October 18, 2004
Despite the severe political crisis of 2002, and a number of severe exogenous shocks, including 1 cyclone in 2002 and 2 cyclones in early 2004, Madagascar has made good progress in the achievement of the objectives set under the program. This progress reflects the strong commitment of the Malagasy authorities to the reform process, their willingness to take quick corrective measures when deviations from the program occurred, and the strong support of the international community for their efforts. This commitment was further strengthened by the government that took office in 2002, and which has been implementing consistently the reform program supported under the PRGF arrangement.
Recent Developments and Performance Under the Program
Developments in 2004 were affected by the hurricanes and a large depreciation of the Malagasy franc. The two hurricanes that hit the island, in early 2004, caused lost of lives, damages to housing, public buildings, infrastructure, and agriculture. Over 300,000 persons were without shelter. The government, with international support, moved quickly to help with the reconstruction efforts. As a result of the hurricanes, there was an increase in imports, mainly of capital goods, as well as a drop in exports, especially of vanilla and shellfish.
These adverse developments in the economy were compounded by the sharp increase in oil and rice import prices, lower than usual repatriation of export proceeds, and larger demand for foreign currency by private imports in response to the tax and tariff exemptions granted in September 2003. All these factors, together with structural weaknesses, and lack of capacity contributed to put pressure on the external accounts, and led to a loss in international reserves, and to the depreciation of the Malagasy Franc. The inflation rate also accelerated. However, in assessing the inflation rate in Madagascar, it is worth noting that if rice and oil prices are excluded, inflation stood at 6 percent in July 2004 (on a year-to-year basis), compared to 17.7 percent for the whole consumption basket.
The above developments were responsible to a large extent for the missed performance criteria. However, the authorities took remedial actions and implemented a number of measures in both the fiscal and monetary sectors, as described below, to ensure that the program remains on track.
In the fiscal area, fiscal targets were broadly in line with the program in the first six months of 2004, except for tax revenue which was 0.03 percent of GDP below the end-March performance criterion, and 0.1 percent of GDP below the end-June indicative targets. These shortfalls reflect, among others, the impact of the cyclones, and the tax exemptions given in September 2003. The government, however, was able to contain outlays on non-priority expenditure. It also resisted demands for wage increases in the public sector, despite the higher inflation, and a 16 percent increase in the private sector minimum wage. The authorities implemented a number of strong corrective actions in July, which included,
tightening eligibility to customs duties advances, and reducing its length to one month;
repealing tax exemptions on non-capital goods;
intensifying the fight against fraud at tax and customs departments;
accelerating customs procedures;
regular rotation of customs agents; and
establishment of performance contracts for customs agents.
Following the introduction of these measures, the revenue performance has improved significantly, with the original July and August forecasts exceeded. My authorities are confident that the end-September and end-of-the-year revenue targets will be met.
In the monetary and exchange sectors, developments in the foreign exchange market and the inflation front posed serious challenges to the authorities. In response, the central bank
increased the reserve requirements on demand deposits from 12 to 15 percent, reduced banks’ maximum net open foreign exchange positions from 20 to 10 percent, and broadened the reserve requirements base;
conducted a reverse auction in August and September, and raised its the base rate from 7 to 16 percent in three steps;
discontinued the purchase of treasury bills from banks in July; and
introduced a new electronic and continuous inter-bank foreign exchange market system in July. The system has contributed to improve the efficiency of the foreign exchange market
As a result, interest rate rose and excess liquidity decreased sharply. Furthermore, the Malagasy franc has stabilized, and the rate of increase of inflation has slowed down.
In the structural area, the performance criterion on the sale of the cotton company, HASYMA, was missed due to the fact that, although five companies expressed interest, only one bid was received, but it had to be rejected as it did not comply with the terms and conditions of the sale. However, on October 7, 2004 the privatization of the company was completed. The structural benchmark on the replacement of the existing system of exchange rate determination by a continuous interbank trading system was missed because some of the commercial banks were not technically ready to start using the new electronic system. It was completed in July. The end-June performance criterion regarding the sugar company SIRAMA has been met, the petroleum prices have been fully liberalized, and the telecommunications company TELMA has been privatized. The public transportation sector was also liberalized, although not a condition of the program.
