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Statement by Damian Ondo Mañe, Executive Director for Republic of Madagascar

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International Monetary Fund
Published Date:
September 2005
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On behalf of my Malagasy authorities, I would like to express their deep appreciation to Management and staff for their continued support and policy advice. This close relationship over the years, sometimes during very difficult times, has been very helpful in guiding the authorities in their policy decisions, and have contributed much to the progress made. My Malagasy authorities wish to maintain this close relationship.

Since March 2004, Directors have had 3 occasions to examine economic and financial developments in Madagascar, in the context of reviews under PRGF arrangements. In my earlier statements, in particular, that of February 16, 2005, I described developments in 2004. The more recent data do not diverge much from those of February. They indicate considerable progress, under successive PRGF arrangements, in stabilizing the economy and laying the foundation for higher growth, but they also show that the economy remains vulnerable to shocks, and that the economic adjustment programs should be pursued steadfastly and strengthened in certain areas.

My Malagasy authorities remain fully committed to the reform efforts which have received strong support from the international community, and for which they are thankful. In 2004, Madagascar reached the completion point under the HIPC Initiative and is benefiting from debt relief. The last PRGF arrangement came to a successful conclusion in March 2005, and my authorities would like to continue the close relationship with the Fund in the context of a successor PRGF that will focus on raising the growth rate. The continued vulnerability of the economy to both domestic and external shocks would justify this new program.

Recent Economic Developments

As I noted above, developments have not diverged much from the February assessment. They confirm that real GDP growth remains relatively strong at 5.3 percent, despite a number of exogenous shocks. Most sectors, in particular those of agriculture, construction, tourism, transport and textiles and garments made strong contribution to growth, which was also helped by the donor-financed capital expenditure.

Two unfavorable developments were in regard to inflation and the exchange rate. The Malagasy franc depreciated significantly in 2004 due to larger than expected demand for foreign currency by private importers in response to the tax and tariff exemptions granted in September 2003, which have since been partially removed, increased government capital expenditure and lower vanilla exports due to the cyclones. Higher world price of oil and rice contributed both to the depreciation and the higher inflation. Weakness in the foreign exchange market and at the central bank were also factors in the depreciation of the currency. A number of strong measures, under the advice of Fund staff, were put in place in the second half of 2004, both in regard to the implementation of monetary and exchange rate policy as well as in regard to structural and administrative measures. The authorities also maintained a tight fiscal policy. In particular, it should be noted that, despite the large increase in prices and strong pressures to increase wages, the government kept its commitment to the Budget. It also improved its coordination with the central bank. These have been successful in containing inflationary pressures and stabilizing the exchange rate. Recent data show that inflation peaked in February and has since fallen sharply. The authorities are fully determined to maintain strong policies so as to restore macroeconomic stability.

Monetary policy has remained tight. Net reimbursement by the Treasury to the central bank enabled an increase in credit to the private sector. The financial sector continued to strengthen in 2004, with improved profitability and prudential indicators for the banking sector. The ratio of nonperforming loans to total gross loans fell from 19.6 percent in 2002, the year of the major political crisis, to 11.4 percent in 2004. While the expansion of credit has contributed to the fall in the NPL ratio, it should be noted that there has also been major improvements in maintaining the quality of the loan portfolio. A Financial Sector Assessment Program (FSAP) is underway and the authorities look forward to its conclusion and recommendations, with a view of strengthening the sector further. The central bank has also started to implement the recommendations of the Stage One Report of the Safeguards Assessment with the help of the Monetary and Financial Systems Department of the Fund. The anti-money laundering legislation adopted in 2004 became operational this year.

In the fiscal sector, revenue performance improved in 2004, on the basis of strong reform implemented at customs, and reached 10.9 percent of GDP, compared to 10 percent in 2003. Capital outlays were higher than projected due to higher-than-expected foreign financed investment. Although the current outlays of the central government were within Budget, insufficient control over expenditure of decentralized governments bodies and public entities caused some expenditure overruns, which were compensated for by cuts in other central government outlays. Overall, the fiscal deficit, including grants, was 4.9 percent of GDP, compared to 4.2 percent in 2003, and the government reduced its domestic debt by about 2.8 percent of GDP.

In the external sector, exports of clothing, especially to the U.S., under the AGOA, increased, but export of vanilla fell significantly. Imports saw a major increase, especially of capital goods, so that the external current account deficit widened to 14 percent of GDP in 2004. The external debt position remains difficult, despite the debt relief obtained under the HIPC Initiative. At end-2004, the NPV of debt-to-exports ratio was estimated at 202.1, and will be 169.8 at end-2005. The ratio will fall below the thresholds only with additional bilateral aid beyond the HIPC Initiative. My authorities continue to make strong efforts to obtain full HIPC Initiative assistance, and have contacted all non-Paris Club creditors. They have already signed agreements with some Paris Club members, and are in discussion with others to obtain additional debt relief.

