On July 13, 2016, the Executive Board of the International Monetary Fund (IMF) concluded the annual discussions on Common Policies and Challenges of Member Countries with the Central African Economic and Monetary Community (CEMAC).

CEMAC growth was subdued in 2015. It slowed to 1.6 percent, from 4.9 percent in 2014, because of reduced public investment and lower oil production. Growth is projected to be 1.9 percent in 2016, as oil production and investment remain sluggish. From 2017 onward, growth is expected to reach 3½ percent a year, as oil prices gradually recover, some one percentage point below the average growth level of the past decade of high oil prices. Growth of money and credit to the economy turned negative in 2015 for the first time in a decade, contributing to keeping inflation low. The regional fiscal and current account deficits grew to 6 and 9 percent of GDP in 2015, respectively, as oil export proceeds fell by 32 percent. Continued low oil prices and high public expenditure will contribute to maintaining both deficits at about 6 and 8 percent of GDP in 2016, respectively. The gradual recovery in oil prices and the expected moderate fiscal consolidation should narrow the regional fiscal and current account deficits to 3 percent by 2021. Reserves have declined. Banks appear to have weathered the economic downturn thus far.

Policies to counter the oil-price shock need to focus on fiscal consolidation and real-economy reforms. In the wake of the oil-price shock, monetary financing has been the primary response tool. Although the non-oil primary deficit dropped by 8 percentage points of GDP in 2015, this response has been insufficient to check the overall fiscal deficit. Fiscal policy coordination among members should be strengthened and fiscal discipline enforcement is needed. Realeconomy reforms, focusing on improving the business climate and boosting private investment, are also needed to preserve macroeconomic stability.

CEMAC medium-term prospects are challenging. A weaker-than-expected oil price recovery or a relapse in security conditions in the Lake Chad region could undermine macroeconomic stability and private investment. Lower growth in China could dampen commodity prices – especially oil, lower demand, and reduce financing. In these challenging times, stronger regional institutions are necessary for promoting regional integration and supporting regional economic growth.

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Staff report on the common policies of Member Countries

CEMAC is buffeted by the oil-price shock. The outlook has deteriorated, as members continue to suffer from the shock. Regional and national authorities have yet to take appropriate measures to address the economic downturn, whilst continuing to face substantial capacity constraints. Although the banking sector has weathered the downturn so far, government payment delays could undermine its soundness. Risks are significant: a weaker-than-expected oil price recovery or deteriorating security conditions could jeopardize macroeconomic stability.

Policy recommendations

• Policy mix. The policy response to the oil revenue loss and increased security spending has been insufficient. It has led to a contraction in reserves – now below recommended levels. Fiscal adjustment and real-economy reforms, focusing on improving the business climate and boosting private investment, are needed to preserve macroeconomic stability. An incomplete policy response could jeopardize external sustainability.

• Monetary policy and safeguards reform. The BEAC’s accommodative monetary policy has contributed to the decline in reserves and delayed fiscal consolidation. Meanwhile, the authorities still need to strengthen weak monetary transmission channels. The BEAC’s Board of Directors has mandated to proceed with two important safeguards recommendations.

• Macrofinancial linkages and the financial sector. Important links between the public and the banking sectors require (i) the non-accumulation of arrears to ensure the stability of the banking system; and (ii) a strong microprudential framework to sustain macrofinancial stability. Progress has been made in implementing some of the 2015 FSAP recommendations.

• Regional integration and convergence framework. CEMAC institutions continue to face internal constraints, which undermine their capacity to support regional integration and growth. The newly approved convergence framework can help to manage revenue volatility. Plans for a medium-term savings rule would help CEMAC to build fiscal buffers to deal with future commodity shocks.

A community blighted by low oil prices

The security situation in the Central African Economic and Monetary Community (CEMAC) improved in 2015, but the economic situation deteriorated markedly. On the one hand, security threats from Boko Haram in the Lake Chad region were reduced through regional military cooperation, but they continue to place a heavy fiscal burden on Cameroon and Chad. Following presidential elections in February 2016, the civil strife in the Central African Republic (CAR) is abating. On the other hand, the oil-price shock took a toll on CEMAC’s five oil exporting members. Oil prices have declined by more than 55 percent since June 2014, and with oil representing more than three-quarters of regional exports and half of fiscal revenues (in 2014), most countries are facing budgetary pressures. Despite its resource wealth, CEMAC has been lagging behind peers in economic performance. CEMAC’s economic challenges are compounded by a timid regional cooperation.

