 2.1 ... 1.7
- Inflation (percent, period average): 6.6 7.9 7.6 7.3 ... 9.2
- Fiscal balance (including grants; percent of GDP): -0.8 -1.9 -3.8 -5.6 ... -8.9
- Total government debt (percent of GDP)1: 41.5 17.6 31.2 16.1 ... 12.3
- International reserves (months of imports): 5.1 3.8 5.0 3.8 ... 19.3
- Current account balance (percent of GDP): -0.8 1.1 -4.7 -13.6 ... -1.3
- Total exports (millions of US dollars): 870 4,149 91,840 1,888 98,746 4,757
- Note: 1 This includes grants.

### Reserve adequacy and reserve coverage (Small CMA countries, selected rows preserved exactly)
- Gross reserves/imports (Months of imports) — 2008, 2009, 2010, 2011 Est.:
  - Lesotho: 6.0, 5.6, 3.8, 2.6
  - Namibia: 3.8, 4.7, 2.8, 2.5
  - Swaziland: 4.6, 3.9, 2.8, 2.3
- Gross reserves/broad money (percent) — 2008, 2009, 2010, 2011 Est.:
  - Lesotho: 155 132 104 67
  - Namibia: 39 53 29 25
  - Swaziland: 116 84 54 48
- Source: National authorities and IMF staff estimates.
- Note: Rand circulation is not included as part of base money.

### The DMP theoretical model (structure, mechanisms, and selected equations)
- Variant of Debrun, Masson and Pattillo (2005); integrates costs of one-size-fits-all monetary policy with benefits from enhanced policy credibility; models substitutability between monetary integration and domestic institutional reforms.
- Economic structure: n-good, n-country area; countries differ by size, economic governance, budget flows, and Phillips-curve shocks (terms-of-trade disturbances); static structure with new-classical Phillips curve augmented with a distortionary tax and a negative externality from competitive devaluations; simple period-budget constraints; no public debt.
- National policy-making and key equations (as presented):
  - Phillips curve with regional spillovers: (equation label 1 as printed)
    -  i n kik e kkkii e iiNi ccyy  1, ,
  - Government budget constraint (no debt): (equation label 2 as printed)
    - iiiig,
  - Government’s utility function: (equation label 3 as printed)
    -      iiii ii G i yggbaU 2 2 2 ~~ 2 1  ,
  - Trade-off between output and inflation variability: (equation label 4 as printed)
    - ii  ~ with 0
- Supranational monetary policy Phillips curve for common central bank (equation label 1’ as printed):
  -  i Mk e kkkii e MM M iNi cccyy   , 1, Mi , with    Mk ki M i,  .
- Key variables and parameters (as listed):
  - i  : Inflation rate in country i. A superscript “e” designates a rationally expected value.
  - i y : Logarithm of output in country i.
  - N y : Logarithm of the natural level of output at zero taxation. Without loss of generality, assume 0 N y.
  - i  : Corporate income tax rate (also tax revenues in percent of output).
  - ki,  : Marginal effect of monetary policy in country k on output in country i.
  - i  : Terms of trade shock (zero-mean, transitory, and with finite variance).
  - i g : Socially beneficial government expenditure in percent of output.
  -  : Inflation tax base in percent of output.
  - i  : Permanent non-tax revenue from natural resource endowment in percent of output.
  - i  : Funds diverted from socially beneficial government expenditure in percent of output.
  -  : Relative preference for output stability against inflation stability.
- Representative equilibrium and social-optimum expressions preserved in the paper (labels and forms preserved as printed), including autonomy equilibrium, autonomy social optimum, inflation bias, and Monetary Union M equilibrium (equation labels 5–9 as printed).

