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Union of the Comoros

Author(s):
International Monetary Fund
Published Date:
October 2006
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I. Article IV Consultation

A. Economic Retrospective

A poor growth record

1. Economic growth has been weak and narrowly based for decades. The economic upturn recorded in most of sub-Saharan Africa since the mid-1990s has been much less pronounced in Comoros. Real GDP growth averaged 2¾ percent for 2001-05, well below the regional average. Per capita, real GDP has declined by an estimated ½-percentage point per year over the past two decades. Economic activity is largely confined to subsistence agriculture, production ofthree export crops (vanilla, cloves, and ylang-ylang), import-related commerce, and government services. Fishing and tourism are well below potential. Manufacturing is almost nonexistent.

2. The poor growth record partly reflects the country’s inherent disadvantages, including (i) the small size of the local market, which limits economies of scale and competition; (ii) very high transport costs and few air links, constraining trade and tourism; and (iii) environmental factors, including high population density, deforestation, scarcity of fresh water, and occasional volcanic eruptions.

Real GDP growth has lagged behind regional averages since the mid-1990s.

3. Political instability and external shocks have also played a detrimental role. Years of interisland tensions, culminating in the 1997-2001 secessionist crisis, have undermined institutional capacity and led to a sharp reduction in donor assistance. The narrow export base has exposed the economy to international price swings, as underscored bythe recent plunge in vanilla prices.

4. Private sector development has been held back by a poor business environment, inadequate infrastructure, and an underdeveloped financial sector. In the World Bank’s 2006 Doing Business Survey, Comoros ranked 144th worldwide and 22nd out of 45 sub-Saharan African countries. Foreign direct investment (FDI) has been deterred by weak contract enforcement, high transport costs, the small local market, and poor telecommunication and utility services. The lack of foreign investors has in turn limited competition, innovation, transfer of know-how, and linkages to export markets. The largest employers are the government and the public infrastructure monopolies. Access to credit from the only commercial bank is largely limited to short-term trade financing.

5. Almost half the population lives in poverty, although social indicators are more favorable than in most of sub-Saharan Africa. This is partly because Comoros has one of the lowest rates of HIV/AIDS in the region. It has therefore not seen the setbacks in life expectancy and infant mortality observed in most of sub-Saharan Africa. Comoros ranks 8th among countries in sub-Saharan Africa on the UN’s Human Development Index (2005), following decades of slow but steady gains. Achieving the Millennium Development Goals (MDGs) would require not only an increase in economic growthand external assistance but also continued efforts to keep HIV/AIDS under control.

Comoros’s Human Development Index rating has gradually improved and remains above most Sub-Saharan countries.

Source: UNDP.

Social indicators are more favorable than regional averages, but poverty is widespread and the MDGs are a distant prospect.
Comoros(year)Sub-Saharan(year)MDG target for 2015
Africa average
GDP per capita (U.S. dollars)633.0(2005)536.9(2004)
Poverty rate (in percent of population)44.8(2004)44.0(2003)(reduce by 1/2 from 50)
Life expectancy at birth (years)62.9(2004)46.2(2004)
Infant mortality rate (per 1,000 live births)59.0(2002)100.5(2004)40.0
Lack of access to safe water (in percent of population)6.0(2002)42.0(2003)(reduce by 1/2 from 7)
Education
Net primary enrollment ratio (percent of relevant age group)54.7(2001)64.1(2003)100.0
Ratio of girls to boys in primary and secondary education (percent)82.4(2001)83.6(2004)100.0
Health
Prevalence of child malnutrition (percent of children under 5)26.0(2002)9.3
Maternal mortality ratio (modeled estimate, per 100,000 live births)480.0(2001)920.9(2000)(reduce by 3/4 from 381)
Immunization rate (DPT, percent of children under 12 months)76.0(2004)63.9(2004)100.0
HIV/AIDS infection (percent of population aged 15-49)0.3(2003)7.0(2004)0.3
(halt rate of spread)
Sources: Comorian authorities, World Bank; World Development Indicators.
Sources: Comorian authorities, World Bank; World Development Indicators.

Macroeconomic stability but a lack of flexibility

6. Membership in the franc zone arrangement has been the economy’s anchor of stability. Comoros has maintained an exchange rate peg with France, its largest trading partner, since the colonial era. The Comorian franc was devalued once, by 33 percent in 1994, when other franc zone countries devalued by 50 percent. The hard peg and the safeguards of the franc zone arrangement have kept annual inflation since 1995 in the range of 1-6 percent and international reserves at comfortable levels. The arrangement has also provided some discipline for fiscal policy, capping the stock of central bank credit to government at 20 percent of fiscal revenues. Monetary policy is mostly passive, constrained by the franc zone framework and the underdeveloped local financial sector.

Limits on central bank credit have helped keep inflation low and reserves at comfortable levels.

Comoros has a higher wage bill but a more balanced fiscal position than other low-income countries in sub-Saharan Africa (2005).

1/ Unweighted average. Includes SSA countries with GDP per capita below $700 and no major natural resource revenue.

7. Fiscal policy has been severely constrained by a large wage bill and lack of access to domestic financing. While the revenue-to-GDP ratio is broadly in line with the regional average, weak expenditure control in the context of fiscal decentralization has pushed up the public wage bill. Lack of domestic and external financing have kept fiscal deficits low, but it has also limited social spending and public investment. The tight fiscal envelope and inadequate institutional capacity have contributed to chronic arrears accumulation.

Excessive debt and limited external assistance

8. External debt has been well above the HIPC threshold for over two decades. With large-scale borrowing from official creditors after independence, external debt accumulated rapidly, reaching 100 percent of GDP by the mid-1980s. At end-2005, the net present value (NPV) of debt amounted to an estimated 419 percent of exports of goods and services, and arrears accounted for almost half of it. In recent years, debt service has been paid in full to the World Bank, whereas arrears have continued to accumulate to other official creditors. Comoros does not have debt to the IMF.

9. External assistance collapsed during the 1997-2001 secessionist crisis, and has not yet recovered. Low levels of aid also reflect unresolved external arrears and lack of adequate monitoring and control of budget execution. The low level of technical assistance has in turn prevented progress in rehabilitating institutional capacity.

External debt (NPV terms) is far above HIPC and DSA thresholds.

External assistance has declined in gross and net terms

(percent of GDP).

Exposure to external shocks

10. Comoros’ terms of trade have fluctuated widely and are now about 10 percent below their ten-year average. International vanilla prices skyrocketed during 2001-03 and collapsed thereafter, reflecting supply conditions in Madagascar and fluctuating global demand. Rising oil prices have further weakened the terms of trade. The real effective exchange rate in 2005 was about 12 percent above its ten-year average, partly because the euro has been gradually appreciating against the U.S. dollar since 2000.

Terms of trade have been highly volatile and the real effective exchange rate has appreciated modestly.

Remittances have financed a large and growing trade deficit

(in percent of GDP).

11. Remittances have offset a large trade deficit and provided a buffer against external shocks (see Selected Issues, Chapter I). Emigrant remittances to Comoros are among the highest in the world, averaging 15½ percent of GDP and 49 percent of all current account receipts during 2001-05. They have mainly been used for imports of consumer products, resulting in a large structural trade deficit. They also helped offset the 2004/05 terms of trade shock and the associated deterioration in the trade balance, keeping the current account deficit relatively modest.

Recent developments and short-term outlook

12. The May 2006 presidential elections were a milestone in the national reconciliation process. They resulted in the first democratic power transfers in over a decade and rotation of the Union presidency to a native of Anjouan island. The new president, Ahmed Sambi, scored a landslide victory with his message of political change, commitment to the rule of law, and a promise of higher living standards. He appointed a new Union government in late May. The three islands of Grande Comore, Anjouan, and Moheli will hold island presidential elections in the spring of 2007.

