Country Reports
2015
January 14, 2015
Senegal: Selected Issues
Description: This Selected Issues paper on Senegal revisits the challenges of emergence by tapping on the experience of other countries across the world that became emerging economies in the past two decades. It then looks at the preconditions needed for growth acceleration in Senegal. The paper also discusses options for strengthening Senegal’s fiscal framework to support Plan Sénégal Emergent (PSE) implementation while keeping risks of debt distress low. It provides an assessment of Senegal’s external stability and explores how to improve the structure of the Senegalese economy to make it more competitive with more diversified exports. The paper describes the electricity problem as a major impediment to growth acceleration. Improved revenue performance and expenditure composition are critical for creating the fiscal space to support the PSE. There is an opportunity cost for development spending, as the economy still faces bottlenecks from high electricity costs and insufficient electricity production. The share of the population living below the poverty line and its exposure to shock remains unacceptably high.
January 12, 2015
El Salvador: Selected Issues
Description: This Selected Issues paper assesses the potential output in El Salvador. Based on various filters and the production function approach, El Salvador’s potential growth is estimated at about 2 percent for 1999–2015, and the output gap is now virtually closed. Potential growth after the global financial crisis has fallen as a result of lower capital accumulation and total factor productivity (TFP). TFP growth depends on technological progress, as well as the institutional, regulatory, and legal environment in which businesses operate. From a cyclical perspective, the economy is assessed to be operating at potential and labor market conditions also appear to be broadly neutral. Strengthening capital and TFP growth going forward is critical to achieve the authorities’ goal of raising potential growth to 3 percent over the medium term. Structural reforms should prioritize mobilizing domestic savings to invest and build a higher capital stock, enhancing research and development/technological diffusion and competition in product and labor markets, strengthening institutions to secure property rights and reduce red tape, improving infrastructure, facilitating access to financing, and fostering human capital to boost TFP growth. Going forward, it is critical to undertake structural reforms to strengthen capital and TFP to raise potential growth.
January 12, 2015
El Salvador: Staff Report for the 2014 Article IV Consultation
Description: KEY ISSUES Focus: The main themes centered on tackling macroeconomic vulnerabilities and improving the medium-term outlook by achieving an ambitious fiscal adjustment while protecting social spending, creating an environment for higher private sector-led growth, and building a robust financial sector. Main policy issues • A reduction in the fiscal deficit of 3½ percent of GDP is needed over the next three years to place public debt on a sustainable path to maintain access to market financing on favorable terms. This adjustment should be accompanied by well- targeted social spending to protect the most vulnerable and continued progress in lessening inequality. • A broad strategy is also needed to reduce the growing imbalances in the pension system and restore its sustainability for future generations. In this regard, a broad- based dialog across all segments of Salvadoran society is needed to build support for a reform that should include an increase in the retirement age and introduce a progressive taxation of benefits. Steps are also needed to further strengthen public financial management to mitigate key fiscal risks, including by enhancing expenditure monitoring and control (to avoid future spending arrears) and recording contingent fiscal liabilities transparently in the fiscal accounts. • The authorities’ goal of raising potential growth to 3 percent while reducing inequality will require substantial supply-side measures to enhance productivity and competitiveness. These should aim to reduce red-tape, increase access to credit, upgrade infrastructure, provide access to and lower the cost of energy, and diversifying the economy. The FOMILENIO II grant from the U.S. provides a valuable opportunity to catalyze such growth-enhancing reforms. • Banking indicators appear sound, a product of prudent supervision and regulation. Nonetheless, there is scope to further strengthen the institutional underpinnings for financial stability by upgrading the legal framework for bank resolution and by creating an appropriate liquidity safety net for banks.
