What is happening with the euro? The Use ofthe EURO in IDA's Operations 1. The Treaty on European Union, signed in Maastricht in 1992, sets the framework for Economic and Monetary Union (EMU). In May 1998, the European Council decided, on the basis of reports of the Commission and the European Monetary Institute (EMI), that eleven member states fulfilled the necessary conditions for the adoption of a single currency, the euro, namely Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Spain and Portugal. The bilateral exchange rates of these states were fixed at that time. On June I, 1998 the European Central Bank (ECB) was officially established replacing the EM!. 2. On January 1, 1999, the euro will become the currency of the participating member states and will be substituted for the currency of each participating member state at the conversion rate. During the transition period from January 1, 1999 to December 31, 2001, the currency of each participating member state (each a "legacy currency") will become a sub-denomination of the euro and payments can be made in each participating member state either in euro or in the country's legacy currency. All new public debt issues will be in euros. The legacy currencies will be completely phased out by not later than July 1, 2002. 3. The exchange rates between the euro and the legacy currencies will be irrevocably fixed by the European Council (composed of Europe's heads of state and government) on January 1, 1999. The European Currency Unit (ECU) will become the euro on January 1, 1999 on a 1: 1 basis. Although the date was confirmed by the Maastrict Treaty, exactly how the new exchange rates will be determined has not yet been defined. What is the effect of the euro on IDA? A. Donor Contributions 4. To illustrate the effect of the euro on donor contributions to IDA, we used the IDA 11 shares to show the percentage of the euro to total donor contributions in IDA 11. Based on the shares of the eleven member states, the euro will represent 30.79% of total donor contributions in IDAII (Table 1).
-2- Table 1: IDAll Shares Shares (%) Donors Austria 0.90 Belgium 1.55 Finland 0.50 France 7.30 Germany 11.00 Ireland 0.18 Italy 4.35 Luxembourg 0.12 Netherlands 3.30 Portugal 0.20 Spain 1.39 aj Total 30.79 aj Includes agreed increase of 0.39% following the "harmonization" exercise completed on June 22, 1998. B. IDA Credits 5. The Executive Board of the IMF decided on September 21, 1998 that there will be no changes to the method of SDR valuation. The currency amounts of the Deutsche mark and the French franc in the SDR valuation basket will be automatically replaced by the euro as the currency of Germany and France, respectively. In addition, the IMF's Executive Board decided not to reset the five-year revision cycle of the valuation of the SDR. The next revision of the SDR valuation basket will be kept as scheduled effective at January 1, 2001. 6. Table 2 below updates Table 8 of the April 1998 Financial Management Paper (Apri11998 paper). In Table 2, we compared the currency composition oflda's resources, mostly in the form of donor promissory notes, and reflows from credits (through FY2020) against the currency composition of the SDR. As shown below, the introduction of the euro reduces the combined shortfall in the Deutsche mark group and French franc in FY2010 from 7.64% to 3.66%. The currency shortfall situation improves further by FY20 15 through FY2020 when the combined shortfall in the Deutsche mark group and French franc decreases from 6.93% to 2.94% and 6.09% to 2.11 %, respectively. In summary, the introduction of the euro will move the currency composition of IDA resources closer to the SDR.
-3- Table 2: Surplus (Shortfall) in Currency Composition of IDA Resources vs. the SDR Counting Reflows Until: FY2010 FY2015 FY2020 Before Euro US dollars Japanese yen Pound sterling Deutsche mark group French franc Others After Euro US dollars Japanese yen Pound sterling Euro Others 0.44% 2.31% 3.00% 1.34% 0.99% 0.94% -3.67% -3.37% -3.01% -5.39% -4.72% -4.02% -2.25% -2.21% -2.07% 9.53% 6.99% 5.16% 0.44% 2.31% 3.00% 1.34% 0.99% 0.94% -3.67% -3.37% -3.01% -3.66% -2.94% -2.11% 5.55% 3.01% 1.18% C. Currency and Liquidity Management 7. Deputies reviewed IDA's financial management in London in May. Management described the currency and liquidity management ofida's resources and presented the currency composition ofida's resources compared to the SDR before the introduction of the euro (April 1998 paper). IDA manages its liquid assets (in terms of currency composition and investment objectives) in order to mitigate the risks it faces as a result of the impact of exchange rate fluctuations on donor resources, and in line with expected disbursement currency composition. 8. IDA uses a "proportional holding" approach to bring the currency composition of all ofida's resources closer to the SDR. In this approach, IDA holds its RITOl liquidity in those SDR component currencies for which its receivables fall short of expected outflows, in such a way that the shortfalls are reduced proportionately. At the beginning of each quarter, IDA reviews the currency composition of its overall resources, determines currency surpluses and/or shortfalls relative to the SDR basket, and rebalances the currency composition of its RITO li$idity accordingly. The result of the currency rebalancing exercise shown in the April 1998 paper was as of December 31, 1997. Table 3 below shows what the results would be with the introduction of the euro. RITO stands for B:eflows, Investment Income, IBRD net income Transfers, and Qther resources.
-4- Table 3: IDA Currency Position Currency SDR Composition IDA Resources Surplus(Shortfall) Currencies Before euro After euro Before euro After euro Before euro After euro US dollars 43.0% 43.0% 33.2% 33.2% -9.8% -9.8% Deutsche marks 18.5% 10.7% -7.8% Japanese yen 15.4% 15.4% 22.3% 22.3% 6.9% 6.9% French francs 10.1% 7.6% -2.5% Pounds sterling 13.0% 13.0% 8.4% 8.4% -4.6% -4.6% Euros 28.6% 22.3% -6.3% Others 17.8% 13.8% 17.8% 13.8% Total 100.0% 100.0% 100.0% 100.0% 0.0% 0.0% 9. IDA's liquidity is held in two separate portfolios: the IDA-B portfolio, which includes the RITO liquidity and the proceeds of the quarterly encashment of donor contributions that are immediately available for disbursements; and, the IDA-R portfolio, which includes those donor resources that are not immediately available for disbursements because they result from accelerated encashments. Most of the IDA-R portfolio consist of advance cash payments or encashments prior to IDAI0 and the accelerated encashment portion of donor contributions under IDAlO, which will be drawn down beginning FY2002. 10. At the beginning of CY99, IDA will start holding a portion of its B-portfolio in euro in line with its proportional holding approach as explained in paragraph 8. Thus, for the IDA-B portfolio, investments will be held in US dollars, pounds sterling, and euro. The IDA-R portfolio will continue to be held in the SDR component currencies, i.e., US dollars, yen, pounds sterling, and euro. D. Operational Preparations 11. A Euro Task Force was established in January 1998 to ensure the continuity of Bank Group business when the euro is launched on January 1, 1999, and to enable a smooth integration of the euro into Bank operations during the 3-year transition period when legacy currencies co-exist with the euro as its sub-denominations. The Task Force has worked with Bank Group organizations, including IDA, and business units to help assess the impact of the euro on their products, business processes, systems and data sources and to prepare appropriate action plans. 12. The Bank Group intends to take a phased approach to converting legacy currency denominated operations into euro. However, recognizing the operational risks and complexities of operating simultaneously in legacy currencies and euro, and the resulting
-5- incremental transactions, accounts, and cash flows between these currencies, it has been concluded that redenomination of balance sheet items and of Bank-administered donor trust funds as soon as practical would improve operating efficiency and operational control. The Task Force has coordinated the strategies developed by individual business units across the Bank Group to ensure integration of solutions while providing sufficient flexibility, particularly on implementation timing, for each unit to respond to its specific business context and environment.