13. After stabilization gains in 2005, economic performance worsened in 2006. Higher tourism and services in 2005 helped speed economic growth, and fiscal performance improved, with a sharply higher primary fiscal balance and a net reduction in domestic expenditure arrears. For 2006, real GDP growth is projected to decline to 1¼ percent, due to the continued weakening of agriculture, resulting from low international vanilla prices, and sharply lower tourism, resulting from the closure of a major hotel. The economic slowdown is mirrored in declines in broad money and credit to the private sector. Given low demand for domestic goods, inflation is expected to remain moderate despite higher fuel prices. A further decline in exports and strong import growth (due to fiscal loosening and higher remittances) are likely to widen the current account deficit and reduce international reserves. Public finances deteriorated sharply during the pre-election period, and the new government has since taken steps to boost revenue and cut expenditure (see SMP discussions, Section II).

Comoros: Selected Economic Indicators, 2004-07
2004200520062007
Est.Orig. Prog.RevisedProj.
Real GDP growth (in percent)-0.24.22.51.23.0
Average annual inflation (in percent)4.53.64.23.83.0
Domestic revenue (in percent of GDP)15.615.715.214.215.7
Domestic primary balance (in percent of GDP)-0.51.10.9-0.31.0
Current account balance (in percent of GDP)-2.8-3.3-3.8-4.5-6.0
International reserves (months of imports of goods and services)9.48.29.47.36.1
Terms of trade (annual percentage change)-34.2-43.96.6-6.0
Official grants and loans (in percent of GDP)3.85.06.77.99.0
External debt (NPV in percent of exports of goods and services)419.4493.2
Sources: Comorian authorities and Fund staff estimates and projections.
Sources: Comorian authorities and Fund staff estimates and projections.

B. Medium-term Macroeconomic Framework

14. The recently issued I-PRSP sets out a clear vision for combining private sectorled economic growth with improved social services. As noted in the Joint Staff Advisory Note (EBD/06/52), the I-PRSP was prepared in what was for Comoros an unprecedented participatory process and served as the reference framework for the December 2005 donor roundtable. It focuses on improvements to public finances, infrastructure, conditions for private sector development, governance, health, and education.

15. The mission discussed with the authorities a medium-term macroeconomic framework (Table 2). The reference point was a baseline scenario with unchanged policies and aid, and real GDP growth of 2 percent per year, in line with the ten-year historical average. Fiscal revenues and wageswould remain broadly unchanged, preventing a pick-up in public investment and social spending. Domestic and external arrears would accumulate steadily and external debt would remain unsustainably high.

Table 1.Comoros: Selected Economic and Financial Indicators, 2002-07
20022003200420052006 1/2007
Prog.Rev. Prog.Proj.
National income and prices(Annual percentage change unless otherwise indicated)
Real GDP4.12.5-0.24.22.51.23.0
Real GDP per capita2.00.3-2.32.1-0.2-0.80.9
Nominal GDP (in millions of CF)131,293141,437143,596153,112160,783158,114167,743
Nominal GDP (in millions of US$)251.9323.2362.9368.9392.7386.2409.7
Nominal GDP per capita (in US$)447.0561.4617.4614.8633.3630.3655.0
GDP deflator4.25.11.82.32.02.03.0
Consumer price index (annual averages)3.53.84.53.64.23.83.0
Money and credit
Net foreign assets6.0-4.8-1.60.93.2-0.6
Domestic credit12.3-3.4-3.69.02.1-4.6
Broad money9.1-1.1-6.33.13.3-1.1
Velocity (GDP/average broad money)4.14.54.85.05.15.2
Investment and savings(in percent of GDP unless otherwise indicated)
Investment11.010.39.49.313.110.213.5
Public5.85.44.44.57.05.36.6
Private5.24.95.04.86.14.96.9
Gross national savings9.67.26.56.09.35.67.6
Public2.11.92.74.65.33.86.2
Private7.55.33.81.44.01.91.4
Government budget
Domestic revenue16.415.815.615.715.214.215.7
Total grants4.12.22.84.34.86.48.0
Total expenditure24.121.520.119.921.722.124.1
Current expenditure18.416.115.715.414.716.817.5
Change in arrears
External interest0.70.70.50.40.00.4
Domestic0.10.90.8-0.5-0.40.0-0.4
Domestic primary balance1.10.5-0.51.10.9-0.31.0
Overall balance
Commitment basis, including grants-3.6-3.4-1.70.1-1.7-1.5-0.4
Cash basis, including grants-2.9-1.9-0.3-0.5-2.2-1.1-0.9
External sector
Exports of goods and services15.715.812.712.513.810.511.1
Imports of goods and services30.831.832.634.729.237.338.4
Current account balance-1.4-3.1-2.8-3.3-3.8-4.5-6.0
Excl. official and private transfers-15.3-16.5-20.5-22.9-15.9-27.4-27.7
External debt (end of year)
In percent of GDP84.281.180.571.568.270.558.6
Of which: arrears23.923.424.124.923.725.3
NPV, percent of exports of goods & services419493
External debt service
In percent of exports of goods & services14.714.017.616.813.418.620.8
In percent of government revenue14.114.014.313.312.213.714.8
Official grants and loans9.55.23.85.06.77.99.0
Gross international reserves (end of period)
In millions of U.S. dollars80.997.292.787.190.187.479.8
In months of imports of goods & services12.511.39.48.29.47.36.1
Real effective exchange rate (2000=100)113.8116.8123.6126.0
Terms of trade (percent change)0.875.6-34.2-43.96.6-6.0
Exchange rate CF/US$ (period average)521.1437.6395.7415.0
Sources: Comorian authorities; and Fund staff estimates and projections.

Program reflects SMP for Jan.-Jun. 2006 (Country Report No. 06/193). Revised program reflects SMP extension through December 2006.

Sources: Comorian authorities; and Fund staff estimates and projections.

Program reflects SMP for Jan.-Jun. 2006 (Country Report No. 06/193). Revised program reflects SMP extension through December 2006.

Table 2.Comoros: Medium-term Scenarios: Baseline and Adjustment, 2005-10
200520062007200820092010
Baseline scenario 1/
Real sector(In units indicated)
Real GDP (percent change)4.21.22.02.02.02.0
GDP deflator (percent change)2.32.02.52.52.52.5
Nominal GDP (US$ millions)368.9386.2403.8422.1441.4461.4
Investment (percent of GDP)9.310.211.010.510.510.5
General government(In percent of GDP)
Grants3.85.15.05.05.05.0
Domestic revenues15.714.214.114.013.913.8
Domestic primary spending14.614.514.714.814.915.0
Project spending and technical assistance4.56.65.05.05.05.0
Domestic primary surplus1.1-0.3-0.6-0.8-1.0-1.2
Overall balance0.1-1.5-1.2-1.3-1.5-1.7
Change in arrears-0.50.01.41.71.92.1
External sector(In percent of GDP)
Current account balance (incl. grants)-3.3-4.5-4.5-4.7-4.9-5.1
Exports of goods and services12.510.510.710.710.710.7
Imports of goods and services34.737.337.337.337.337.3
Current transfers19.522.922.722.522.322.0
External debt71.571.067.764.461.258.1
Of which: external arrears24.925.325.525.525.525.5
External debt service due2.11.92.12.02.01.9
NPV of ext. debt to exports of goods, & services419.4493.2470.9457.1444.5430.9
Gross international reserves (months of imports)8.27.36.55.44.33.1
Adjustment scenario 2/
Real sector(In units indicated)
Real GDP (percent change)4.21.23.04.54.54.5
GDP deflator (percent change)2.32.03.03.03.03.0
Nominal GDP (US$ millions)368.9386.2409.7441.0474.7510.9
Investment (percent of GDP)9.310.213.515.116.116.6
General government(In percent of GDP)
Grants3.85.18.09.310.010.0
Domestic revenues15.714.215.716.016.316.6
Domestic primary spending14.614.514.615.015.415.8
Project spending and technical assistance4.56.69.09.710.410.4
Domestic primary surplus1.1-0.31.00.90.80.7
Overall balance0.1-1.5-0.40.10.10.1
Change in arrears-0.50.0-24.3-0.4-0.4-0.5
External sector(In percent of GDP)
Current account balance (incl. grants)-3.3-4.5-6.0-5.9-5.7-5.4
Exports of goods and services12.510.511.111.712.313.0
Imports of goods and services34.737.338.438.438.238.0
Current transfers19.522.921.821.120.419.5
External debt71.570.558.652.616.415.5
Of which: external arrears24.925.30.00.00.00.0
External debt service due2.11.92.31.71.60.7
NPV of ext. debt to exports of goods & services419.4493.2310.9271.874.064.5
Gross international reserves (months of imports)8.27.36.16.16.36.4
Sources: Comorian authorities and Fund staff estimates and projections.

