Public Information Notice: IMF Concludes Review of the Compensatory Financing Facility

IMF News, April 7, 2004

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Canonical URL: Public Information Notice: IMF Concludes Review of the Compensatory Financing Facility

The Compensatory Financing Facility (CFF) was established in 1963 to help member countries cope with temporary export shortfalls caused by exogenous shocks.
The facility has been modified several times, including by broadening its coverage to include shocks affecting cereal imports.
At the time of the most recent review in 2000, the Executive Board decided to simplify the structure of the CFF and that CFF financing would need to be made in parallel with a Fund-supported adjustment program when preexisting balance of payments weaknesses needed to be addressed.
The CFF has not been used since the modifications introduced in 2000; the review notes it has not been used since 1999.
The Executive Board concluded its review of the CFF on March 31, 2004.
The review was undertaken in parallel with a paper on instruments and financing options for low-income countries and with the broader ongoing review of the role of the Fund in low-income countries.

Directors examined three key premises underlying the usefulness of the CFF:
- (i) temporary shocks are common and the appropriate response is upfront financing rather than adjustment;
- (ii) members have little or no access to alternative sources of financing to cushion a temporary balance of payments shock; and
- (iii) other Fund facilities are not suitable for dealing with CFF-type shocks.
On the time profile of balance of payments shocks:
- Many Directors agreed that, especially with regard to commodity prices, it is typically hard to distinguish ex ante between temporary and persistent components.
- Directors pointed to empirical evidence suggesting a significant downward trend and increased volatility of commodity prices over time, as well as a substantial persistence of negative commodity price shocks.
- These factors indicate that upfront compensatory financing entails the risk that needed adjustment could be postponed.
- A few Directors noted that commodity price slumps have a transitory component and that adjustment measures could be readily adopted should a shock prove persistent; they cited relevant shocks since the previous review that could be reasonably viewed as temporary.

Most Directors noted that the growth in private capital flows since the inception of the CFF has diminished the facility's usefulness for middle-income members.
Members with access to private capital markets could reasonably be expected to retain such access in the face of shocks widely expected to be temporary if their underlying balance of payments position remains strong.
A few Directors observed that capital markets suffer from imperfections and tend to behave procyclically.

Directors acknowledged low-income members have much more limited access to capital market financing and that official financing is often not large or flexible enough to deal with temporary shocks.
The CFF is typically not an attractive option for low-income members mainly on account of its non-concessional nature.
Directors considered subsidizing the rate of charge for stand-by or CFF resources for low-income members without an active Poverty Reduction and Growth Facility (PRGF) arrangement, but viewed this as a sub-optimal allocation of scarce concessional resources.
Many Directors preferred a short-term "window" under the PRGF Trust Fund to help PRGF-eligible countries without an active PRGF arrangement deal with temporary shocks; several Directors opposed this, expressing concerns that it would erode PRGF program design.
For countries with an active PRGF arrangement, Directors generally supported the use of augmented access to PRGF resources to accommodate temporary shocks.
Overall, Directors favored developing the PRGF instrument in the context of discussions on the role of the IMF in low-income countries so that it could also serve the purposes of the CFF in low-income countries.

For middle-income members, many Directors considered that stand-by or extended arrangements could provide sufficient resources in a timely fashion to deal with shocks for which the CFF had been envisaged, and these arrangements are sufficiently flexible to incorporate appropriately tailored conditionality.
A few Directors believed that conditionality is often applied inflexibly or that stand-by/extended arrangements require substantial time to negotiate and approve; they therefore believed the CFF remains useful for temporary shocks.
Directors debated possible changes to the CFF:
- Some argued for broadening the import coverage beyond cereals to other basic food items, but many acknowledged that data shortages would limit the usefulness of such an option.
- Some favored providing greater automaticity for CFF purchases by relaxing the requirement of a satisfactory underlying balance of payments position for "stand-alone" CFF purchases.
- Many Directors considered that the strengthened requirements introduced in 2000 are consistent with the Fund's mandate to support orderly balance of payments adjustment with appropriate safeguards and should be retained.

On balance, many Directors argued there is a strong case for eliminating the CFF to streamline the Fund's facilities:
- For middle-income members, other Fund and non-Fund financing sources could cope with temporary balance of payments shocks.
- For low-income members, envisaged new financing instruments were viewed as a superior response to shocks of this type.
Most of these Directors were willing to retain the CFF in its current form until the next review to allow time to prove its usefulness and to permit development and evaluation of new financing instruments; they suggested that in the absence of clear demand by the next review the facility should be eliminated.
Many other Directors viewed the CFF as a useful element of the mix of financing options:
- Most of these supported keeping the CFF as it is.
- Others believed demand would pick up with appropriate modifications.
Directors agreed that the CFF should be reviewed again in three years.

Public Information Notice: IMF Concludes Review of the Compensatory Financing Facility — April 7, 2004