*Source: _wp12136 - References; Section VII; IMF staff report (extracted content).*

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

### References

### Overview and methodology
- The paper uses a fully updated calibration of the DMP model (Debrun, Masson, and Pattillo) to assess net gains from the Common Monetary Area (CMA) and hypothetical expansions.
- DMP simulations compare costs of losing monetary sovereignty to gains in terms of greater policy credibility, emphasizing dilution of individual governments' ability to extract an inflation tax from a regional central bank.
- The model focuses on welfare impacts under counterfactuals: (i) membership of the CMA, (ii) expanding the CMA, (iii) establishing a regional central bank conducting union-wide monetary policy, and (iv) combinations of (ii) and (iii).
- The simulations are partial and positive; they are not normative policy prescriptions and do not capture political factors, institutional preparedness, or all dimensions of monetary integration.

### Key empirical context and calibration inputs
- The paper references data and indicators spanning at least 1994–2010 and selected indicators for 2008–2010 (as reflected in the tables listed).
- The analysis builds on prior DMP calibrations applied to Africa (Masson and Pattillo, 2005; Debrun, Masson and Pattillo, 2008 and 2011).

### Main findings on welfare effects and monetary arrangements
- Being a member of the CMA:
  - The model suggests there are significant benefits of being a member of the CMA, particularly for Lesotho and Swaziland.
- Expanding the CMA to include all current Southern African Development Community (SADC) members:
  - A larger CMA including all current SADC members is desirable for all except:
    - Mauritius (fiscally conservative), and
    - Tanzania (fiscally conservative), and
    - possibly Angola (terms of trade very volatile and uncorrelated with neighbors).
- Establishing a genuine CMA-wide monetary union with a regional central bank:
  - Would carry some costs in terms of foregone anti-inflationary credibility because fiscally profligate countries could extract a higher inflation tax despite small size.
  - All members would be better off maintaining the current asymmetric CMA regime where South Africa sets monetary policy rather than shifting to a union-wide central bank.
- Creating an SADC-wide currency union under a regional central bank:
  - Continues to be beneficial for all except Mauritius.
  - The gains for existing CMA members—compared to the existing arrangement—are likely limited and fall well within plausible margins of error.

### Insights on drivers of gains and costs
- Credibility gains are the main driver of benefits from monetary unification in the model: larger unions dilute individual governments' capacity to raise inflation for fiscal purposes.
- Costs emphasized by traditional Optimum Currency Area (OCA) literature—owing to asymmetric shocks—are relatively small in the DMP framework.
- Larger currency unions are more likely to be beneficial for most members unless newcomers are relatively large, fiscally undisciplined, and without meaningful trade linkages.

### Limitations and excluded dimensions
- The model omits several critical dimensions:
  - Political factors essential for monetary unions to work (e.g., solidarity, risk sharing).
  - Intrinsic benefits from exchange rate stability (investment and intraregional trade effects).
  - The creation of a common money market.
  - Institutional building requirements (a central bank, regional financial supervisor, common accounting standards) and broader coordination of fiscal, structural, and regulatory policies.
- The analysis cannot resolve normative questions about acceptable losses of sovereignty or political costs required for union sustainability (e.g., lessons from the recent euro area crisis).
- Estimates are intended to provide broad and comprehensive welfare estimates of CMA participation and hypothetical enlargements, not precise country-by-country prescriptions; more precise estimation would require capturing country-specific factors and data up to 2011.

### Policy-relevant implications
- Maintain the existing asymmetric CMA arrangement (South Africa setting monetary policy) rather than moving to a CMA-wide central bank, to preserve anti-inflationary credibility.
- Consider enlargement benefits cautiously: expansions are generally beneficial but depend critically on the fiscal behavior, size, and trade linkages of prospective members.
- Institutional development and political arrangements (solidarity mechanisms, fiscal coordination, supervisory frameworks) remain essential complements to any monetary integration effort but are outside the model’s quantitative assessment.