Other reforms that have been implemented are:
the promulgation of a new legislative framework for public finance;
the recommendations of an independent audit of the Treasury and the strengthening of the treasury accounting system;
the overhaul of the procurement system with the introduction of a new Procurement Code;
a fully functioning independent anti-corruption agency has been set up; and
work is continuing on the strengthening of the judicial system.
In view of the measures taken, the program is now fully on track. My Malagasy authorities would like, therefore, to request waivers for the missed performance and structural criteria. My authorities would also like to point out that at end-June 2004, all quantitative indicative targets were met, except for those pertaining to net foreign assets and tax revenue. Measures that have been taken will ensure that the end-of-the-year targets in those two areas will be fully met.
In spite of the shocks felt, it is worth noting that economic and financial performance has been encouraging, indicating that the reforms that have been undertaken are bearing fruits, and that the economy is gaining resiliency. In this regard, real GDP is expected to grow by a healthy 5.3 percent in 2004, on the basis of strong activities in the tourism sector, export processing zones and construction sector. Good progress is also being made in the implementation of the poverty reduction strategy.
Program for the remainder of 2004 and 2005
My Malagasy authorities remain fully committed to the reform process and to the objectives of the program. As noted above, they have taken strong steps to strengthen the program, and are confident that the program targets will be met. Policies for the remainder of the year will be focused on safeguarding macroeconomic stability, limiting the second round effects of the rising inflation, meeting the revenue target, reducing volatility on the foreign exchange market, and securing a gradual build-up in official reserves. In terms of quantitative objectives, the program expects to achieve real growth rate of 5.3 percent in 2004, and 7 percent in 2005. The annual average inflation rate is expected to be contained at 10.1 percent in 2004, and reduced to around 7 percent in 2005. The level of international reserves is also projected to increase to an equivalent of about 3 months of imports by year-end.
In the fiscal sector, measures already implemented should help tax revenue to reach the target of 11.2 percent of GDP. Non-interest expenditure is projected to be reduced. However, interest charges will increase, together with domestically financed capital expenditures, which would cause a slight increase in domestic balance. For 2005, tax revenue is expected to grow to 11.8 percent of GDP, reflecting the full year effect of the strengthening of the tax and customs administrations, as well as the repeal of the tax exemptions. On the expenditure side, wage policy will remain prudent, and capital expenditure will decline due to the phasing-out of domestically financed capital expenditures related to the cyclones. As a result, domestic balance is projected to show an improvement, equivalent to 1 percent of GDP.
Building on the successful measures already implemented, monetary policy will continue to focus on containing inflation and excess exchange rate volatility. At the same time, the central bank will continue its policy of strengthening liquidity management, and ensuring consistency in the use of monetary policy instruments. In this regard, a number of recommendations made by the MFD mission are being implemented, and regular meetings are now held between officials from the Ministry of Finance and the central bank to assess and update the Treasury financing needs. These measures are helping to better coordinate actions by the Central Bank and the Ministry of Finance regarding the purchase and sale of Tbills. The central bank is also implementing the recommendations regarding the safeguards assessment report.
In the external sector, the main concerns remain the increase in the international prices of petroleum products and rice, and the fall in the export price of vanilla. These developments could worsen the balance of payments. However, the authorities are hopeful that the gains in competitiveness will help the tourism sector and the export processing zone, thus helping to mitigate those increases. The authorities are also pursuing their efforts to encourage external trade, and economic diversification. In this regard, the tariff structure has been simplified, and the top rate has been reduced to 25 percent. Moreover, work is ongoing to ensure Madagascar’s full integration into the economic zone of the SADC.
