Macroeconomic Assessment and Risk Management Framework

Slide 1 Macro I Macroeconomic Assessment and Risk Management Framework Outline of the lecture Introduction Overview Identification of macroeconomic risks Filling up the RMF Budget support is an. Budget support is an aid modality. It involves the transfer of financial resources to the national Treasury of a partner country. The process that leads to BS involves 4 assessments by the Commission of (the relevance and credibility of): Public policies Macroeconomic framework Public financial management Transparency and oversight of the budget process.

Macroeconomic Assessment and Risk Management Framework

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• - Identification of macroeconomic risks

• - Filling up the RMF

Budget support is an aid modality It involves the transfer of

financial resources to the national Treasury of a partner country.

The process that leads to BS involves 4 assessments by the

Commission of (the relevance and credibility of):

•Public policies

•Macroeconomic framework

•Public financial management

•Transparency and oversight of the budget process.

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political or economic development in the economy 5 risk categories are

considered

1 Political risks

2 Macroeconomic risks

3 Development risks

4 Public Financial Management risks

5 Corruption and fraud

The materialization of any of these risks is likely to significantly reduce the effectiveness of budget support unless adequate mitigating measures are taken by the partner country

• - Introduction / Overview

• - Detecting macroeconomic risks

• - Filling up the RMF

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Key elements of macroeconomic stability:

Sustainable balance of Payments (external balance)

Low and stable inflation and low

unemployment (internal balance)

Public debt sustainability (internal balance)

Sound financial system

Sustainable private (corporate and

household) debt

Growth is hard to achieve without a sustainable

Growth is hard to achieve without price

stability

investment, distorts relative prices, promotes

wasteful financial activities, and encourages

speculation, dollarization, and capital flight

consumption, investment (if real interest rates

are positive) and delays relative price

adjustments (because of nominal rigidities)

Unsustainable public debt can threaten

macroeconomic stability and economic growth

A high public debt

oMay reduce the ability of the government to

implement contra-cyclical fiscal policies as needed

oCan panic investors and thus result in a self-fulfilling

public debt crisis (high interest rates and inability to

roll-over short term debt)

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In addition, high fiscal deficit can lead to

•

o High inflation (notably in case of fiscal

dominance that forces the CB to “print money”

to finance the budget deficit)

o A reduction in private investment when

government borrowing crowds out the private

sector

o Increased external vulnerability in case of

foreign borrowing

The global financial crisis showed that the health

of a country’s financial sector has far-reaching

implications for its economy as well as for other

economies

Financial soundness is crucial to shock

absorption

A fragile banking system is likely

(i) to reduce the effectiveness of monetary policy because of weak transmission channels to the real sector

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(ii) to propagate and amplify shocks, rather than facilitate their absorption by the economy

oe.g by impeding recovery because of inability

to lend to sectors important for the recovery

oe.g by putting public debt sustainability in case

of recapitalization needs

(iii) to complicate policy responses to shocks

and imbalances

oe.g in case of BoP imbalances, devaluation

might be delayed for fear of its impact on the

banking sector (short in foreign currency)

oe.g in case of inflation, monetary policy

tightening might be delayed for fear of an

increase in non performing loans (NPL) that

would undermine banks

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Large gross private debt can challenge

macroeconomic stability

-Large and growing private debt can be a sign

of an unsustainable growth model (based on an excessive increase in borrowing by the private sector)

-CAB: Deficit or Surplus? Reason for deficit ?

(high investment? Low saving?)

-Composition of exports (product diversification

of exports ; destination of exports)

-Level and evolution of the real exchange rate

(has the country lost competitiveness ?)

Current Account Balance check list (2/2)

-In case of large inflows of remittances: are

these flows at risk?

-In case of large inflows of officials grants: are

these flows at risk?

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-Size and composition of capital flows (short

term / long term)

-In case of large short term capital flows:

- How volatile are they?

- Are they at risk? (for example in case of change in

global interest rate)

- Did portfolio flows in the last few quarters coincide

with large stock market appreciation?

- Would banks be able to roll-over their short term

External debt sustainability and stock of FX

reserves check list (1/1)

-Is the external debt sustainable?

-In case of large short term capital flows: what is

the amount of FX reserves available in case of sudden stop in capital flows?

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Size of budget deficit

• Central bank financing?

• Other domestic financing? (any risk of crowding out

private sector borrowing and investment?)

Public debt check list (1/1)

How high is it?

Is it sustainable?

Is it sustainable under a stress scenario?

Risks to the public debt (contingent liabilities):Economic outlook for State owned

enterprises (any need of recapitalization or large subsidies?)

Any risks of recapitalization need of the

banking sector? (see later)

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Past inflation, expected future inflation (above

5%?)

Central bank independence and credibility

Level of private credit / GDP and recent evolution

of this ratio

Large discrepancy between official and shadow

(i.e black market) nominal exchange rate (against the USD or the euro)

Any sign of “dollarization” (share of deposits in

Financial check list (1/1)

General FSAP assessment

Recent evolution of Financial Soundness

Indicators

…… more on financial sector in lecture 5

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- IMF article IV report (or IMF reviews for countries under IMF programs)

- IMF FSAP documents and Financial Soundness Indicators

-Debt sustainability

- Debt sustainability : IMF - WB Debt sustainability assessment (for both public and external debts)

-Vulnerability and Exogenous Shocks

- IMF article IV reports (notably the Risk Assessment Matrix)

The Excel spread sheet (1/3)

2 files: Questionnaire - Risk profile

The process leads to a recommendation regarding EU

The Excel spread sheet (2/3)

- Questionnaire: concentrates on basic risks

-44 questions in total, 7 of which for macroeconomic risks

-For each of them, one needs to

- assess the level of risk (Low – Moderate – Substantial – High)

- give a justification for the level chosen and a description of the exact nature of the risk

- Most of the answers are not straightforward

- For the numerical part, level of risk are averaged by dimensions (14 of them) with some room for ad-hoc adjustment (up or down by one notch) based on judgement.

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The Excel spread sheet (4/4)

• Major risks and risk (or benefits) of non EU intervention (written statement)

• Key mitigating measures (written statement)

Overall risk

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- Using IMF information, please write a short country fiche for either

Cambodia or Ghana and fill the RMF excel file

identify the relevant risks for the country Then indicate whether the

country authorities are aware of the risks and are taking measures to reduce/mitigate them.

will be adjusted in the afternoon of day 3 to include financial stability

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