*Source: _wp12136 - References*

### Section VII.

### Section VII.

### II. LITERATURE REVIEW
- Classic OCA literature emphasizes costs of forfeiting monetary policy autonomy and the role of alternative adjustment mechanisms:
  - Mundell (1961): labor mobility as crucial for idiosyncratic shocks; price and wage flexibility important.
  - McKinnon (1963): degree of openness (ratio of tradable to nontradable goods) as key indicator.
  - Kenen (1969): product diversification and fiscal integration as mitigating factors for asymmetric disturbances.
- Extensions and new dimensions in the literature:
  - Beetsma and Bovenberg (1999): effectiveness and credibility of monetary policy.
  - Alesina, Barro, and Tenreyro (2002): centrality of shock correlations.
  - Mélitz (1991): identical shocks can require different policy responses due to different initial economic positions and transmission mechanisms.
  - Endogeneity of OCA criteria:
    - Frankel and Rose (1997): openness and income correlation linked because business cycle correlation depends on trade integration.
    - Mongelli (2002): endogeneity depends on pre-existing degree of convergence.
    - De Grauwe and Mongelli (2004): endogeneity of economic integration, financial integration, symmetry of shocks, and labor market flexibility.
  - Debrun, Masson and Pattillo (2005) (DMP): integrates costs of one-size-fits-all monetary policy with benefits from enhanced policy credibility; models substitutability between monetary integration and domestic institutional reforms; emphasizes asymmetries in institutional quality and credibility of monetary commitments; highlights positive “monetary externalities” from larger monetary unions.
- Empirical literature on the Common Monetary Area (CMA):
  - Historical and institutional reviews: Van Zyl (2003); Wang and others (2007).
  - Country-focused studies: Tjirongo (1995); Lledo, Martijn, and Gons (2005); Gons (2006); Dwight (2006).
  - Critiques finding CMA does not meet traditional OCA criteria regarding vulnerability to asymmetric shocks and labor mobility: Cobham and Robson (1994); Van der Merwe (1996); Metzger (2004); Masson and Pattillo (2005).

### III. THEORETICAL MODEL
- Model specification:
  - Variant of Debrun, Masson and Pattillo (2005).
  - Focuses on impact of institutional changes on credibility of commitment to low inflation; aligns with literature on EMU and credibility-enhancing institutional reforms (Beetsma and Bovenberg—1998, 1999; Martin—1995).
  - Based on positive theory of monetary policy (Barro and Gordon, 1983) and extensions to fiscal policy (Alesina and Tabellini, 1987).
  - n-good, n-country area small vis-à-vis rest of world; countries differ by size, economic governance (propensity to wasteful public spending), budget flows, and Phillips-curve shocks (interpreted as terms-of-trade disturbances).
  - Economic structure is essentially static: new-classical Phillips curve augmented with a distortionary tax and a negative externality from competitive devaluations (monetary surprises); simple period-budget constraints; no public debt.
  - Welfare analysis rests on strategic interactions between monetary and fiscal policymakers.
- Benchmark regime:
  - Complete monetary policy autonomy (flexible exchange rates) with politically dependent central banks.
  - Monetary and fiscal policies jointly determined by minimizing deviations of effective tax rate, public expenditure, and inflation from nonnegative constant objectives (inflation fluctuates to partly accommodate Phillips-curve shocks).
  - Governments also care about level of output (prefer expansions; dislike contractions).
- Equilibrium implications:
  - Systematic deviation from first best: government penchant to use monetary policy to boost activity beyond potential and wasteful public spending lead to too high inflation and too low productive public spending relative to credible pre-commitment.
- Modeling monetary unification:
  - Change of regime: monetary policy decided by regional central bank; fiscal policy remains national.
  - Benefits akin to delegation to independent central bank: regional monetary policy less effective at stimulating output in each country (no depreciation gain vs. regional partners), yielding lower inflation across board.
  - Credibility gains proportional to size of initial bias (reflecting slope of Phillips curve, reluctance to raise distortionary taxes, appetite for productive public spending, amount of wasteful public spending) and intensity of intraregional trade linkages.
  - Costs arise from inadequacy of regional monetary policy facing country-specific shocks, consistent with OCA literature.