Notes: Also Available in Spanish
January 9, 2015
Republic of Mozambique: Third Review Under the Policy Support Instrument
Description: Context and policy challenges. Mozambique’s macroeconomic performance remains robust, with strong growth and low inflation. In spite of the heightened risks from an uncertain global outlook, growth is expected to be broad-based in the medium term and boosted by the natural resource boom and infrastructure investment. Short-term policy framework. The main short-term challenge is to maintain the growth momentum while preserving fiscal and debt sustainability. The 2014 fiscal stance is expansionary, and fiscal consolidation needs to be initiated in the 2015 budget to restore prudent fiscal management. While low international prices have dampened inflation, the Bank of Mozambique should stay vigilant and adhere to its medium-term inflation target. Key structural reform priorities include improving VAT and overall tax administration, continuing public financial management reforms, strengthening capacity for transparent public investment management and borrowing, and enhancing the business environment and financial sector development. Completion of the LNG contract negotiations is a critical milestone for the launch of this project, one of the largest in sub-Saharan Africa. Medium-term reforms. Fiscal adjustment over the medium term will be essential to preserve debt sustainability and macroeconomic stability. This requires measures to contain current spending pressures while bringing investment to a more sustainable level. Structural reforms focusing on public financial management, monetary policy tools and banking supervision, and business facilitation should be implemented vigorously to sustain growth and render it more inclusive. With foreign aid likely to decline over the medium term, increased borrowing can provide additional resources for improving both Mozambique’s physical infrastructure and human capital. To ensure the efficiency of investment and borrowing, further strengthening of investment planning and implementation, and debt management are essential.
Notes: Also Available in Portuguese
January 9, 2015
Republic of Korea: Financial Sector Assessment Program-Stress Testing And Financial Stability Analysis-Technical Note
Description: The financial stability assessment under the Financial Sector Assessment Program (FSAP) for Korea was carried out in close collaboration with the authorities. The assessment included top- down (TD) and bottom-up (BU) stress testing of Korea’s commercial banks and certain non-bank depository institutions (NBDIs); and evaluation of the potential contagion across banks (stemming both from funding pressures and potential defaults). The FSAP team did not have access to confidential supervisory data for the stress tests and the contagion analyses.2 The practice of withholding information in the context of an FSAP, while undesirable, is also observed in other FSAPs. As a result, the analyses were carried out by the authorities in cooperation with participating banks, with the FSAP team performing extensive methodological and estimation validations of the results. The stress testing exercise included TD and BU stress tests of banks’ solvency and liquidity. For the solvency analysis, the TD tests were based on the internal Systemic Risk Assessment Model for Macroprudential Policy (SAMP) developed by the Bank of Korea (BOK), complemented by macroeconomic projections from the BOK’s macroeconomic model. These were supplemented by BU tests, carried out by individual banks. For the liquidity analysis, the TD tests were carried out by the Financial Supervisory Service (FSS), with separate assessments of banks’ local currency and foreign exchange (FX) liquidity risks. BU tests of liquidity were performed by individual banks, and were based on a different set of assumptions on potential liquidity outflows. All stress tests were based on assumptions and parameters agreed between the authorities and the FSAP team.
January 9, 2015
Republic of Korea: Financial Sector Assessment Program-Crisis Preparedness and Crisis Management Framework-Technical Note
Description: Korea experienced significant financial distress in the late 1990s along with some of its Asian neighbors. The authorities’ experience in handling this crisis and the experience in handling the fallout from the global financial crisis in 2007–08 helped them establish a broad crisis management framework in Korea. Improving and formalizing the framework for crisis management would help preserve and build upon institutional memory. Authorities can consider formally setting up an apex forum for leading the inter-agency cooperation and coordination work on crisis preparedness and crisis management. With a view to avoid duplication, the authorities may consider upgrading the Macroeconomic Financial Meeting (MEFM) with participation by the heads of the Ministry of Strategy and Finance (MOSF), Financial Services Commission (FSC), Financial Supervisory Service (FSS), Bank of Korea (BOK), and Korea Deposit Insurance Corporation (KDIC) as members, and by including crisis preparedness and crisis management as an explicit mandate. The essential elements of a financial safety net are available in Korea, and the Emergency Liquidity Assistance (ELA) framework and deposit insurance system can be improved to make the safety net more responsive. For ELA, this can be achieved by reviewing and revising the legal and procedural aspects to remove any scope for delays in actual disbursement of funds. For deposit insurance system, improvements can be made by bringing the deposit insurance fund out of deficit, and assuring a back-up funding. The financial safety net is well supported by an efficient framework of financial sector supervision. While the corrective action framework has some of the main elements in place it can, among others, be improved in the following areas for better effectiveness: (a) reviewing the triggers for corrective actions and improving their objectivity to enable timely intervention, including even before banks breach regulatory thresholds; and (b) putting in place norms and guidance determining the use of the powers to postpone or suspend corrective actions.
