Counterpart funds: a force for good and ill

Counterpart funds are now well known throughout ACP States. They accrue through the operation of food aid, General Import Programmes, Sectoral Import Programmes and, in some cases, in Stabex and Sysmin transfers. They are the local cash equivalent of products normally requiring foreign exchange which have been imported by the cooperating partner. For example, in times of food scarcity, the Community will send 50 000 tons of wheat or maize to Country X, using its own foreign exchange. The 50 000 tons will be sold in local currency to those who wish to buy, and the local money thus generated (since the food is normally sold and not distributed free) can be used for a variety of purposes: it can, and often is, earmarked for specific development programmes which have a local currency content (wages and salaries, local materials and so on); they can also be used to reduce the government’s budgetary deficit; they may, on the other hand, remain on deposit for some time in either the Central Bank or in commercial banks. However they are used, counterpart funds are playing an ever - greater role in the macroeconomic behaviour of a number of ACP States, for good and ill.

Background

The origins of counterpart funds date back to the early post - war period, when they were used in the framework of the American Marshall Plan for the reconstruction of Europe. In 1954, the US government passed the Agricultural Trade Development and Assistance Act (Public Law 480) which attempted to deal with US agricultural surpluses and developing country food deficits and whereby the proceeds from the sale of PL 480 products was loaned to the governments of recipient countries. India has been a major recipient of food aid from the US, and counterpart funds have been in operation there since 1960, while the EEC also used them there in the framework of Operation Flood, a scheme to extend milk consumption in urban areas, based on milkpowder from the EEC with counterpart funds used to expand local production and distribution. But the background to renewed concern about counterpart funds in ACP States lies in the fact that they have, in recent years, become far more widespread and their effects more far - reaching. Almost all African ACP States are now recipients of the sort of aid that generates counterpart funds. Partly this is because of the deterioration of their food supplies (food aid) or their export crops (Stabex). Sometimes climatic conditions are to blame for this, but more often than not it can be traced to other sources - world prices for the raw materials, environmental degradation or population growth. But it is equally true that a worsening of the external and internal imbalances in many a developing country has played an equally important role: the Import Programmes financed by the Commission, the aid to balance of payments provided by the Bretton Woods Institutions are evidence of a more widespread failure. And the adoption of structural and sectoral adjustment programmes is the ultimate testimony of all that went before.

Given the deteriorating conditions in Africa and the countries’ desperate need for foreign exchange simply to keep going, counterpart funds have assumed enormous importance in macro - economic planning, largely because they represent a higher proportion than ever before of the State’s own resources. In 1987, Kenya saw the creation of counterpart funds of a value equivalent to US$ 93 m, the equivalent of 18 % of that year’s budget deficit and of 4% of total money supply. In 1989, Somalia possessed more than $ 100 m, representing 30% of the State budget. Sums like this are like an unexploded bomb when the country is, at the time of piling up counterpart funds, undertaking structural adjustment, one of whose staple ingredients is invariably the rectification of budgetary imbalances.

Counterpart funds - the macroeconomic effect

In themselves, counterpart funds are neutral. If food worth ECU 1 m, say, is delivered and sold, the local money equivalent of ECU 1 m, let us call it 500x, is put into either the Central Bank, or into a commercial bank. While the food is being sold, there is a deflationist tendency, as 500 x is taken out of circulation (to buy the food) and put into the Central Bank. If the funds are used rapidly, and for specific projects linked to a long - term development programme, then within a short time, the 500 x reappears in circulation and thus will have no impact on inflation.

But, as is so often the case, the funds are not wholly used. This may be because the project or programme is not a heavy user of local money, or because the local elements of the programme (people, materials, etc.) cannot be got together. Let us say that only 200 x of the 500 x is actually used on the programme, and that 300 x remains on deposit with the Central Bank. If the Central Bank remains passive, the money on deposit has a deflationary effect because the amount in circulation is reduced by 300 x . But over time, it is unlikely that a Central Bank will remain passive for long, and then the 300 x, appearing on their books as a credit, becomes a stimulus to lending to the private sector.

The money is lent on to commercial banks, who lend it to their customers who use it, more often than not, to convert it back into hard currency to finance imports. Sometimes the counterpart funds are put directly into the commercial banking system and there is no ‘gap’ between the deposit and the stoking of inflationary fires. The moment the 500 x is deposited with a commercial bank it appears on the ledgers as part of the bank’s reserves. If the obligatory reserves are topped up, the bank can lend on to customers while maintaining the book value of 500 x on the debit side. Interest on the loans swell the reserves, higher reserves mean higher lending, and the longer the delay between depositing the 500 x and using them in an approved fashion, the more money is created.

Then there is the problem of resource transfer and allocation. The idea behind the counterpart funds is that there is a real transfer of goods from donor to receiver. In the case of a General Import Programme, goods are delivered from overseas and paid for in local currency. So far so good: the receiving country has saved valuable foreign exchange and can, in theory, use local money to pay for the local element of, say, a social programme. But in countries of the Franc Zone where the local money is convertible, the counterpart funds can be used to finance imports which give rise to new counterpart funds, which can be used to finance new imports, and so on forever. And the next danger to be faced is that of resource transfer from the private to the public sector. Food aid is an example: imported food is sold to people and the money is placed in the Central Bank. At some time, this money emerges to finance a development programme in the public sector, thus causing the private sector to lose out.