In the structural area, the authorities will pursue the reforms already started. In particular, a number of reforms are envisaged in the fiscal area to strengthen budgetary operation, and to align the budget closer to the PRSP priorities. Strong measures have also been taken to strengthen customs administration. Additional measures will be implemented in 2005, and include the reassessment of previously granted ad hoc customs exemptions, the mandatory payments of customs duties through the banking system, and the prosecution of custom agents who commit fraud. Port procedures and customs operations are being reformed, and the procedures for approval of foreign investment are being streamlined through the creation of a one-stop window. The regulations on subcontracting of EPZ operations to small firms are also being simplified. The program of privatization will be pursued according to the plan of action, and efforts will continue as regards the strengthening of governance.
PRSP Progress Report
Madagascar is making good progress in the implementation of its poverty reduction strategy. The participatory process and ownership remain high. Workshops were held early this year involving a wide range of stakeholders to receive feedbacks and assess implementation. The workshops indicated that progress was being achieved in many areas, and they also identified weaknesses which are being addressed.
The progress achieved can be seen in the primary schools where over 3,400 teachers have been recruited since 2001, with 89 percent being deployed in rural areas. The enrolment rates in primary schools have increased from about 70 percent in 2002 to 84 percent in the school year 2003/04. In the health area, surveys show a continuing downward trend in child and infant mortality rates, and improved immunization rates. Progress is also evident in the area of nutrition, which is benefiting from initiatives undertaken with donor participation. Efforts are also ongoing to improve the performance of existing hospitals prior to further expansion of the hospital network. As regards infrastructure improvement, the Government has complied with the condition calling for 100 percent of current road maintenance needs being covered through the Road Maintenance Fund. HIPC resources have been used to maintain 6,000 km of road, rehabilitate 1,670 km of rural roads and 180 km of paved roads. This has also created employment for about 12,000 workers, and contributed much to the alleviation of poverty in rural areas. However, not much progress has been achieved in the reduction of overall poverty, as efforts were nullified by the recent hurricanes. Reforms in many sectors, including governance, the simplification of many regulations, and the new Property Act of August 2003, which allow foreign investors to own land are expected to help diversify the economy and have a positive impact on poverty.
My authorities have taken good note of the assessment of the staff of the Fund and the World Bank as well as the views of stakeholders during the workshops. Based on these recommendations, the authorities will take the necessary measures to improve the implementation of the PRSP.
Completion Point Under the HIPC Initiative
In spite of the political crisis, and the exogenous shocks that have affected Madagascar since the decision point, the authorities have maintained their commitment to the reform process, and have implemented with determination the measures and policies envisaged under the program of adjustment. As a result good progress has been achieved towards macroeconomic stability, and in the implementation of a wide range of structural reforms. The growth rate has strengthened, and progress is being made to improve the quality of life. Madagascar has also broadly met the completion point triggers, prepared a full participatory PRSP in July 2003, and released the Fist Annual Progress Report on the implementation of the PRSP. Moreover, budgetary savings from interim debt service relief have been used in line with the criteria set forth at the decision point, and have been used to support improved service delivery in primary education, health, and rural infrastructure. The government with donor assistance has also improved its ability to use public resources effectively, through enhancement of the poverty reducing expenditure tracking mechanisms, and in the monitoring system, as well as improving governance.
As regards debt sustainability, the revised calculations, after taking into consideration full implementation of traditional debt relief mechanisms, show a slight increase of the NPV of debt from the calculations made at the decision point. However, additional debt relief received from bilateral creditors, has enabled the NPV of debt-to-exports ratio to be brought to 137 percent. While we are appreciative to the creditors who have provided the additional relief, we note that had this not been the case, the debt ratio would have been much higher than the HIPC threshold. We are, therefore, of the view that, under the principle of equal treatment for all creditors, Madagascar should have been provided with additional debt relief. In view of the vulnerabilities to exogenous shocks and the difficult financial position of the country, we hope that other creditors will follow the example of those that have already provided additional relief, so that Madagascar can quickly reach a fully sustainable external position, that enables the country to allocate resources to poverty reduction and economic development that can enable the country to reach the MDGs.
In conclusion, in view of the fact that Madagascar has satisfied broadly the conditions for reaching the completion point, the assurances received from creditors, the progress achieved under the program, and the strong commitment of the authorities to pursue the adjustments process, I would appreciate Directors’ support for the proposed decisions.