January 8, 2015
Georgia: Financial Sector Assessment Program-Safety Nets, Bank Resolution, and Crisis Preparedness and Management Arrangements -Technical Note
Description: Recent experience in handling troubled banks was limited. The National Bank of Georgia (NBG) is the lead authority responsible for managing problem banks, as it can appoint a temporary administrator, declare a bank as insolvent and bankrupt, and commence a liquidation procedure. In the 1990s, market entry was not subject to significant restrictions, and the number of banks operating in Georgia reached a peak of 229 in 1994. Since then, the authorities have commenced a significant number of liquidation procedures, and the last cases based on insolvency grounds have been closed in 2009. Therefore, the legal framework for bank resolution and liquidation has not been applied to a significant extent in recent times. The framework for emergency liquidity assistance (ELA) has been improved, but enhancement is needed to protect the NBG against financial risk. The NBG is explicitly authorized to provide ELA to commercial banks that are considered to be viable, and a 2012 NBG decree sets out certain procedural rules governing the disbursement of the ELA. However, when financial stability is endangered, rules on collateral, interest rate, and duration of the facility can be relaxed. This special carve-out can expose the NBG to financial risks—the existence of a systemic threat, rather, calls for a role to be played by the government. Moreover, provisions on collateral, interest rate, and duration should be updated to better take into account the specificities of ELA, and accountability mechanisms should be enhanced. The bank resolution and liquidation regime presents important shortcomings. The NBG can take control of a problem bank by appointing a temporary administrator, which can, in theory, arrange for certain resolution transactions. The bank liquidation framework is prescribed in more detail, given the significant experience gained by the NBG in the past. However, the bank resolution framework lacks a number of important features and several amendments are needed to update it in line with emerging international best practices, with a view to enabling the authorities to implement a speedy and cost-effective resolution process.
January 8, 2015
Georgia: Financial Sector Assessment Program-Stress Testing the Banking Sector-Technical Note
Description: The Georgian banking sector is sound and stable and has continued to perform well, but faces a number of key risks and vulnerabilities that need to be closely monitored. Particularly challenging among them are credit and funding risks related to dollarization, concentration in the banking sector, and reliance on nonresident deposits. While NPLs are gradually declining from their peak in 2009, credit growth is above its long-term sustainable trend. Dollarization presents specific challenges as it increases credit and liquidity risks. There are two major dollarization-related problems: First, most of the borrowers in U.S. dollars (USD) are unhedged, as their income and expenditures are in national currency (this is especially evident in case of households). Second, the NBG has limited ability to provide liquidity support in USD and other foreign currencies. However, it should be noted that the NBG is implementing a set of macroprudential measures aimed at making FX lending more expensive for banks. For example, current risk weights for FX loans are topped at 175 percent. Separate stress tests (STs) performed by the NBG and by the FSAP mission show that the banking system as a whole is able to withstand severe shocks, given that most banks maintain healthy capital buffers well above regulatory minimum. The tests were conducted in several scenarios ranging from slow growth to severe macroeconomic shocks, and the results show that major banks would generally remain adequately capitalized, taking into account current profits and introduction of Basel II. In adverse scenarios, recapitalization needs are manageable in terms of GDP (1.6 percent for the worst-case scenario). At the same time, uncertainty due to non-linearity of shocks related to lari depreciation warrant continuation of build-up of capital buffers as long as FX denominated loans constitute substantial share of banks’ loan portfolios. Credit portfolio concentration risks are limited: default by the largest three borrowers would require additional capital of GEL 50 million for five banks. Market risks are very limited, and trading books do not exist. However, some banks are particularly vulnerable and need to strengthen their capital buffers and to mitigate funding risks. These banks exceed the minimum capital requirement by only a few percentage points (p.p.), which limits their loss-absorption capacity. The high level of profitability and solid net interest margins would go down during crisis periods, driving down net interest and other income. To avoid this pitfall, it is important to introduce Individual Capital Guidance, especially for the weakest banks. When it comes to funding risks, further diversification of funding sources and de-dollarization could help to minimize identified vulnerabilities.