The program of structural reforms was pursued steadily in 2004, with good progress in the area of privatization, and in the improvement of the business and legal environment. Measures to improve governance have also been taken. These should contribute to lower domestic costs of doing business in Madagascar and also help to attract foreign investors.

Medium Term Policies

The objective of the authorities for the medium term is to build on the progress achieved and put in place policies, consistent with the PRSP, and that will enable Madagascar to raise its annual growth rate to a higher level, 6 percent or above, which would help the country to make progress towards the achievement of the MDGs. While structural policies and investment on infrastructure should help to improve competitiveness and create more investment opportunities for the private sector, the authorities will also pursue strong macroeconomic policies aimed at raising government revenue and keeping inflation low. The authorities expect much from foreign direct investment and donor assistance. In this regard, the authorities are pleased that Madagascar was the first country selected by the U.S. Millennium Challenge Corporation (MCC). Assistance under the MCC will focus on land reforms, financial sector development and agricultural.

Efforts to raise government revenue will be pursued, and measures will include a comprehensive reform of the tax system. The authorities will maintain a tight control over expenditure, and a number of steps are being taken to strengthen public expenditure management. Strengthening of governance at customs will remain a priority. Monetary policy will continue to aim at reducing inflation, while ensuring the financial needs of the developing private sector are met. To encourage the development of small enterprises, a law establishing the legal framework for microfinance operations is expected to be approved by parliament this year. The strengthening of banking supervision and improving the effectiveness of monetary policy will remain a priority for the monetary authorities.

However, in spite of the extensive reforms being made, the authorities have concerns about the medium term, in particular, as regards the textile and garments industry, which up to now have contributed significantly to growth and the creation of employment, and which will face increase competition with the expiration of the Agreement on textiles and Clothing and also with the expected termination of the AGOA by 2007. The authorities expect that the ongoing program of structural reforms will help to diversify the productive base, but this may take some time to bear results. The development of the tourism industry and agriculture, among others, are being encouraged, as well as that of other industries, including mining. The authorities expect substantial increase in regional trade through their adhesion to COMESA and SADC.

Ex Post Assessment

My Malagasy authorities agree broadly with the ex post assessment paper. Despite the fact that the political situation, over the past decade, had been unstable, important progress was made in the area of macroeconomic stabilization, although my authorities would have preferred that it had not relied so much on expenditure compression. It is true that revenue mobilization had been less successful than had been anticipated, but it should be recognized that a large segment of the population lives on less than a dollar a day, and contribute little to government revenue. Moreover, during the last few years, Madagascar has been implementing a large reduction in custom tariffs, including in the context of regional agreement. The country has also suffered from natural shocks such as cyclones, locusts infestation, etc, which have had a severe adverse impact on agricultural production and export, a main source of revenue. The government has thus experienced a loss of income, which has not been fully made up through the VAT. Nevertheless, a number of important reforms have been put in place in tax and custom administration, the issue of corruption is being addressed forcefully, and additional revenue-increasing measures are being taken. The revenue-to-GDP ratio is increasing gradually, and my authorities are confident that as economic activity increases, especially, in view of the reforms undertaken, there will be an increase in the tax ratio. It is therefore doubtful if a tougher approach, as suggested in the EPA paper, would have worked.

My Malagasy authorities agree that the structural reform agenda did take some time to produce results. In the early nineties, program ownership was weak, as reforms were more or less imposed. The difficulty to build a consensus caused progress to be uneven. However, as the paper rightly recognizes, structural reforms have been more successful in the past few years, as there have been a better and broader consultation on the reform measures, with more flexible conditionality. The linkage with the PRSP, a document that has broad popular acceptance has also helped. The authorities intend to build on the recent progress to accelerate the reform process, and create the conditions for the development of a strong private sector which will be the engine of growth.

However, and more importantly, the difficulty encountered showed that lack of capacity played an important role in the failure to implement many policy measures. The inability of the civil service to attract sufficient numbers of skilled staff, due to low very low salaries, have hindered progress in many sectors, including the judicial system. Madagascar has made use of technical assistance from the Fund and other multilateral institutions and donors, but this has not been enough, and often the newly trained personnel left the service. My authorities are giving full attention to the issue of capacity-building. In this regard, they are finalizing a time-bound technical assistance plan which will prioritize their needs. The plan will then be presented to donors and a coordinated deliver process will be put in place.

Finally, as noted in the EPA paper, Madagascar is making good progress in its reform process, but the economy remains weak and vulnerable. It will continue to require balance-of-payments assistance over the medium term. Without external assistance, it is unlikely that the MDGs will be achieved. For their part, my Malagasy authorities are fully committed to continue the adjustment process. They are of the view that Madagascar is at a crossroad, and that it will be important to build on the progress achieved. They therefore would like to request continued Fund support in the form of a successor-PRGF arrangement. They also hope that donors will continue to give the country their full support, and that Madagascar will benefit from further debt relief assistance.

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