### IV. THE CMA: HISTORY, INSTITUTIONAL ARRANGEMENTS, AND ECONOMIC CONVERGENCE

#### A. History and Institutional Arrangements
- Historical milestones and institutional features:
  - 1921: after establishment of the South African Reserve Bank (SARB), South African currency (initially the pound; since 1961 the rand) became the only medium of exchange and legal tender in South Africa, Bechuanaland (now Botswana), Lesotho, Namibia, and Swaziland.
  - System institutionalized on December 5, 1974 with the Rand Monetary Area (RMA) agreement; Botswana left the RMA in 1975 in favor of policy independence (continued to use rand until August 1976).
  - April 1986: RMA revamped into the Common Monetary Area (CMA), composed of Lesotho, Swaziland, and South Africa.
  - Swaziland introduced the lilangeni in 1974; Lesotho’s loti in 1980; Namibia joined CMA formally in 1992 and launched the Namibian dollar in 1993.
- Exchange rate and legal tender arrangements:
  - Lesotho, Namibia, and Swaziland (LNS countries) have pegged their domestic currencies at par to the South African rand.
  - Bilateral agreements define legal tender status: South African rand is legal tender in all CMA members; the three other currencies are legal tender only in their own country.
  - In each LNS country, local currency and rand are perfect substitutes, with no conversion cost, and no restrictions on funds transfers for current or capital transactions.
  - SARB has adopted an inflation targeting framework.
- Trade and capital mobility:
  - All four CMA members (together with Botswana) belong to the Southern African Customs Union.
  - Capital and goods are highly mobile across CMA, though further progress needed in removing nontariff barriers to trade.
  - In normal times, LNS countries benefit from goods and capital mobility; in crises, sharp reversals in net capital flows (moving to South Africa) can strain smaller economies, exacerbated by absence of conversion cost between local currency and rand.
- Institutional limitations relative to full currency union:
  - CMA is not a full currency union: no common central bank for the region; no pooling of external reserves; no formal regional surveillance of domestic policies; no fiscal transfers to cushion asymmetric shocks.
  - Exchange rate arrangements resemble characteristics of a currency board—domestic currency issues required to be fully backed by foreign reserves (except Swaziland)—but central banks of small members may hold domestic assets (unlike a typical currency board).
  - 1-to-1 parities with the rand are not backed by irrevocable commitments such as mutual assistance promises if the peg is under pressure; SARB may make foreign exchange available to other CMA members.
  - Swaziland can adjust its exchange rate unilaterally without formal consultations with South African authorities; such an adjustment would require a six month notice to the SARB.
  - Swaziland is not required to hold foreign exchange at the SARB to cover its currency in circulation, unlike Lesotho and Namibia.
  - Reintroduction of the rand as legal tender in 2003 was done with the concurrence of the rest of the CMA.
- Contrast with other African monetary unions:
  - CMA’s free trade area and unrestricted capital mobility contrast with CEMAC and WAEMU where some trade restrictions persist and intra-regional capital mobility remains low (Masson and Pattillo, 2001).

#### B. Economic Convergence
- Size and weight:
  - South Africa accounts for more than 90 percent of the region’s GDP and trade.
- Fiscal positions and public debt (2008–2010 and related figures):
  - Fiscal positions remained fairly benign on average in 2008–2010 despite global financial crisis’s impact on growth.
  - Swaziland posted fairly sizeable and increasing deficits: 5.6 percent of GDP on average over in 2008–10, with 13.8 percent, on a commitment basis, during the fiscal year 2010/11.
  - Lesotho’s public debt was 41.5 percent of GDP, staying well above the regional average.
- Monetary policy transmission and convergence:
  - Pegged exchange rates and perfect intra-regional capital mobility imply monetary policy rates move in parallel among CMA countries, with SARB’s monetary stance being the area’s anchor.
  - Monetary hegemony is the only possible equilibrium in a fixed exchange rate system without formal cooperation procedure to set interest rates in line with CMA-wide conditions.
  - Discount rates in Namibia and Swaziland closely aligned with the SARB repo rate; Lesotho implements monetary policy through the treasury bill market, hence a spread observed with respect to policy rates of other members.
  - As a result of monetary policy convergence, LNS countries benefited from South Africa’s adoption of a formal inflation-targeting framework.