Based on unchanged policies.

Reflects economic reform program, external assistance in line with December 2005 donors conference, and debt relief under HIPC/MDRI in 2009. External arrears are assumed to be rescheduled in 2007.

Sources: Comorian authorities and Fund staff estimates and projections.

Based on unchanged policies.

Reflects economic reform program, external assistance in line with December 2005 donors conference, and debt relief under HIPC/MDRI in 2009. External arrears are assumed to be rescheduled in 2007.

First-half 2006 SMP targets were missed by wide margins.

Second-half 2006 SMP targets have been strengthened relative to original flow targets.

16. An adjustment scenario was prepared to anchor the authorities’ medium-term economic reform program. The authorities believed that their program could help raise real GDP growth to 4 percent on average for 2007-09, supported by a pick-up in public and private investment. As in the I-PRSP, growth sectors are assumed to include tourism, agriculture, fishing, finance, infrastructure, and communication. A rebound in exports would limit the increase in the trade deficit caused by higher aid-related imports (Table 2).

17. The adjustment scenario allows for higher social spending and public investment while minimizing new debt and reducing arrears. A primary surplus of about 1 percent of GDP would be targeted each year to allow for a modest amount of debt service and a gradual reduction in domestic arrears. Public investment and social spending could be raised by about 6 percentage points of GDP between 2006 and 2009, based on a gradual rise in domestic revenue, a modest reduction in the wage bill, and higher external assistance in line with pledges announced during the 2005 donor conference.

18. The adjustment scenario assumes comprehensive debt relief under the HIPC Initiative and MDRI. The staff estimates that the NPV of debt would decline to about 64 percent of exports by 2010, assuming: (i) arrears clearance and rescheduling on concessional terms in 2007, (ii) bilateral debt rescheduling for 2007–09, (iii) interim debt relief in 2008-09, and (iv) HIPC and MDRI debt relief in 2009. In 2007, debt service would be somewhat higher than in the baseline scenario, reflecting rescheduled arrears.

Comparison of Baseline and Adjustment Scenario, 2005–10

C. Medium-term Challenges

19. Article IV discussions focused on three medium-term challenges critical for raising economic growth and improving social conditions:

  • Moving toward external sustainability, through regularization of arrears, HIPC and MDRI debt relief, higher external assistance, and domestic policy adjustments to improve external competitiveness.

  • Supporting private sector growth and economic diversification, by developing the financial sector, improving the investment climate, simplifying the tax system, liberalizing trade, and enhancing competition and private sector involvement in infrastructure.

  • Enhancing the capacity of fiscal institutions, by improving interisland cooperation, budget execution monitoring, expenditure management, and revenue administration.

Moving toward external sustainability

20. A high priority for the authorities is bringing debt to a sustainable level through comprehensive debt relief. A debt sustainability analysis (Appendix I), conducted jointly with World Bank staff, shows that debt would remain unsustainably high in the baseline scenario even without economic shocks. By contrast, in the adjustment scenario, based on an economic reform program and HIPC/MDRI debt relief, debt would come down to the point where it would be sustainable under a range of stress tests.

21. The mission urged the authorities to build on recent momentum in arrears clearance discussions with official creditors (see Section II.C for details). Reaching understandings with official creditors on clearing Comoros’ large external arrears (25 percent of GDP) is a precondition for a PRGF arrangement, which in turn is required to make Comoros eligible for HIPC and MDRI debt relief. The specifics of arrears clearance and rescheduling will have implications for near-term debt service.

22. The authorities called for more external assistance to support urgently needed institution-building and the reforms envisaged in the I-PRSP. The 2005 donor conference generated about $200 million in external assistance pledges for 2006-09. Annualized, this would be triple the amount received in 2004-05, although it is only about half of what was envisaged in the I-PRSP. Additional assistance will likely be needed to clear arrears and achieve the MDGs. Authorities and staff agreed that new projects should be mostly grant-financed and that expenditure-tracking mechanisms need to be put in place to ensure that aid is used effectively.

23. The mission discussed the causes of Comoros’s apparent lack of external competitiveness, evidenced by poor export performance and growing external imbalances (Box 1). The authorities noted that structural constraints—in particular very high transport costs, the underdeveloped financial sector, and emigration—were the main reasons for low exports and the lack of sectoral diversification. They considered that the current level of private sector wages was not a major constraint on competitiveness, as exports are mainly produced from self-employment in agriculture.

Box 1:External Competitiveness and the Exchange Rate

The discussions highlighted linkages between export performance, external balances, the terms of trade, and the real exchange rate:

  • The size of the goods and services deficit (18 percent of GDP) is mostly explained by remittances and foreign aid. About three-quarters of remittances and project aid are spent on imports, thus not directly affecting the real exchange rate. Such imports averaged an estimated 15 percent of GDP during 2001-05, which explains much of the goods and services deficit.

  • Exports are low mainly because of structural constraints and low vanilla prices. Structural constraints include emigration, an underdeveloped financial sector, low institutional capacity, and high international transport costs.

  • Dollar wages are in line with comparable countries. Wages and other local costs play a relatively minor role in agricultural production, which is family-based, though they are more important in tourism. At about €60–90 a month, private wages are not out of line with wages in other low-income countries. Government wages, which average €140 a month, are also not high by regional standards, but the public sector tends to siphon off skilled labor from the private sector.

  • Past movements in the real exchange rate have had little discernible impact on exports. The 33 percent devaluation in 1994 caused a lasting real exchange rate depreciation that averaged 17 percent against the ECU and 13 percent in real effective terms for the next five years but, in contrast to what happened in many other franc zone countries, exports did not pick up and the trade deficit increased. The episode highlighted the structural rigidities in Comoros, such as the limited capacity of the tradables sector and its high dependence on international export prices, which declined during 1995-98).

  • External imbalances have widened in recent years, reflecting real exchange rate appreciation and terms of trade shocks. From 2002 to 2005, the goods and services balance deteriorated by more than 7 percentage points of GDP, partly reflecting rapid import growth caused by a surge in remittances. Excluding imports financed by remittances and foreign aid, the goods and services deficit deteriorated to an estimated 4½ percent of GDP in 2005, from near zero in 2002, mainly reflecting real exchange rate appreciation, rising oil prices, and the collapse in international vanilla prices.

Given poor data quality, especially for longer historical series, it is not possible to quantify the degree of potential exchange rate misalignment. On balance, the exchange rate seems to have become moderately overvalued, with recent terms of trade shocks and real exchange rate appreciation contributing to a growing but still moderate aid- and remittances-adjusted goods and services deficit.

24. The large and growing goods and services deficit can be explained partly by the direct effect of remittances on imports and partly by relative price movements. Because remittances to Comoros are mainly spent on imports, they do not appear to have created a significant Dutch disease problem, notwithstanding short-term fluctuations in monetary aggregates and prices (Selected Issues, Chapter I). Strong import growth in recent years has been mainly driven by surging remittances. The current account deficit has widened moderately, reflecting rising oil prices, falling vanilla prices, and real exchange rate appreciation caused by the appreciation of the euro against other currencies.

The recent rise in the trade deficit is partly, but not fully, explained by higher remittances.

The 1994 devaluation did not boost exports.