The Kenyan example

An interesting example of counterpart funds utilisation, already experimented under LomII, is the integration of counterpart funds into one of the components of a structural adjustment programme. This has been the case in Kenya for the Cereals Sector Reform Programme. Under the programme, the marketing of maize, historically under the monopoly of a State Marketing Board (NCPB), is going to be gradually liberalised. NCPB, which is going to retain the functions of market stabilisation and management of the food reserve stock (maize being the staple food in the country) is being restructured, with the aim of enabling it to manage efficiently the new and more limited functions it is going to perform, and to recover from the huge budget deficit it used to run in the past.

One of the immediate objectives of financial restructuring was to create a separate crop purchase fund, covering the commercial operations of the Board, and enabling it to pay the farmers without long delays. The programme included a foreign exchange facility component - in the form of a sectoral import programme for inputs for the agricultural sector - whose immediate aim was to ease the serious balance of payments constraints of the country.

The counterpart funds generated by this import programme have been entirely allocated to the establishment of the crop purchase revolving fund. In this way, the funds allocated to the Import Programme (ECU 42 m in total) have both enabled the private sector to obtain the foreign currency needed for essential imports, and, through the counterpart funds, contributed to the reorganisation of the cereals market, enhanced the competitiveness and sound management of the NCPB and contributed to the Budget Rationalisation Programme of the country (as the budget deficit of the NCPB is eventually covered by a government subsidy and thus ends up in the deficit of the State Budget).

The whole machnism is not without its problems: first, the funds thus mobilised represent a limited contribution to the functioning of the system and do not even cover entirely the current needs of the crop purchase revolving fund; second, as Kenya had, for a number of years, a surplus production of maize, the crop purchase revolving fund is somewhat sterilised in the piling up of surplus stocks and does not fully perform the function envisaged in the reform programme.

A set of complementary measures is necessary to implement the financial restructuring of the Board, and even more to tackle the more fundamental structural problems of the cereals sector. However, the possible negative consequences outlined above, deriving from an uncontrolled use of counterpart funds, have been avoided by binding such funds to a direct utilisation in the framework of a sectoral adjustment programme.

A. Piergrossi

Counterpart funds and structural adjustment

As over 30 countries in Africa know, structural adjustment is usually preceded by an IMF - steered stabilisation programme, geared to rectifying public finances prior to a sectoral or structural adjustment programme which deals with the broader aspects of supply and demand.

How do counterpart funds enter the picture here? Obviously, they are government receipts, local currency counterparts paid by the importer as part of SIP/GIP or income from the sale of food or other items. But, in balancing the budget, the government must also look to the long term, and assess the future impact of the programmes to which these funds are allocated. Will they not create further strains on the budget by involving the budget in recurrent costs? Will they generate further imports? Will there be a big time - lag between receipt and expenditure?

Moreover, since the projects themselves are in the public sector they will, by their nature, involve the budget more heavily in relation to the private sector. Where the stabilisation effort calls for civil and public servants to be retrenched, the counterpart funds offer a lifetime - salaries for them while they work on the chosen programme. When the public debt should be repaid, the counterpart funds offer the possibility of solvency by appearing on the credit side of the Central Bank’s ledgers. While imports should be curtailed, and foreign exchange hoarded, counterpart funds, by appearing in banks’ books, offer the legitimate possibility of extending credit and, in the cases where the local currency is freely convertible, of financing non - essential imports.

Thus, while the programmes generating counterpart funds offer a valuable service - the use of local money to finance needed imports - there are a number of potential pitfalls. The programmes to which they are devoted may not become operational for some time? and during that time, the local funds may accumulate and form the platform for some serious ‘destabilisation’ of the money supply, the balance of payments and the State budget. And, in the case of structural adjustment, which normally involves a shift from the public to the private sector, counterpart funds may undo whatever good work was done and push the balance back into the public sector.

The future

None of the foregoing means of necessity that counterpart funds are a bad thing. Indeed, they have a number of advantages: aid is timely, aid comes in a very acceptable form; the funds themselves can be targetted to very specific programmes to aid sectors or social groups most in need. But there are also dangers, those outlined above, that the funds could have a destabilising effect. With the emphasis in LomV even more firmly on debt and structural adjustment, both sides, donors and recipients, will have to look at ways of making counterpart funds serve the interests of the structural adjustment process. It is with this preoccupation in mind that the LomV negotiators stipulated that the counterpart funds generated by the various Community instruments shall be used for budgetary support to alleviate domestic financial constraints.

It is therefore in the framework of the overall budgetary policy of the government, and in particular of its recurrent budget (The Public Expenditure Programme) that the use of counterpart funds must be put. In this context, typical examples of expenditure that could be supported are those relating to health, education as well as those attenuating the negative social consequences of adjustment.

Money is neutral - ‘Non odet’. ‘It does not smell’ remarked a Roman emperor of the money received from a tax on waste disposal. But it is a force - and whether in the form of counterpart funds it is a force for good or ill will be for the Commission and its ACP partners to work out.

Tom GLASER