*Source: _wp12136 - Section VII.*

### 2001. The convergence of inflation rates across the CMA supports the view that the area

### _wp12136 - 2001. The convergence of inflation rates across the CMA supports the view that the area

### Key macroeconomic indicators (memo table)
- Countries listed in order: Lesotho, Namibia, South Africa, Swaziland, CMA Total, Botswana
- Nominal GDP (millions of US dollars): 1,939 9,947 307,743 3,167 322,795 13,323
- Real GDP growth rate (percent): 3.7 2.8 1.6 2.1 ... 1.7
- Inflation (percent, period average): 6.6 7.9 7.6 7.3 ... 9.2
- Fiscal balance (including grants; percent of GDP): -0.8 -1.9 -3.8 -5.6 ... -8.9
- Total government debt (percent of GDP)1: 41.5 17.6 31.2 16.1 ... 12.3
- International reserves (months of imports): 5.1 3.8 5.0 3.8 ... 19.3
- Current account balance (percent of GDP): -0.8 1.1 -4.7 -13.6 ... -1.3
- Total exports (millions of US dollars): 870 4,149 91,840 1,888 98,746 4,757
- Source of table: National authorities and IMF staff estimates.
- Note: 1 This includes grants.

### Reserve adequacy and reserve coverage (Small CMA countries, Table 2)
- Gross reserves/imports (Months of imports) — 2008, 2009, 2010, 2011 Est.:
  - Lesotho: 6.0, 5.6, 3.8, 2.6
  - Namibia: 3.8, 4.7, 2.8, 2.5
  - Swaziland: 4.6, 3.9, 2.8, 2.3
- Gross reserves/short-term external debt (percent) — 2011 Est.:
  - Lesotho: n.a.
  - Namibia: 4039 08599591  (as printed)
  - Swaziland: n.a.
- Gross reserves/base money (percent) — 2008, 2009, 2010, 2011 Est.:
  - Lesotho: 93 98 44 67 0 51 0  (as printed)
  - Namibia: 54 26 36 31 22 74  (as printed)
  - Swaziland: 74 94 96 38 42 37  (as printed)
- Gross reserves/broad money (percent) — 2008, 2009, 2010, 2011 Est.:
  - Lesotho: 155 132 104 67
  - Namibia: 39 53 29 25
  - Swaziland: 116 84 54 48
- Source: National authorities and IMF staff estimates.
- Note: Rand circulation is not included as part of base money.

### Fiscal balances, debt, and volatility across the CMA
- LNS (Lesotho, Namibia, Swaziland) countries exhibit more volatile fiscal positions than South Africa, owing to smaller size, lack of diversification, and the SACU revenue-sharing formula.
- During cyclical upturns (2004–07) LNS countries recorded much larger surpluses than South Africa, supporting low and relatively stable public debt levels; Lesotho gradually converged to the 20–40 percent of GDP range (textual description; exact series shown in figures).

### Model-based assessments: costs and benefits of CMA membership (DMP model)
- Purpose of DMP simulations: compare costs of sharing a single monetary policy (foregone stabilization) with benefits of policy coordination (credibility, insulation from fiscal financing pressures) under fixed exchange rates.
- Key model mechanisms:
  - Costs rise with lower correlation of terms-of-trade (TOT) shocks with South Africa and with larger TOT volatility.
  - Benefits increase with intensity of intraregional trade and with greater fiscal “financing need” (FN), via anti-inflationary credibility and insulation from pressures to monetize deficits.
- Calibration notes:
  - Seigniorage and inflation tax revenues in simulations are allocated according to GDP shares (not the current rules-based allocation); induced discrepancies are small (about ½ percentage point of GDP for Lesotho, per text).