25. The authorities stressed that the hard exchange rate peg and safeguards under the franc zone arrangement have provided the country’s main anchor of stability. In their opinion, any short-term competitiveness gains from a devaluation would be limited by the narrow economic base, capacity constraints in agriculture and tourism, and possible negative feedback effects through increased emigration. Any potential benefits from an exchange rate realignment were likely to be outweighed by the adverse effects on domestic confidence in the currency, with a risk of further eurorization and higher lending rates. The authorities stressed that the fixed exchange rate regime, franc zone lending limits, and central bank independence had been critical for keeping inflation low. Staff agreed. Given the apparent moderate overvaluation of the currency (Box 1), staff emphasized the need to tighten fiscal policy and accelerate structural reforms aimed at promoting private sector development (see below), so as to enhance external competitiveness and prevent a continued widening of external imbalances.

Private sector development

26. Policymakers and private sector representatives stressed that private sector growth will require a significant expansion of financial intermediation. Lending rates are high and credit to the private sector, at 6 percent of GDP, is low even by regional standards and largely limited to short-term trade financing, partly reflecting credit risk, but also lack of competition. The mission discussed medium-term reform priorities with the central bank, with a focus on preparing the supervisory framework for the prospective entry of several foreign banks and strengthening the supervision of microfinance institutions.

27. There was consensus that higher FDI will be critical for raising GDP growth and improving external competitiveness. In addition to capital, FDI would provide knowledge transfer and linkages to international markets. It could also enhance competition in the service industry and diversify the economy. The authorities stressed that their commitment to good governance would help improve the investment climate and noted their recent efforts to attract investors to the tourism and banking sectors. The mission pointed out that contract enforcement had been perceived as a problem by several foreign investors. The authorities noted their efforts to prepare a new investment code that would introduce a one-stop shop for investors and give them legal recourse to the courts.

28. There was agreement on the need to further liberalize trade policy and simplify the tax system. Important steps this year were the conversion of high specific import duties on key commodities into domestic excise taxes and the reduction in ad valorem tariff rates, with a new maximum rate of 30 percent. As a result, the average weighted import tariff declined to less than 20 percent in 2006. There was agreement that simplifying and further reducing import duties, eliminating exemptions, and overhauling the tax code would help improve the investment climate. One option under consideration is to introduce a low uniform ad valorem import tariff, a uniform domestic consumption tax, and excise taxes on a few commodities with high revenue potential. The mission advocated termination of the forfait regime (fixed charges on containers involving about a quarter of the value of all imports), which has depressed customs collection. The authorities thought the regime was useful in the short term to alleviate existing capacity constraints but agreed that it should be reviewed as part of a wider revenue reform. They reiterated their commitment to regional trade integration and implementing the COMESA free trade area.

29. The mission emphasized the urgency of reforming public infrastructure companies, whose poor performance has impeded private sector growth. It urged the authorities to accelerate their discussions with the World Bank/IFC on preparing a sector reform strategy for the telecommunications and hydrocarbons monopolies, including possible introduction of competition and privatization. Given the critical importance of these two companies for the fiscal revenue base, such reforms should accompany tax reform and improvement of revenue administration. The staff noted that greater competition would also be important in transportation, where high costs have impeded foreign trade and economic growth. The authorities agreed that these sectors need reform and that the precarious financial situation of Grande Comore’s electricity and water utility (Mamwe) affected the cash flow of its suppliers and reduced fiscal revenues. The government intends to become current on its utility bills and improve governance at Mamwe.

Improving fiscal institutions in a decentralized system

30. Lack of interisland cooperation in the context of fiscal decentralization has undermined the country’s institutional capacity (see Selected Issues, Chapter II). Fiscal decentralization has been a cornerstone of the national reconciliation process but, as the authorities acknowledged, it has also created an excessively large civil service. Many functions are replicated at each level of government. Without effective interisland information-sharing and policy coordination, decentralization has also undermined transparency and administrative capacity. The mission stressed that the resulting weakness in fiscal institutions, including the lack of timely consolidated data, has contributed to chronic arrears, poor expenditure targeting, volatile revenues, and low levels of aid. The revenuesharing mechanism, with a large share of each government’s revenue designated for distribution, has created free-rider incentives that impair revenue collection. The collapse in revenues ahead of the presidential power transfer highlighted these problems.

31. The new government has centered its reform strategy on improved governance and transparency, with a near-term focus on strengthening fiscal institutions. It has already moved to reinforce the management of revenue agencies and public enterprises. The mission stressed the importance of further improvements to fiscal transparency and intergovernmental coordination. It was agreed that customs procedures should be strengthened, including through external import valuation on all islands, following the recent suspension of operations by the existing pre-shipment agent on Grande Comore due to contractual disputes. There was also agreement that accounting of consolidated budget execution and large taxpayers administration should be unified this year, and that economic statistics need to be strengthened significantly for both Union and island-level data. Policymakers agreed that the civil service must be streamlined and downsized to make operations more effective, reduce the public wage bill, and create an opportunity to redeploy skilled labor to the private sector. As a short-term measure, they aim to reduce the wage bill through new budget ceilings for all ministries except education and health, to be followed by broader civil service reforms.

II. Program Discussions

A. Performance Under the SMP Through June 2006

32. After improving in 2005, public finances deteriorated sharply in the run-up to the May 2006 presidential elections, and most SMP targets were missed by wide margins. The primary surplus increased sharply in 2005 and domestic arrears were reduced for the first time in years, but several important quantitative and structural targets under the 2005 SMP were not met (Country Report No. 06/193). In the first half of 2006, revenues fell 17 percent short of the SMP target (10 percent below the same period last year), in large part due to governance problems in customs and public enterprises during the pre-election period. Moreover, some revenues were diverted away from treasury accounts and the interisland revenue-sharing mechanism was disrupted. Primary current spending exceeded the target by 1 percent of GDP, salary arrears and borrowing from the central bank increased drastically, and the domestic primary balance turned sharply negative.

After improving in 2005, public finances have deteriorated in 2006.

33. The new government moved quickly to investigate pre-election corruption and restore interisland cooperation, in line with President Sambi’s emphasis on good governance. Four inspection commissions have reviewed the management of revenue agencies and public enterprises, and several senior officials have been arrested. To restore interisland cooperation in fiscal matters, the four ministers of finance of the Union and island governments agreed in late June to meet monthly, ensure that all revenues are channeled through a single account, and enhance transparency and controls in revenue administration by placing Union officials in key positions at the island level.

B. Extension of the SMP Through December 2006

34. The SMP was extended through December 2006 to bring fiscal performance into line with original program objectives for the second half of the year (see Letter of Intent, Attachment I). The quantitative targets for the extended SMP were set with a view to restoring revenue collection and sharply reducing primary current expenditure compared to the original flow targets for the second half of the year, in order to make up for part of the deviations that occurred in the first half (Attachment I), Table 1). This would limit the full-year primary fiscal deficit to ¼ percent of GDP for the year as a whole and keep net domestic arrears and borrowing from the central bank close to zero. Specific objectives for the second half of 2006 are to:

  • Restore fiscal revenue collection, aiming for nominal revenues in line with the original flow target for the second half of 2006, despite lower GDP. Here the mission helped the authorities to identify near-term administrative measures to restore revenue collection at customs (see Attachment I).

  • Curtail expenditure. Parliament approved a supplementary budget in August with spending cuts of just over ¾ percent of GDP for the second half of the year; these would effectively reverse the spending overrun in the first half.

  • Pay down wage arrears accumulated in the first half of the year to keep net domestic arrears accumulation near zero for the year as a whole. This objective can only be met with substantial donor support. France has already provided €1.5 million in grants and the EU is considering additional support.

  • Accelerate structural reforms. In addition to the comprehensive fiscal reforms carried out by the new government this summer (Attachment I), the SMP is aimed at implementing the structural reforms that were planned earlier but delayed by the elections. Among them are improving the monitoring of budget execution, reinforcing revenue administration for large taxpayers, preparing reforms for the telecommunication and hydrocarbons monopolies, and finalizing a draft new investment code.