Regional growth more than halved in 2015 and medium-term prospects are uncertain. Growth slowed to 1.6 percent, from 4.9 percent in 2014, because of reduced public investment and lower oil production. Growth is projected to be 1.9 percent in 2016, as oil production and investment remain sluggish. From 2017 onward, growth is expected to reach on average 3½ percent a year, as oil prices gradually recover. Growth of money and credit to the economy turned negative in 2015 for the first time in a decade, contributing to keeping inflation low.

The region’s “twin” deficits widened in 2015 and are projected to grow in 2016. The regional fiscal and current account deficits grew to 6 and 9 percent of GDP in 2015, respectively, as oil export proceeds fell by 33 percent. Continued low oil prices and high public expenditure will contribute to maintaining both deficits at about 6 percent and 8 percent of GDP in 2016, respectively. The gradual recovery in oil prices and the expected moderate fiscal consolidation should narrow the regional fiscal deficit to 2½ percent by 2021. Similarly, the current account is projected to improve with recovering exports and lower public imports.

Fiscal dominance has come to the fore. In the wake of the oil-price shock, monetary financing has been the primary response tool. Although the non-oil primary deficit dropped by 8 percentage points of GDP in 2015, this response has been insufficient to check the overall fiscal deficit. A major weakness in CEMAC is the lack of fiscal policy coordination among members and the absence of fiscal discipline enforcement. In spite of a decade of high oil prices and robust growth, most CEMAC countries have failed to diversify their economies and build sufficient buffers.

Banks’ exposure to the public sector is the main transmission channel of macrofinancial risks. With dwindling oil revenues, public sector bank deposits have shrunk. The increase in government payment delays and the scaling down of public investment programs could increase banks’ non-performing loans (NPLs), especially to the construction sector. In turn, higher NPLs could limit credit to the private sector and undermine non-oil GDP growth.

The medium-term outlook is fraught with risks. A weaker-than-expected oil price recovery or a relapse in security conditions could undermine macroeconomic stability and private investment. Lower growth in China could dampen commodity prices – especially oil, lower demand, and reduce financing. Previous IMF staff advice has generated limited traction.

Policy discussions: Managing the economic downturn

An External Position at Risk

CEMAC’s non-oil competitiveness is poor and the external position could weaken further in the near term. At end-2015, reserve coverage was 4.6 months of future imports and represented 52 percent of broad money. Despite the depreciation of the euro in 2014-15, both the nominal and real effective exchange rates (REERs) appreciated during the 12 months to April 2016, because of the inflation differential and CFA franc appreciation vis-à-vis the currencies of trade partners. According to model-based assessments, the REER appears to be moderately overvalued (by about 6 percent) with respect to the current account norms. In addition, large structural competitiveness challenges persist.

Staff expressed concerns about the significant fall in reserves. Between December 2014 and March 2016, international reserves contracted by 41 percent in CFA francs. By end-March 2016, reserve coverage dropped to 3.9 months of prospective imports, below what is considered adequate (5 months) for a resource-rich monetary union with a fixed exchange rate. Staff projects that, without policy adjustment, reserve coverage could shrink in 2016 to a decade low. Staff urged a stronger CEMAC-wide policy mix (e.g., fiscal retrenchment; end to monetary accommodation; and structural measures) to forestall this.

Staff reiterated its call for the repatriation of foreign assets and improved reserve management. In a context of falling foreign assets, within and outside CEMAC, member states and their agencies (e.g., national oil companies) should repatriate them to support the Community’s external viability. The BEAC has made efforts to improve the management and performance of its reserves to encourage member states to comply with regional repatriation regulations. However, the current outlook requires additional measures, such as those recommended by the 2015 Financial Sector Assessment Program (FSAP). These include: (i) the definition of the optimal level of reserves; (ii) a better reserve portfolio structure to meet new liquidity requirements; and (iii) a new method to manage member states’ deposits and ensure that foreign reserves are backed by longterm resources (Selected Issues Paper-SIP-1). Higher remuneration of reserves should increase incentives for foreign asset repatriation.

The BEAC needs to strengthen its balance sheet. To maintain the required proportion of liquid reserves, the BEAC sold 37 percent of its investment portfolio (at market value) in 2015. This resulted in a significant realized profit for the BEAC, about one third of which was distributed to member states as dividends. Given the continuing decline in reserves, the BEAC may be required to pursue similar operations in 2016. Staff recommended retaining the full amount of future sales to boost the BEAC’s balance sheet.