### Quantified welfare effects for current CMA members (permanent per capita income changes)
- Model estimates of permanent per capita income gains owing to the CMA:
  - Lesotho: 6.1 percent
  - Swaziland: 2.1 percent
  - Namibia: 1.8 percent
  - South Africa: 0.5 percent
- Interpretation:
  - Costs from shock asymmetry imply a permanent decline of per capita income equal to 0.3 to 0.5 percent for affected countries (text).
  - The monetary externality (credibility gain) is 0.46 percent (same for all countries by construction).
  - For LNS countries, a quantitatively much larger benefit arises from insulation from pressures to finance budgets via inflation tax; model finds very high equilibrium inflation tax rates under monetary sovereignty.

### Hypothetical single-country additions to the CMA (selected qualitative results)
- General finding: All existing CMA members appear to benefit marginally from adding any individual SADC country provided the SARB sets monetary policy.
- Countries that would lose if joining alone:
  - Angola, Mauritius, Tanzania — losses driven by low or negative TOT correlations with South Africa and, in some cases, high TOT volatility; OCA considerations dominate.
- Largest hypothetical winners among potential entrants (joining individually):
  - Botswana, Zambia, Zimbabwe — significant gains mainly from lower inflation via reduced fiscal pressures on monetary policy; positive TOT correlations help contain stabilization costs.
- Strategic insight: financing needs (FN) substantially shape a country’s willingness to join; large dispersion of FN across SADC matters.

### Block expansion (all SADC members join simultaneously)
- Block expansion results:
  - Only Mauritius remains a net loser from full SADC-wide accession to the CMA; Angola and Tanzania would gain from joining together even if they would lose as sole entrants.
  - Credibility effect (single monetary policy) becomes a sizable gain: in excess of 1.3 percent of permanent per capita consumption for SADC candidates and about 0.9 percent for existing CMA members.
  - Implication: a coordinated, simultaneous expansion can reverse individual-entry outcomes because credibility gains and cross-country interactions change the welfare calculus.

### Hegemony (SARB) versus a regional central bank (CCB)
- Simulations for moving from a SARB-led arrangement to a regional CCB (weighted by GDP shares) find:
  - Under current calibration and past data, no CMA member would benefit from replacing SARB leadership with a CCB. Gains from better stabilization for LNS countries would be offset by pressures on a CCB to raise the inflation tax.
  - Differences between a hegemonic SARB and a regional CCB are small and fall within plausible calibration margins.
  - Political/institutional guarantees on CCB independence could alter results; the DMP model does not capture elimination of currency risk or full convergence of nominal interest rates.
- For a larger SADC currency union with a regional CCB:
  - The set of net beneficiaries is similar to the SARB-led case: only Mauritius would have no interest in joining.
  - Losses from a one-size-fits-all monetary policy would be spread across virtually all countries; current CMA members would gain little, if anything, from a larger SADC union under a regional CCB.

### Policy implications and concluding messages
- Three broad implications drawn from model simulations:
  (i) Costs of a one-size-fits-all monetary policy can be significant when shocks are large and uncorrelated; nevertheless, the CMA provides substantial credibility and macroeconomic-stability gains that make membership beneficial for current members.
  (ii) A regional CCB conducting policy on area-wide averages would generally be preferable to full monetary autonomy because of credibility gains; however, to be preferred to the existing SARB-led arrangement, institutional guarantees on CCB independence would likely be required.
  (iii) Mechanisms that alleviate stabilization costs—more countercyclical fiscal policies and effective risk-sharing/transfer systems—would be important, especially for an expanded CMA; agreeing and implementing such transfer systems in a heterogeneous group like SADC would be challenging.
- Summary judgement:
  - The current CMA arrangement is beneficial for all CMA members, including South Africa; Lesotho and Swaziland gain the most due to insulation from fiscal pressures.
  - Expanding the CMA: if all SADC countries join simultaneously, all except Mauritius could be better off; but individual accession would make Angola, Mauritius, and Tanzania worse off.
  - Establishing a full CMA-wide monetary union with a regional CCB carries costs in anti-inflationary credibility (due to influence of fiscally profligate members); under current calibration, members are better off maintaining the existing arrangement.

