Our Tunisian authorities extend their great appreciation to staff for the constructive dialogue and sound policy advice, and a well-written and balanced report, and to the Executive Directors and Fund management for their continued support.
Program implementation gained momentum in 2018 and has improved since the Second Review, despite the persistence of a challenging external environment, including spillover of the regional refugee crisis, greater risk aversion, and rising oil prices. Domestically, the difficulty of maintaining public support for the program should not be discounted as “reform dividend” is slow to emerge and austerity measures continue to squeeze the purchasing power of low to mid-income Tunisians and tax their patience.
Despite the unfavorable conditions, all Quantitative Performance Criteria (QPCs) for end-March were met; all Quantitative Indicative Targets were observed; all Quantitative Prior Actions for the Third Review were completed; and significant progress was made on structural reforms. Three of the nine of Structural Benchmarks (SBs) were met; two were not met on time, but one (on Banque Franco Tunisienne––BFT) will be met with delay in August; one was dropped as it was no longer important for the success of the program (elaborated below); and the remaining three were reprogrammed as the authorities sought to rationalize the number of SBs and prioritize their effective implementation. The authorities are requesting waiver of applicability for all end-June QPCs since relevant data will only be available after the Board discussion.
The authorities recognize that 2018 is a pivotal year for the turnaround of the Tunisian economy and are determined to stay on course with program implementation to address the economy’s vulnerabilities and restore sound macroeconomic fundamentals, despite risks to the outlook. They are in broad agreement with staff on the sources of risks to the outlook, but are of the view that the staff’s Risk Assessment Matrix could be better presented by not duplicating the refugee problem and risks to global growth and trade, which appear in the Metrix as both domestic and external risks.
Macroeconomic stabilization, ensuring adequate social protection during adjustment, and promoting private sector-led growth and job creation continue to be the pillars of the program. It is a home-grown-and-owned program and maintaining public support and political consensus for the program ultimately hinges on the conviction that there is indeed light at the end of the tunnel and that there are significant reform dividends for all Tunisians.
Recent Economic Development
Economic recovery has found traction, and real GDP growth in 2018 is now expected at 2.4 percent––the highest rate since 2014––benefiting from the revival of tourism, higher phosphate production, and growing exports due to gains in competitiveness and robust EU demand. Inflation, however, accelerated to 7.7 percent in May, the highest level since 1991, reflecting a number of one-off factors, as well as a combination of demand-pull and cost-push elements, including the pass-through of a sizable exchange rate depreciation, robust credit growth, past public-sector wage awards, and rising international oil prices. The fiscal deficit remained unchanged at 5.9 percent of GDP in 2017, largely due to higher subsidies and transfers, notwithstanding higher revenue. Recovery of tourism and higher exports and remittances narrowed the current account deficit, despite higher oil imports, but foreign reserves fell, reflecting large debt amortization. Both public debt and external debt ratios increased in 2017, which also reflected the impact of exchange rate depreciation.
Fiscal retrenchment is at the core of macroeconomic stabilization, and the authorities are fully committed to the program’s fiscal consolidation path that envisages a 1 percent of GDP per year reduction in the overall deficit to 2.5 percent of GDP by 2020, and anchors public debt on a firm downward path. In 2018, despite a 12 percent increase in tax receipts and a 9 percent cut in the wage bill during the first quarter, the deficit target of 5.2 percent of GDP came under pressure due to larger-than-anticipated international oil prices; lower-than-anticipated number of civil servants taking advantage of government’s voluntary departure and early retirement schemes; higher transfers to the public pension fund to meet its larger-than-anticipated liquidity deficit; and higher social transfers.
To put the program back on track, the authorities are making additional fiscal effort–– mainly through expenditure cutting measures––equivalent to 2 percent of GDP during the second semester of 2018 or 4 percent of GDP on an annual basis. Specifically, the bulk of higher energy subsidies (0.8 percent of GDP) will be met through monthly adjustments in prices of automobile fuels starting in July on top of the June price hike; increases in gas and electricity tariffs for corporate consumers; and by controlling leakages. The authorities are prepared to make further fuel price adjustments in October should the subsidies exceed projections. The adjustment in June, the subsequent monthly adjustments, and the possible additional adjustment in October have already been publicly announced. Social transfers will increase by 0.1 percent of GDP to partially defray the impact of fuel price increases.
Containing the government wage bill—currently around 14 percent of GDP––is another key element of fiscal consolidation plans. Applications for voluntary departure and early retirement so far have been lower than expected. To reach the wage bill target of 12.4 percent of GDP by 2020, the government has called for a second round of voluntary departures next month and strict limits on new hires this year and next. The government is further committed not to grant any wage increases in 2018, and to consider increases in 2019 only if growth surprises on the upside, but even then, the 2020 target will remain the focus.
The government also adopted a comprehensive reform on June 20, 2018 to reduce the financial imbalances of the two pension funds (public CNRPS and private CNSS) and the medical insurance fund (CNAM). Parliamentary approval is expected by end-September, effective retroactively from July 1. As mentioned earlier, the government will make an additional transfer of 0.4 percent of GDP in 2018 to CNRPS to meet part of its liquidity shortfall, with the remaining shortfall as well as the deficit of the CNSS to be covered by greater effort to collect contribution arrears, including from state-owned companies.