35. The 2007 budget is expected to target a domestic primary surplus of close to 1 percent of GDP. This would allow for some clearance of domestic arrears and external debt service. Revenues should increase by about 1½ percentage points of GDP, although the specific revenue target will depend on tax and customs code reforms. The mission discussed with the authorities options for a further shift from trade-based to domestic taxation. The authorities requested technical assistance from the IMF to prepare such reforms. Meanwhile, the government intends to reduce the public wage bill and reallocate spending to social sectors and public investment, which will require a significant increase in external assistance.

C. PRGF Prospects

36. The authorities stressed that entering a PRGF arrangement is a strategic priority for them. They consider a PRGF arrangement to be critical for achieving the I-PRSP’s key objectives by anchoring their medium-term economic reform program, ensuring sound public finances, unlocking donor support, and paving the way for comprehensive debt relief. The government expressed regret that fiscal mismanagement in the months before the May elections had delayed a PRGF arrangement and urged staff to conclude negotiations as soon as possible. The staff noted that, ahead of a PRGF arrangement, Comoros would need to establish a satisfactory track record relative to quantitative and structural SMP targets through end-December 2006, and reach understandings with official creditors on mechanisms to clear its large stock of external arrears.

37. Much progress has been made on external arrears clearance discussions, but arrears to the AfDB remain a significant hurdle. Comoros is $93 million in arrears to official creditors, equivalent to about 160 percent of revenues and 106 percent of reserves (Table 6). After an informal creditors meeting at the IMF in April 2006, the Arab Bank for Economic Development in Africa (BADEA) offered a long-term rescheduling of arrears, and the authorities have discussed similar mechanisms with the Kuwait and Saudi Funds. The Paris Club has indicated the possibility of a rescheduling of bilateral debt. Comoros is currently not eligible for the AfDB Group’s post-conflict country facility and no financing mechanism for the $30 million in arrears to the Group has been identified.

D. Program Risks

38. Program implementation is subject to substantial risks. Political instability and interisland conflict remain key concerns. Because the new administration represents a major break with the old political order, new tensions could well emerge, including during the runup to the island presidential elections in the spring of 2007. There is also a high risk that slow progress on enhancing institutional capacity and interisland cooperation could prevent the government from meeting its ambitious revenue and expenditure targets for the remainder of 2006, further delaying a prospective PRGF arrangement. Other potential risks are external shocks, such as a further worsening of the terms of trade or a decline in remittances, and natural disasters, such as a major volcanic eruption. Finally, poor data quality will continue to hamper economic analysis and policy formulation.

III. Staff Appraisal

39. Comoros faces significant economic and political challenges. The most urgent macroeconomic tasks are to remedy the recent deterioration in public finances and reach understandings on clearing external arrears, which could open the way for enhanced donor support and a PRGF arrangement. For the medium term, the authorities are rightly focused on raising economic growth and improving social conditions, in line with I-PRSP objectives. This will require continued political normalization and steps to address the country’s lack of institutional capacity, its unsustainable debt position, and its narrow economic base.

40. The fiscal priorities are to restore revenues and curtail spending so that domestic arrears can be reduced and the SMP brought back on track. Following the severe slippages in SMP implementation in the first half of 2006, the new Union government acted quickly to restore interisland cooperation and strengthen governance in revenue agencies and public enterprises. It then took steps to bolster revenue administration and contain spending, with key measures approved by parliament in a supplementary budget. These measures should help Comoros return to a broadly balanced primary fiscal position for the year as a whole. To maintain stability, it will be important to respect the independence of the central bank and the franc zone borrowing ceiling.

41. Clearing external arrears is a key hurdle on the path to debt sustainability. Comoros has been running arrears to official creditors for two decades and does not have the capacity to service its external debt obligations. Understandings on clearing arrears clearance are required ahead of a PRGF arrangement, which in turn is a prerequisite for eventual HIPC and MDRI debt relief. In the near term, the authorities should make every effort to reach arrears clearance agreements while avoiding a significant increase in near-term debt service commitments. In this regard, the arrears rescheduling schemes recently offered by key creditors are welcome steps in this direction.

42. Weak interisland coordination of economic policy, in the context of fiscal decentralization, has been at the core of governance problems in Comoros. Decentralization is an important element of the national reconciliation process, but it requires greater efforts to avoid the pitfalls that have become apparent in recent years, such as an excessively large civil service, lack of transparency in government operations, inadequate incentives to collect revenue and curtail spending, and the absence of timely consolidated data. It is now critical to intensify interisland cooperation and unify certain government functions, including revenue administration of large taxpayers, monitoring of budget execution, and economic statistics. The authorities should also consider further improvements to the revenue-sharing mechanism to reinforce incentives for subnational revenue collection and expenditure management.

43. Comoros will need substantial external assistance for the critical task of institution building, particularly technical assistance to enhance the capacity of fiscal institutions. Additional aid will be required to finance external arrears clearance and the social spending and public investment programs the I-PRSP identified as necessary to make progress toward the MDGs.

44. While external competitiveness is constrained primarily by structural factors, the recent real exchange rate appreciation and terms of trade shocks have exacerbated the situation. Although the Comorian franc appears moderately overvalued, the current account deficit is not excessively large and a devaluation is unlikely to boost exports significantly in the short term. The authorities are rightly committed to maintaining the exchange rate peg under the franc zone arrangement, which has been the country’s main anchor of macroeconomic stability. Structural reforms to improve the investment climate, develop the financial sector, overhaul the tax system, further liberalize trade, and introduce competition and private sector involvement in infrastructure offer the most promising avenue for enhancing external competitiveness.

45. Improvements to the investment climate will be critical for attracting FDI and raising the country’s economic growth potential. Large inflows of remittances have sustained consumption and provided a buffer against external shocks. To help redirect some of these resources toward growth-oriented investment and attract foreign investors, it will be important to improve the investment climate by improving governance and overhauling the tax, customs, and investment codes. Following recent reductions in import tariffs, a promising reform option under consideration is the introduction of a low uniform import tariff, a uniform domestic consumption tax, and excise taxes on a few commodities with high revenue potential. However, without structural reforms and external assistance to improve local transport and communication infrastructure, there is little prospect of significantly higher foreign investment.

46. Financial sector development is needed to support private sector growth and economic diversification. The prospective entry of foreign banks could help reduce the cost of credit and make services available beyond short-term trade financing. It would also present the central bank with new regulatory challenges, in addition to its efforts to strengthen supervision of microfinance institutions.

47. After continued delays, it is increasingly urgent to introduce greater competition and private ownership in sectors currently dominated by inefficient public monopolies. The authorities should accelerate their work with the IFC and World Bank on a reform strategy for the telecom and hydrocarbons companies, including possible privatization. Greater competition in transportation and financial rehabilitation of the energy and water utility are also urgently needed.

48. There is considerable risk that economic performance and policy implementation will fall short of the authorities’ objectives. Institutional capacity problems and lack of interisland cooperation have been key reasons behind SMP slippages in 2005 and the sharp deterioration in public finances in early 2006. Unless remedied, these problems could prevent the rebound in fiscal revenues and cut in expenditures needed to bring the SMP back on track. Political tensions could reemerge if the new government is not able to solidify national reconciliation and improve living standards. Severe capacity in economic statistics will remain a significant obstacle to sound policy formulation for the foreseeable future.

49. If implemented successfully, the authorities’ policies could be the basis for a PRGF arrangement. The new government has made a positive start in restoring interisland cooperation, improving governance, and restoring prudent fiscal management after the severe pre-election slippages earlier this year. The extended SMP focuses on restoring a balanced fiscal position and reforming fiscal institutions. Successful implementation would help establish a track record for entering into a PRGF arrangement, possibly in early 2007, in support of the authorities’ medium-term economic reform program aimed at higher economic growth and poverty reduction.