Authorities’ views

The authorities shared staff’s concerns about falling reserves. They had implemented reforms to enhance reserve management, promote reserve repatriation, and make reserves management more transparent, which also bolstered the BEAC’s balance sheet. The authorities are working on a solution to pool reserves without requiring member states to repatriate all their foreign currency holdings by creating BEAC correspondent accounts in major international public and private financial institutions. They concurred that governments and private companies, especially oil companies, should fully comply with reserve pooling requirements. They considered that, in the event of a dramatic fall in reserves, the French Treasury’s guarantee will protect the peg. To ensure compliance with their obligations vis-à-vis the French Treasury, they conducted regular asset sales to match their liquidity needs in foreign currencies.

A New Convergence Framework for Regional Stability

The economic downturn underscores the need to overhaul the regional convergence framework. In late 2015, the CEMAC Commission presented a revised framework, to enter into force on January 1, 2017. The new framework includes a number of innovative features, including (i) a new fiscal rule based on a three-year average overall budget deficit; (ii) a public deficit ceiling, reinforced with a debt break; (iii) a revised inflation criterion; and (iv) additional secondary criteria. The Commission is exploring options to include a budgetary savings mechanism to help build buffers for future commodity shocks.

Staff welcomed the adoption of the new framework as an important step for strengthening macroeconomic surveillance. Although the framework does not fully reflect staff's earlier advice, it nonetheless constitutes progress in restraining the pace of debt accumulation. Staff considered that because of the difficulties in monitoring certain criteria (e.g., non-accumulation of arrears), the new framework should be complemented by a strengthened monitoring mechanism for primary and secondary criteria, including a mandate for the Commission to validate the data submitted. This would require strong political support and adequate resources. Staff supported creating a fiscal savings mechanism.

Staff encouraged the authorities to enhance regional policy coordination and harmonization. One element would be the implementation of a structural budget-balance rule which requires, inter alia, comprehensive data, technical forecasting capacity, and the ability to analyze sector linkages and business cycles (SIP 3). Because these take time to develop, the shortterm priority should be meeting the new fiscal criterion. Implementing the six regional public finance management (PFM) directives would also enhance coordination (SIP 4). Similarly, CEMAC authorities should promote harmonized tax policies to reduce dependence on foreign trade in favor of broadbased domestic taxes. This is particularly important, as international trade negotiations will lower custom tariffs.

Authorities’ views

The CEMAC Commission indicated that the new framework will be brought to CEMAC Heads of State for endorsement. Although the new framework had already been adopted by the ministers of finance, its approval by the presidents would reinforce its legitimacy. The approval would also help the implementation of new mechanisms, such as the budgetary savings instrument. To strengthen monitoring, the Commission would enhance cooperation with the BEAC to share macroeconomic data. The Commission was making a determined effort working with national authorities to have the CEMAC PFM directives incorporated into national legislation. They expected significant progress by end-2017.

A Regional Financial Sector Showing Vulnerabilities

So far, the financial sector has been able to cope with the challenging economic environment, but troubled banks remain an issue.

• Banks appear generally profitable, even though the situation varies by country and type of institution. Most banks have a business model, which relies on service fees, and which has partially shielded them thus far from the downturn. However, because of increasing NPLs, some banks have already suffered a significant reduction in their interest revenues.

• Bank liquidity has declined because of the drop in government deposits, but remains broadly adequate. Excess liquidity of banks at the BEAC represented 12 percent of their balance sheet in January 2016 against 15 percent in September 2014. Liquid assets and interbank deposits, excluding statutory reserves, remained stable at 26 percent of total assets during the same period. With the recent decline in reserve requirement, bank liquidity should rise to close to 30 percent, ensuring that banks remain liquid.

• Bank solvency ratios have remained high and relatively unchanged. At end-2015, capital to riskweighted assets represented about 13 percent, in line with the findings of the last FSAP. The increase in NPLs from 11.9 percent of total loans in September 2014 to 12.6 percent in January 2016 has not undermined overall bank soundness so far, as shown by broadly unchanged solvency ratios. During the same period, banks’ adjusted net capital remained also unchanged, because of the increase in equity in the banking sector by nearly 8 percent. The majority of NPLs derives from “connected” lending and does not come from the downturn. Similarly, the NPLs in microfinance institutions (MFIs) increased modestly, from 13.3 percent of total loans in December 2014 to 14.0 percent in September 2015. However, the regional banking supervisor (COBAC) reports that NPLs could exceed 20 percent in some MFIs.