*Source: IMF staff report (extracted content from _wp12136 - 2001. The convergence of inflation rates across the CMA supports the view that the area).*

### REFERENCES

### _wp12136 - REFERENCES

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### Appendix I. History of the Common Monetary Area (Table A.1: Major Events)
- 1974: Lesotho, South Africa, and Swaziland signed the Rand Monetary Area (RMA) treaty. Swaziland established a monetary authority and issued its own national currency, the lilangeni, pegged at par to the rand. Botswana did not sign the RMA agreement: it had withdrawn from the negotiations in September.
- 1975–76: Botswana established a central bank, and replaced the rand at par with its own national currency, the pula.
- 1980: Lesotho established a central bank and issued its own national currency, the loti, pegged at par with the rand.
- 1986: South Africa, Lesotho, and Swaziland signed the Common Monetary Area Trilateral Agreement to replace the RMA, making additional provisions regarding the capital account, intra-CMA fund transfers, and seigniorage compensation. Swaziland discontinued the use of the rand as legal tender alongside the lilangeni.
- 1989: The CMA was amended, removing exchange restrictions resulting from limitations on conversion of balances upon termination of the monetary agreement or the withdrawal of one party.
- 1992: Following its independence from South Africa, Namibia formally joined the CMA. The Multilateral Agreement replaced the Trilateral Agreement.
- 1993: Namibia initiated issuing its own national currency, the dollar, pegged at par to the rand.
- 2003: Swaziland reauthorized use of the rand as legal tender.

### Appendix II. Institutional Framework of the Common Monetary Area (summary of key provisions from Wang and others (2007))
- Currency Arrangement:
  - Article 2 of the CMA (Multilateral) Arrangement gives the three small member countries the right to issue national currencies, and their bilateral agreements with South Africa define the areas where their currencies are legal tender.
  - The local currencies issued by the three members are legal tender only in their own countries. The South African rand, however, is legal tender throughout the CMA.
  - Bilateral agreements require LNS central banks to permit authorized dealers to convert, at par, notes issued by their central banks or the South African Reserve Bank without restriction and subject only to normal handling charges.
  - Under the Lesotho-South Africa and Namibia-South Africa bilateral agreements, the central banks of Lesotho and Namibia are required to maintain foreign reserves at least equivalent to the total amount of local currencies they issue. Such reserves may comprise rand balances, rand currency held in a Special Rand Deposit Account with the SARB, South African government stock (up to a certain proportion), and investments in the Corporation for Public Deposit in South Africa.
- Movements of Funds Within the CMA:
  - Article 3: No restrictions can be imposed on the transfer of funds, whether for current or capital transactions, to or from any member country, except investment or liquidity requirements prescribed for financial institutions.
  - Investment and liquidity requirements function as minimum local asset requirements to address concerns that funds generated in small members tended to flow to South Africa.
- Access to South African Financial Markets:
  - The CMA Agreement provides access to South African capital and money markets for the three small members, but only through prescribed investments or approved securities held by financial institutions in South Africa, subject to prudential regulations in the LNS countries.
  - Short-term money market: no regular arrangements exist for taking up treasury bills issued by LNS countries in South Africa; temporary central bank credit can be obtained via bilateral negotiations in special circumstances.
- Gold and Foreign Exchange Transactions:
  - Article 5 requires LNS exchange control regulations to be – in all material aspects – similar to those in effect in South Africa.
  - Gold and foreign exchange receipts of residents are subject to a surrender requirement. There are no exchange restrictions on current international transactions and for nonresidents.
- Compensation Payments:
  - South Africa compensates small members for forgone seigniorage based on a formula equal to the product of (i) two-thirds of the annual yield on the most recently issued long-term South African government stock, and (ii) the volume of rand estimated to be in circulation in the member country concerned.
  - The ratio of two-thirds approximates the yield of a portfolio of reserve assets comprising both long-term and short-term maturities.
- Consultation and other Provisions:
  - Member countries established a commission with one representative each; the commission holds regular consultations at least once a year and convenes at other times on request.
  - Article 9 provides for a tribunal to arbitrate disputes regarding interpretation or application of the agreement.
- Footnotes preserved:
  - Footnote 1: Swaziland suspended the use of rand as legal tender in 1986 despite wide acceptance; in fall of 2003 Swazi authorities re-authorized use of rand alongside the lilangeni.
  - Footnote 2: The foreign-reserve provision was not included in the Swaziland-South Africa bilateral agreement of April 1986; however, the Central Bank of Swaziland has maintained foreign reserves larger than the total amount of local currencies it issued throughout the past two decades.