50. It is proposed that the next Article IV consultation be held on the standard 12-month cycle.

Table 3.Comoros: Balance of Payments, 2003-10
20032004200520062007200820092010
Prel.Proj.Adjustment scenario
(in millions of U.S. dollars, unless otherwise indicated)
Current account-10.1-10.3-12.3-17.4-24.5-26.0-26.8-27.5
Goods and services-52.0-72.3-82.1-103.5-111.8-117.6-122.7-127.4
Trade balance-39.9-62.0-76.8-92.2-97.9-103.2-108.6-114.5
Exports (f.o.b.)26.718.713.810.612.914.817.119.7
Of which: vanilla20.98.63.22.22.42.72.93.2
cloves3.67.37.45.06.57.58.69.9
ylang-ylang1.52.12.42.63.03.54.04.6
Imports (f.o.b.)-66.7-80.7-90.6-102.9-110.8-118.0-125.7-134.2
Of which: petroleum products-13.6-17.9-20.2-23.7-26.3-29.0-31.9-35.1
Services (net)-12.0-10.2-5.3-11.3-14-14-14-13
Receipts24.227.332.230.032.836.841.446.7
Of which: travel10.712.514.111.613.315.718.621.9
Payments-36.2-37.5-37.5-41.2-46.7-51.2-55.5-59.7
Income (net)-1.3-2.2-2.3-2.5-1.8-1.5-1.10.4
Current transfers (net)43.264.172.188.589.193.197.099.6
Government1.94.77.114.513.816.419.020.4
Private41.359.465.074.075.476.778.079.2
Capital and financial account14.47.03.511.618.123.920.932.5
Capital transfers5.25.48.710.319.024.6176.130.7
Financial account9.21.6-5.21.3-0.9-0.7-155.21.8
Direct investment1.41.81.92.02.93.23.53.9
Net portfolio and other investment7.8-0.1-7.1-0.7-3.8-4.0-158.7-2.1
Government5.7-1.2-2.60.5-3.7-4.0-158.2-1.0
Drawings9.53.72.55.64.01.92.02.1
Amortization-3.7-4.9-5.2-5.1-7.7-5.9-6.0-3.0
MDRI & HIPC-------------154.1--
Banks, net2.20.8-4.9-0.9-0.5-0.7-0.7-0.8
Other-0.20.30.5-0.30.40.70.1-0.3
Errors and omissions-10.7-1.01.2----------
Overall balance-6.3-4.3-7.6-5.9-6.4-2.1-5.95.0
Financing6.34.37.65.96.42.15.9-5.0
NFA of central bank (- increase)2.20.74.11.46.9-6.1-8.9-8.8
Net change in arrears4.23.53.54.5-97.8------
Exceptional financing--------87.4--6.5--
Financing gap 1/--------9.98.28.33.8
Memorandum items:
Current account (percent of GDP)-3.1-2.8-3.3-4.5-6.0-5.9-5.7-5.4
Excluding transfers-16.5-20.5-22.9-27.4-27.7-27.0-26.1-24.9
Exports of goods & services (percent of GDP)15.812.712.510.511.111.712.313.0
Imports of goods & services (percent of GDP)31.832.634.737.338.438.438.238.0
External public debt
In millions of U.S. dollars2952852662752402327879
Of which: arrears85859399--------
In percent of GDP81.180.571.570.558.652.616.415.5
Debt service (% of exports of goods & services14.017.616.818.620.814.412.85.3
Exchange rate CF/US$ (period average)438396415409
Gross international reserves
In millions of U.S. dollar97938787808695104
In months of imports of goods and services11.39.48.27.36.16.16.36.4
Nominal GDP (millions U.S. dollar)323.2362.9368.9386.2409.7441.0474.7510.9
Sources: Comorian authorities, and Fund staff estimates and projections.

Financing gaps for 2007-09 are projected to be covered in part by interim debt relief after HIPC Decision Point.

Sources: Comorian authorities, and Fund staff estimates and projections.

Financing gaps for 2007-09 are projected to be covered in part by interim debt relief after HIPC Decision Point.

Table 4.Comoros: Monetary Survey, 2004-06
200420052006200620062006
Dec.Dec.MarchJuneSeptDec
Prel.Prel.Prog.Prog.
(In millions of Comorian francs)
Monetary survey
Net foreign assets37,05737,39837,14535,02735,35437,191
Net domestic assets-7,326-6,748-8,081-4,419-4,900-6,891
Domestic credit12,64113,78013,44314,61513,68013,145
Net credit to government2,1703,4503,9195,1314,3523,864
Claims on public enterprises16744158153153153
Claims on other financial institutions686061696060
Claims on private sector10,23610,2279,3059,2629,2169,169
Other items net-19,967-20,528-21,524-19,033-18,580-20,036
Broad money29,73030,64929,06430,60930,45430,300
Money20,89422,80221,12822,79422,83923,369
Currency in circulation11,73011,45610,66411,23111,33611,925
Demand deposits9,16411,34610,46411,56211,50311,445
Quasi-money8,8367,8477,9367,8157,6156,931
Central bank
Net foreign assets37,42035,71834,25834,51534,79435,146
Net domestic assets-9,926-8,966-7,763-6,933-7,196-7,041
Domestic credit2,2863,7814,2245,5864,7064,218
Net credit to government2,1883,6774,1285,4854,6054,117
Claims on government3,4574,5384,4286,1295,2494,761
Deposits of government-1,270-860-299-644-644-644
Other items net-12,212-12,747-11,987-12,520-11,902-11,259
Reserve money27,49426,75126,49527,58227,59828,104
Currency in circulation11,73011,45610,66411,23111,33611,925
Bank reserves13,84112,97313,96615,06314,98714,911
Private sector deposits
Cash holdings12098144192191190
Deposits13,72112,87513,82214,87114,79614,721
Deposits of other financial institutions1,7621,4701,4781,0211,0101,005
Deposits of public enterprises160853388268265264
Deposit money banks
Net foreign assets-3631,6802,8875125602,045
Net Domestic Assets18,20316,66015,12518,59818,29316,066
Domestic credit10,3559,9999,2199,0298,9748,927
Net credit to government-18-228-209-354-354-354
Claims on public enterprises16744158153153153
Claims on other financial institutions181011191010
Claims on private sector10,18710,1739,2599,2119,1649,118
Claims on other financial institutions181011191010
Bank reserves14,91913,32412,93614,69014,61714,544
Other items net-7,071-6,663-7,029-5,121-5,298-7,405
Total deposits17,84018,34118,01219,11018,85318,112
Demand deposits9,00410,49310,07611,29511,23811,181
Term and savings deposits8,8367,8477,9367,8157,6156,931
Memorandum items:(change in percent of end-year broad money, unless otherwise indicated)
Net foreign assets-1.91.1-0.8-7.7-6.7-0.7
Domestic credit-1.53.8-1.12.7-0.3-2.1
Broad money-6.33.1-5.2-0.1-0.6-1.1
Velocity (GDP/average M2)4.85.05.45.25.25.2
Credit to private sector (percent change)-10.0-0.1-9.0-9.4-9.9-10.3
Sources: Central Bank of Comoros; and Fund staff estimates and projections.
Sources: Central Bank of Comoros; and Fund staff estimates and projections.
Table 5.Comoros: Consolidated Government Financial Operations, 2004-07(in millions of Comorian francs, unless otherwise indicated)
2004200520062007
Jan-Mar.Jan-JuneJan-Sept.Jan-Dec.
ActualActualProg. 1/ActualProg. 1/Prelim.Prog. 1/Rev. 2/Prog. 1/Rev. 2/Proj.
Total revenue and grants26,43430,5095,8256,88714,17814,47123,37022,81832,11432,60939,671
Revenues22,44523,9724,6504,47911,6009,65618,07516,13124,40022,45626,252
Tax revenues19,40717,7973,5923,9448,7007,80814,47013,57819,85018,95822,163
Nontax revenues3,0386,1751,0585352,9001,8483,6052,5534,5503,4984,089
External grants3,9896,5371,1752,4072,5784,8155,2956,6877,71410,15313,419
Budgetary assistance1536690000075002,0140
Projects (incl. techn.assist.)3,8365,8681,1752,4072,5784,8155,2955,9377,7148,13913,419
Total expenditure and net lending28,84730,4256,5508,89815,49719,14424,43426,05134,88834,97040,419
Current expenditure22,54623,5234,8446,13511,06113,83416,36419,76123,64426,62129,298
Primary current expenditures20,65820,9114,4824,87110,08411,20714,84915,97221,39921,57622,803
Wages and salaries12,63112,8723,3003,2476,5006,7199,6509,86912,79912,90012,748
Goods and services6,0385,1609251,2872,7362,9593,8644,0875,7415,6486,591
Transfers1,9892,8792573388481,5291,3362,0172,8593,0293,463
Interest payments1,2821,1822122445275877158041,0451,115859
External debt1,1871,048190200480499668697950989741
Domestic debt95134224447884710795126118
Foreign-financed project assistance7843947881,3601,9322,340
Technical assistance6066471506264501,2528001,6251,2001,9983,296
Capital expenditure6,3016,9021,7062,7634,4365,3118,0706,29011,2448,34911,121
Domestically financed investment2,5391,411632255806369501,0321,6281,4281,700
Foreign-financed investment3,7625,4911,6432,1373,8564,2747,1204,8579,6166,5209,421
Counterpart funds-financed401401401401
Domestic primary balance-7521,650105-617936-2,1882,276-8731,373-5481,749
Overall balance (commitment basis)-2,41383-725-2,011-1,318-4,674-1,064-3,233-2,774-2,361-747
Excluding budget support-2,566-586 0-725-2,011-1,318-4,674-1,064-3,983-2,774-4,375-747
Change in net arrears1,862-27201,15301,657-3001,318-700613-700
Interest on external debt6655420940308040706130
Domestic arrears1,197-81401,06001,348-300911-7000-700
Change in Treasury accounts125-5480-690-1280-64000
Overall balance (cash basis)-426-737-725-926-1,318-3,145-1,364-1,979-3,474-1,748-1,447
Financing8291,1177249441,3192,7241,3641,9792,2251,748-1,035
Foreign (net)262-1631044757171,0431,1011,1781,0691,435-1,510
Drawings, PIP (identified)1,4621,0546187491,7281,4992,6251,9053,1022,3111,638
Amortization-1,935-2,152-514-529-1,011-1,041-1,524-1,570-2,033-2,093-3,147
Arrears (principal)73593502540585084301,2170
Domestic (bank financing, net)5671,2796204706021,682263802-44314475
Privatization revenues1,20000
Errors and omissions-403-380-18421
Financing gap01,24902,482
Memorandum items:(in percent of GDP)
Grants2.84.30.71.51.63.03.34.24.86.48.0
Domestic revenue15.615.72.92.87.26.111.210.215.214.215.7
Expenditure20.119.94.15.69.612.115.216.521.722.124.1
Non-interest domestic expenditure15.214.62.83.26.67.59.810.814.314.514.6
Wages and salaries8.88.42.12.14.04.26.06.28.08.27.6
Social expenditure8.12.14.46.97.09.59.711.7
Domestic primary balance-0.51.10.1-0.40.6-1.41.4-0.60.9-0.31.0
Overall balance (commitment basis)-1.70.1-0.5-1.3-0.8-3.0-0.7-2.0-1.7-1.5-0.4
excluding budgetary support-1.8-0.4-0.5-1.3-0.8-3.0-0.7-2.5-1.7-2.8-0.4
Overall balance (cash basis)-0.3-0.5-0.5-0.6-0.8-2.0-0.8-1.3-2.2-1.1-0.9
Nominal GDP (in millions of CF)143,596153,112160,783158,114160,783158,114160,783158,114160,783158,114167,743
Sources: Ministry of Finance; and Fund staff estimates.

