IMF praises Madagascar’s approach to monetary framework change

The International Monetary Fund (IMF) has praised the Central Bank of Madagascar’s proposed alterations to its monetary policy framework, but said there is still work to be done.

In its Article IV report published on July 18, the fund said a “successful introduction” of an interest rate corridor would only be possible if market participants trusted the repo transactions and deposit facility “would always be available on demand”.

Since its last Article IV in 2014, the central bank has met all targets set by the fund, while the country has introduced a new central banking act.

With its newfound independence, IMF staff noted the central bank has now set about developing the policy instruments through which it transmits monetary policy.

One such change is for the central bank to move away from a monetary targeting framework towards an interest rate-based framework. To do this, the central bank has proposed introducing an on-demand overnight deposit facility that will help create the basis for an interest rate corridor.

“Over the next few years, the central bank’s monetary policy framework will evolve further with the gradual introduction of these new policy instruments, as well as the reinforcement of its analytical capacity, especially in liquidity forecasting,” the fund said.

The past 12 months have been tough for Madagascar. In late 2016 and early 2017, it suffered a serious drought and a major cyclone, which according to the IMF was the worst in 13 years. The fund has estimated the total cost of the cyclone to be at about $400 million (4% of GDP).

Meanwhile, because of the drought, electricity utility Jirama has had to rely on more expensive diesel power generation in place of hydro power. As a result, the authorities spent “at least” an additional $50 million on emergency relief and reconstruction work and an additional $60 million in transfers to Jirama in 2017, the fund said.

Trouble at the mill

But it was the vanilla bean shock that caused the most trouble for the central bank. Following the drought, a shortage sent export prices skyrocketing.

“Unbanked small vanilla producers received large cash payments because of the high prices,” IMF staff explained. As a result, between May and September 2016 the amount of currency in circulation expanded by 18%, draining bank liquidity and tightening bank lending.

The central bank subsequently began purchasing large amounts of foreign exchange – a total net purchase of $312 million – to help improve bank liquidity.

The real effective exchange rate appreciated 3.5% in 2016, followed by an additional 2.2% through to March 2017 to trade at around 2,900 ariarys per dollar.

“Following aggressive purchases by the central bank, gross reserves reached $1.12 billion at end of 2016, or 3.9 months of current imports (compared to the initial objective of 3.3),” staff said.