Looking beyond 2018, stronger focus will be placed on revenue generation. The authorities plan to converge the “onshore” and “offshore” tax regimes with the 2019 budget and to raise the VAT rate for liberal professions (including lawyers, doctors, accountants). Tax administration will be also strengthened, modernized and be made more efficient by merging the two ministry of finance departments dealing with tax assessment, accounting and collection along the French model. Since the reforms will serve the same purpose, the SBs on the new Large Taxpayers Unit were no longer deemed necessary and dropped.
The authorities believe that adequate social protection to alleviate the economic hardship of adjustment is critical for maintaining public acceptance of reforms. With that in mind, the program has a floor on social spending for vulnerable groups—mostly in the form of cash transfers, healthcare support, education scholarships and job training programs––which in fact was exceeded at end-March. Further, as a reflection of their strong commitment to social protection, the authorities intend to elevate the current indicative target on social spending to a QPC from September. They have already broadened the coverage of vulnerable families and are planning to finalize improvements in data base and targeting by end-2018, with the assistance of the World Bank.
Monetary and Exchange Rate Policy
Fighting inflation continues to be the main priority of the Central Bank of Tunisia (CBT), consistent with its mandate. Although, the key policy interest rate was increased twice in 2018 for a total of 175 basis points, money market rates remain negative in real terms, and private sector credit fueled by central bank refinancing is still growing, jeopardizing price stability. The authorities feel it is prudent to tighten monetary policy to avoid unhinging inflation expectations and eroding central bank credibility, and to that end, are determined to raise policy rates until the real money market rates are firmly in the positive territory, which would also help reduce central bank refinancing. The effectiveness of monetary policy will be further enhanced through better public communication and strengthening the monetary transmission mechanism by gradually relaxing interest rate caps on business loans, more frequent updating of effective lending rates, and encouraging commercial banks to fund their lending operations in the interbank market, instead through central bank refinancing.
The Tunisian dinar has depreciated substantially in recent years in terms of REER (13 percent since the start of the program) and NEER (30 percent), with the latter largely reflecting the depreciation of the dinar versus the euro. REER depreciation has helped improve the current account deficit, but the authorities recognize that greater exchange rate flexibility—especially in view of the increasing inflation differential with the main trading partners—would help achieve a more sustainable current account position and improve foreign reserves coverage. Strict observance of program targets on net foreign exchange sales by the CBT in April and May helped keep the dinar on a flexible path and preserve foreign reserves. The CBT intends to begin to set up the framework for conducting more competitive foreign exchange auctions—with the help of Fund TA—and gradually limit its interventions to smoothing excessive market volatility. The authorities reaffirm their commitment to remove the restrictions on financing of non-priority imports by end-2018.
Financial Sector Stability
Financial sector indicators and bank profitability have improved, and the authorities are committed to accelerating financial sector reforms to underpin the success of the program and facilitate economic and financial inclusion. Addressing the high level of NPLs is a key issue, and recent parliamentary adoption of a set of laws placing NPL restructuring of public banks on the same footing as private banks is expected to facilitate NPL resolution of public banks. Further, the banking resolution committee in its first meeting on June 28 began reviewing the situation of the BFT with the vote on its orderly resolution expected by August. The Ministry of Finance and the Financial Sector Reform Committee intend to publish a comprehensive report on NPL resolution by end-2018, and have also made significant progress towards developing a national strategy for financial inclusion. In the context of rising interest rates and the rapid growth of private sector credit, the CBT is committed to ensuring financial sector soundness by strengthening its supervisory capacity, and will be working closely with METAC to develop tools for monitoring market and interest rate risks and assessing bank capital adequacy. The authorities are also reinforcing their AML/CFT framework and are making good on their commitments under the action plan agreed with FATF in November 2017, including a set of preventive measures adopted in 2018 (¶21 MEFP) that should help facilitate Tunisia’s exit from the FATF-enhanced surveillance list at an early date.
Supporting the Private Sector
Government support for the private sector has many dimensions, including facilitating investment, cutting administrative red tape, encouraging public-private-partnerships, and strengthening governance and fighting corruption. The new Tunisian Investment Authority has been set up as a “one-stop shop” for investors to ease burdensome administrative procedures and speed up approvals. A government decree in May significantly reduced the number of authorizations required for investment by establishing an eight-sector negative list where prior authorization is mandatory, but even then, authorization is granted after the lapse of 60–90 days on a “silence is consent” basis. For all other sectors, no prior authorization is required. Fighting corruption is another important government priority and, to that end, the High Anti-Corruption and Good Governance Authority will become functional once its board members are appointed by Parliament following consultations among political parties— expected by September.
The challenging domestic conditions and heavy global and regional headwinds have not weakened the authorities’ resolve to press ahead with macroeconomic stabilization and structural reforms to secure sustainable high levels of growth with widespread benefits for all Tunisians. Maintaining political consensus and public support for the program is critical to its success. Tunisia is pressing at the limits of its program absorption capacity, and any further hardening or frontloading of the program in sensitive areas runs the risk of its rejection by the public. Tunisia has already benefitted greatly from, and will continue to rely on, Fund policy advice and technical assistance, for which the authorities are thankful. They also express their appreciation for the financial and technical assistance provided by their partners during this crucial transition and look forward to their continued support. The authorities will be thankful for Board approval of completion of the Third EFF Review, and waiver of applicability and modification of performance criteria.