Based on January-June 2006 SMP, see Country Report 06/193.

Based on SMP extension through end-December 2006. Revisions reflect end-June 2006 preliminary outturn.

Sources: Ministry of Finance; and Fund staff estimates.

Based on January-June 2006 SMP, see Country Report 06/193.

Based on SMP extension through end-December 2006. Revisions reflect end-June 2006 preliminary outturn.

Table 6.Comoros: External Debt and Arrears, Official Creditors, 2005-06
20052006
StocksFlowsFlows
CreditorsOf which:Debt serviceChange inDebt service
Total debtArrearsduearrearsdue
(in millions of U.S. dollars)
Total265.692.77.73.47.5
Multilaterals219.461.96.62.36.6
AfDB Group62.628.71.41.01.7
BADEA26.226.20.40.40.4
EIB0.60.10.20.20.0
IDB-OPEC13.06.81.30.71.4
IFAD8.20.10.30.3
IDA109.30.03.00.02.8
Bilaterals46.230.81.11.10.9
UAE (Abu Dhabi)1.21.20.00.00.0
France (AFD)4.50.0
China1.241.2
Kuwait Fund24.915.01.01.00.8
Saudi Fund13.413.40.10.10.1
Mauritius1.00.00.00.00.0
Source: Comorian authorities. Data not reconciled with creditor statements.
Source: Comorian authorities. Data not reconciled with creditor statements.
Table 7:Comoros: Millennium Development Goals
19901995200120022015
Target
Goal 1. Eradicate extreme poverty and hunger
Target 1: Halve between 1990 and 2015, the proportion of people whose income is less than one dollar a day.
1. Population below US$1 a day (percent)
2. Poverty gap ratio at US$1 a day (percent)
3. Share of income or consumption held by poorest 20 percent (percent)
Target 2: Halve, between 1990 and 2015, the proportion of people suffering hunger
4. Prevalence of child malnutrition (percent of children under 5)18.525.825.4269.3
5. Population below minimum level of dietary energy consumption (percent)
Goal 2. Achieve universal primary education
Target 3: Ensure that, by 2015, children will be able to complete a full course of primary schooling
6. Net primary enrollment ratio (percent of relevant age group)52.054.7100.0
7. Percentage of cohort reaching grade 545.5100.0
8. Youth literacy rate (percent age 15-24)56.757.758.859.0
Goal 3. Promote gender equality and empower women
Target 4: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education by 2015
9. Ratio of girls to boys in primary and secondary education (percent)71.081.382.4100.0
10. Ratio of young literate females to males (percent ages 15-24)77.878.579.479.5100.0
11. Share of women employed in the nonagricultural sector (percent)
12. Proportion of seats held by women in the national parliament (percent)
Goal 4. Reduce child mortality
Target 5: Reduce by two-thirds between 1990 and 2015, the under-five mortality rate
13. Under-five mortality rate (per 1,000)120.0100.082.079.040.0
14. Infant mortality rate (per 1,000 live births)88.074.061.059.0
15. Immunization against measles (percent of children under 12-months)87.069.070.071.0
Goal 5. Improve maternal health
Target 6: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio.
16. Maternal mortality ratio (modeled estimate, per 100,000 live births)480.0
17. Proportion of births attended by skilled health personnel51.661.8
Goal 6. Combat HIV/AIDS, malaria and other diseases
Target 7: Halt by 2015, and begin to reverse, the spread of HIV/AIDS
18. HIV prevalence among females (percent ages 15-24)
19. Contraceptive prevalence rate (percent of women ages 15-49)21.0
20. Number of children orphaned by HIV/AIDS
Target 8: Halt by 2015, and begin to reverse, the incidence of malaria and other major diseases
21. Prevalence of death associated with malaria
22. Share of population in malaria risk areas using effective prevention and treatment
23. Incidence of tuberculosis (per 100,000 people)61.060.7
24. Tuberculosis cases detected under DOTS (percent)60.043.0
Goal 7. Ensure environmental sustainability
Target 9: Integrate the principles of sustainable development into policies and programs. Reverse the loss of environmental resources
25. Forest area (percent of total land area)5.43.6
26. Nationally protected areas (percent of total land area)0.00.0
27. GDP per unit of energy use (PPP $ per kg oil equivalent)
28. CO2 emissions (metric tons per capita)0.20.10.1
29. Proportion of population using solid fuels
Target 10: Halve by 2015 proportion of people without access to safe drinking water
30. Access to improved water source (percent of population)88.096.0
Target 11: Achieve by 2020 significant improvement for at least 100 million slum dwellers
31. Access to improved sanitation (percent of population)98.098.0
32. Access to secure tenure (percent of population)
Goal 8. Develop a Global Partnership for Development 1/
Target 16: Develop and implement strategies for productive work for youth.
45. Unemployment rate of population ages 15-24 (total)
Female
Male
Target 17: Provide access to affordable essential drugs
46. Proportion of population with access to affordable essential drugs
Target 18: Make available new technologies, especially information and communications
47. Fixed line and mobile telephones (per 1,000 people)7.57.212.213.5
48. Personal computers (per 1,000 people)0.10.35.55.5
Sources: World Bank; and Fund staff estimates.