### Appendix III. Description of the DMP Model (model structure, key equations, and variables)
- National policy-making
  - Phillips curve with regional spillovers:
    -  i n kik e kkkii e iiNi ccyy  1, ,  (1)
  - Government budget constraint (no debt):
    - iiiig,                                           (2)
  - Government’s utility function:
    -      iiii ii G i yggbaU 2 2 2 ~~ 2 1  ,                 (3)
  - Trade-off between output and inflation variability:
    - ii  ~ with 0 (4)
- Supranational monetary policy
  - Phillips curve faced by the common central bank for each member of M:
    -  i Mk e kkkii e MM M iNi cccyy   , 1, Mi , with    Mk ki M i,  . (1’)
- Key variables and parameters (as listed)
  - i  : Inflation rate in country i. A superscript “e” designates a rationally expected value.
  - i y : Logarithm of output in country i.
  - N y : Logarithm of the natural level of output at zero taxation. Without loss of generality, we assume 0 N y.
  - i  : Corporate income tax rate (also tax revenues in percent of output).
  - ki,  : Marginal effect of monetary policy in country k on output in country i.
  - i  : Terms of trade shock (zero-mean, transitory, and with finite variance).
  - i g : Socially beneficial government expenditure in percent of output.
  -  : Inflation tax base in percent of output.
  - i  : Permanent non-tax revenue from natural resource endowment in percent of output.
  - i  : Funds diverted from socially beneficial government expenditure in percent of output.
  -  : Relative preference for output stability against inflation stability.
- Note: complete solutions are available from the authors upon request.
- Inflation Rates Under Alternative Monetary Regimes (equilibrium and social optima formulas preserved)
  - Autonomy — The equilibrium (time-consistent) inflation is:
    -  c bb iii  + +  +        ***  (5)
  - Autonomy — The socially optimal rate is:
    -      ionstabilizatOutput taxationof costOutput trequiremen financing of Size **~ iiii ba cg b                  , with  0 2 bba. (6)
  - Autonomy — Inflation bias:
    -  cyinefficien sector Public biasinflation Gordon-Barro Augmented"" *** )( iii b c b             , (7)
  - Monetary Union M (utilitarian CCB) — equilibrium inflation for all Mi:
    -   , 1 *M A M A M A M i ba c b FN b                     (8)
    - with    Mi i M i M A xx , for  ,,FNx and iiii gFN ~ . Hence, Average policies in M produce a reduction in the Gordon-Barro bias:  . bias.Gordon -Barro in thereduction Average national under inflation Average **  c b M A A M A        
  - Legally independent national central banks:
    -  i ii ii b c b                  1 *** (9)
    - with 10 i , the extent of political interference. If 0 i , the government has no influence on central bank’s decisions; and if 1 i , the government effectively sets monetary policy (see (5)).

*Content derived from: _wp12136 - REFERENCES*

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