January 8, 2015
Georgia: Financial Sector Assessment Program-Detailed Assessment of Observance of the Basel Core Principles for Effective Banking Supervision-Technical Note
Description: There have been significant improvements in both the quality of regulation and the supervisory approach since the 2007 FSAP. Many amendments to existing laws, new laws, and regulations have been introduced, aimed at addressing shortfalls identified in the 2007 FSAP. These improvements will be evident throughout this assessment. At the same time, a number of weaknesses have been identified. Among these is an operational risk within the NBG’s own Banking Supervisory Department. There has been a very high level of staff turnover in recent years due to a lack of salary competitiveness vis-à-vis the commercial banks, and there appears to be over-reliance on key personnel. Also, the level and type of staff training need to be expanded. While the NBG puts significant effort into understanding the risk profile of each individual bank and the banking system as a whole, more attention is needed to improve the quality of risk management of the banks. In a number of areas, notably bank licensing, the NBG relies on its broad supervisory powers to carry out its functions in the absence of detailed explicit powers. While this regime generally seems to work well in practice, it could leave the NBG open to challenge where these broad powers are not supported by more granular powers. Recently, several amendments to the legislation have been introduced in order to address these shortcomings.
January 8, 2015
Georgia: Financial Sector Assessment Program-Macroprudential Policy Framework-Technical Note
Description: The National Bank of Georgia (NBG) has a broad mandate to safeguard financial stability in Georgia and has applied several measures that can be considered macroprudential. For instance, the NBG adjusted risk weights for foreign-currency (FX) loans to unhedged borrowers in a countercyclical manner in recent years. Going forward, it plans to introduce the Basel III countercyclical capital buffer regime for the banking system in 2015, which will require that it sets or releases the buffer on a regular basis, based on assessments of cyclical risks. Policymakers should consider establishing a full-fledged macroprudential policy framework in line with international best practices. The current framework is too broad to support the effective and transparent use of macroprudential policy going forward. An improved system would involve a revised legal framework to cement the use of a broad range of macroprudential instruments, the establishment of a Financial Stability Committee at the NBG level, and strong accountability and communication practices, including by the publication of regular reports on financial stability. The list of available macroprudential instruments should go beyond risk buffers and allow the NBG to set measures that directly influence the banks’ activities, e.g., through the application of loan-to-value (LTV) or payment-to-income (PTI) caps. The introduction of macroprudential measures for FX-induced credit and liquidity risks have led to a strengthening of banks’ risk buffers. On the asset side, additional risk weights are applied to FX loans to unhedged borrowers, while on the liability side, reserve requirements are higher for FX deposits and other borrowings. Furthermore, banks have to hold more liquidity for nonresident deposits (of which 92 percent are in foreign currency as of end-2013), if those deposits exceed 10 percent of total deposits. Combined with the general liquidity regulation, these measures have increased banks’ capital and liquidity buffers, as shown in the results of the FSAP solvency and liquidity stress tests. The planned introduction of buffer requirements to mitigate cyclical and structural risks is a welcome step. The countercyclical capital buffer and the capital surcharge for systemically important banks are planned to be implemented over the next few years. The capital surcharge for systemically important banks, which would currently apply at least to the three largest banks by total assets, is particularly important in the Georgian context due to the high market concentration in the banking sector.