• Eight of fifty-two banks have negative equity and do not comply with the solvency norm. Total assets of these banks is less than 5 percent of total bank assets, but the inability of the national and regional authorities to close them remains an issue and sends the wrong signal to the financial sector.

Staff noted that banks appeared to have weathered the economic downturn thus far, but vulnerabilities were increasing. These stem partly from delayed government payments to the private sector, and specifically the construction sector, which is heavily indebted to domestic banks. For instance, in Equatorial Guinea, credit to the construction sector represented 57 percent of gross bank loans at end January 2016. Recent stress tests showed that macroeconomic risks had increased in three countries, compared to the findings of the last FSAP. Tests show that if the oil price shock further spreads in the real economies, bank solvency will deteriorate. To assess this risk, the COBAC should run additional stress tests for all member countries.

Staff emphasized the importance of the effectiveness of the microprudential framework to prevent the spreading of macrofinancial risks. Given the importance of direct and indirect links between the public and financial sectors, ongoing reforms of the microprudential framework are critical to ensure financial stability. Progress has been made following the 2015 FSAP recommendations, especially in the treatment of connected loans; cross-border supervision; and treatment of NPLs. Additional efforts are necessary to implement the remaining FSAP recommendations. Staff encouraged the COBAC to increase the solvency ratio for systematically important banks, and develop bank supervision on a consolidated basis. Staff supported the COBAC’s efforts to enhance its supervisory framework through an effective risk-based supervision, focusing on liquidity and foreign exchange risks.

Staff encouraged the BEAC to develop its macroprudential framework. The analytical tools and institutional capacities needed upgrading to deal with the current economic challenges. The BEAC had created a Financial Stability Committee (FSC) in 2012, but the Committee's first working meeting took place only in April 2015. The Committee’s analytical agenda is ambitious, but constrained by the lack of macrofinancial data. The current approach of “expert judgment” does not provide a detailed risk mapping, but is a critical step in the design of vulnerability indicators.

Staff noted the improvement in bank supervision, following the hiring of new staff. However, following FSAP recommendations, a number of additional measures should be implemented to align COBAC’s supervisory framework better with the specificities of CEMAC. Given the banks’ varying risk profiles, it would be advisable to implement the Basel Pillar II approach, to allow the COBAC to adjust capital requirements to banks’ risk profiles. To reflect the weakness of some guarantees or collaterals for loans, the COBAC should increase risk weights applied to these assets for the calculation of the solvency ratio, to reflect more accurately the associated risk. Finally, the BEAC and national authorities should agree on resolving troubled banks in a timely manner.

Staff welcomed progress in the supervision of MFIs. The COBAC launched e-Sesame, a data collection system to improve financial information. In addition, increased staffing at the COBAC’s microfinance department should allow closer monitoring and more frequent inspections. The COBAC plans to update prudential regulation to raise the minimum capital requirement for MFIs and restrict lending to non-members. Staff noted, however, that strengthening governance within MFIs requires a more effective judicial system and more resolute prosecution of fraud.

Staff advised promoting financial inclusion. The BEAC, working in tandem with national authorities, should facilitate small and medium-size enterprises’ (SMEs) and households’ access to credit. With the increase in credit risk of public and construction companies, banks are looking for new customers, particularly SMEs. However, the lack of financial transparency, accounting reliability, and governance problems of SMEs hinder credit growth. Staff noted that mobile banking had been growing rapidly because of recent changes to the legal framework for issuing electronic money. This development should be supported by appropriate regulation and enhanced supervision.

Authorities’ views

The authorities agreed with staff’s assessment of the financial sector. They concurred that banks were only moderately affected by the economic downturn, because of their business model. They noted that some banks had strengthened their equity position. Nonetheless, they remained vigilant and were following closely the situation of the banking sector and stood ready, if needed, to implement contingency plans, such as appointing interim administrators for problem banks. They emphasized that the recent increase in COBAC’s staffing (34 new executives) would enable closer supervision and more on-site visits to banks and MFIs.

The authorities concurred with staff’s assessment of macrofinancial linkages. They agreed that enhanced microprudential supervision should be a priority and that a proper macroprudential framework should be in place to support financial sector development. They were committed to strengthening regulations with transnational supervision on a consolidated basis; implementation of Basel II Pillar II; and enhanced cooperation among regional financial institutions through the FSC.