Targets 12-15 and indicators 33-44 are excluded because they cannot be measured on a country-specific basis. These are related to official development assistance, market access, and the HIPC initiative.

Sources: World Bank; and Fund staff estimates.

Targets 12-15 and indicators 33-44 are excluded because they cannot be measured on a country-specific basis. These are related to official development assistance, market access, and the HIPC initiative.

APPENDIX I

Union of the Comoros: Debt Sustainability Analysis

1. This assessment of Comoros’s external public debt dynamics was prepared jointly with Bank staff based on the IMF-World Bank debt sustainability analysis (DSA) for lowincome countries. It makes clear that in a baseline scenario of unchanged policies, Comoros would remain in debt distress even in the absence of shocks. In an adjustment scenario, which assumes improved economic performance and HIPC/MDRI debt relief at end-2009, debt would become sustainable even under a variety of stress tests. Comoros’s external arrears are a major near-term hurdle for achieving debt sustainability, and the specifics of arrears clearance mechanisms will have important implications for near-term debt service.

I. Background

2. External debt has been unsustainable for over two decades. Large-scale borrowing from official creditors after independence led to rapid accumulation of external debt, which had reached 100 percent of GDP by the mid-1980s. The debt burden became quickly unsustainable and arrears as a proportion of total debt increased from 9 percent in 1984 to 35 percent in 2005. At yearend 2005, the net present value (NPV) of total debt amounted to 419 percent of exports of goods and services. Though debt service to the World Bank has been paid in full, arrears to most other official creditors have accumulated.

3. At end-2005, Comoros’s public external debt was estimated to be $266 million (72 percent of GDP). Multilateral creditors accounted for 82 percent of this and the two largest creditors were the World Bank and the AfDB Group. Comoros has no loans from the IMF. With 69 percent of its total debt stock in SDRs, 14 percent in U.S. dollars, and 14 percent in currencies that are linked to the U.S. dollar, Comoros’s external position is highly exposed to fluctuations of the euro (to which the Comorian franc is pegged) against the U.S. dollar. Since 2001, Comoros has benefited from the depreciation of the U.S. dollar against the euro, which has contributed to a gradual reduction in its debt-to-GDP ratio.

More than 80 percent of Comoros’s debt is owed to multilateral creditors.

Most of the debt stock is affected by the Euro/U.S. dollar rate.

4. Comoros has accumulated a large stock of arrears. Arrears to official creditors amounted to $93 million at the end of 2005 (160 percent of government revenues and 106 percent of gross international reserves), of which two-thirds was owed to multilateral creditors, mainly the AfDB Group and the Arab Bank for the Economic Development of Africa (BADEA). External debt service obligations amounted to $7½ million in 2005 (13½ percent of revenues), of which Comoros serviced about half, including full payments to the World Bank and partial payments to the AfDB Group, the Islamic Development Bank, and OPEC in 2005. No debt service was paid to BADEA, the European Investment Bank (EIB), and bilateral creditors.

Two-thirds of Comoros’s arrears are owed to multilateral creditors.

5. Debt indicators for Comoros are well above HIPC and Low-Income DSA thresholds. The Bank-Fund low-income DSA framework classifies Comoros as a “poor performer,” reflecting the low quality of its policies and institutions.1 At the end of 2005, the NPV of external debt was well above all policy-dependent thresholds, in particular in relation to exports of goods and services, with debt more than four times above the threshold. Debt service due slightly exceeds the DSA threshold for exports but is below the threshold for revenues.

Policy-Dependent External Debt Burden Indicators and Thresholds
Thresholds
ComorosLow income DSAHIPC
end-2005(poor performers)
NPV of debt in percent of:
Exports419.4100.0150.0
GDP52.330.0
Revenues334.2200.0250.0
Debt service in percent of
Exports16.815.0
Revenues13.325.0

6. Comoros’s external debt is well above regional averages. In relation to GDP, debt was on a par with African HIPC countries but its debt-to-exports ratio was far higher than most. Debt service due is somewhat below regional averages, but its near-term liquidity problems are more severe than in most other countries, given the amount of its arrears.

Comoros’s external debt in 2005 was above regional and HIPC comparators

(in percent of GDP).

Comoros’external debt in 2005 was far above regional and HIPC comparators

(in percent of exports).

II. Diagnosis, Arrears Clearance, and HIPC and MDRI Assistance

7. Comoros is to be grandfathered under the Enhanced HIPC initiative. According to IMF and World Bank Board meetings on September 6 and 7, 2006, Comoros is one of the countries to be grandfathered under the HIPC initiative based on meeting the income and indebtedness criteria at end-2004. Comoros has therefore more time to start an IMF-supported program than envisaged under the previous HIPC sunset clause.

8. Comoros needs to clear a large stock of arrears before it can benefit from future debt relief. Before a PRGF arrangement with the IMF, Comoros would need to reach understandings with its creditors on clearing arrears. Clearance might take four forms: (i) a payment by Comoros, using its international reserves, (ii) an arrears rescheduling agreement with the creditor, (iii) debt relief from the creditor, or (iv) third-party donor assistance to help with arrears clearance. While Comoros has a relatively comfortable level of international reserves of about 8 months of imports of goods and services, it can use only a minimal amount of them given the franc zone ceiling on government borrowing from the central bank.

9. An informal meeting between the authorities and key creditors and donors was held at the IMF during the Spring Meetings in 2006. Most creditors have since proposed a multiyear rescheduling of arrears, which would keep open the possibility of including part of the arrears in future debt relief. A special case is the AfDB Group, where assistance with arrears clearance is constrained given that the AfDB does not currently classify Comoros as eligible for its post-conflict country facility.2

10. The staff performed a debt sustainability analysis for both the baseline and the adjustment scenarios. The baseline scenario assumes that economic growth stays in line with historical averages (2 percent), economic reform is limited, and inflows of aid are minimal. Comoros would continue to service IDA while arrears with other creditors build.3

11. The adjustment scenario assumes accelerated economic reforms and debt relief. It allows for higher growth (4 percent over the long term), higher exports, fiscal adjustment, higher external assistance, arrears clearance in 2007, and HIPC and MDRI debt relief in 2009, with interim relief in 2008-09 (Table 1a). It is assumed that there will be no new nonconcessional debt, while concessional borrowing will be relatively low, with most assistance coming in the form of grants.4

Table 1a.Comoros: External Debt Sustainability Framework, Adjustment Scenario, 2006-2026 1/(In percent of GDP, unless otherwise indicated)
ActualHistoricalStandardProjections
Average 6/Deviation 6/2006-112012-26
2005200620072008200920102011Average20162026Average
External debt (nominal) 1/71.591.111.370.558.652.616.415.513.937.98.12.66.4
o/w public and publicly guaranteed (PPG)71.591.111.370.558.652.616.415.513.937.98.12.66.4
Change in external debt-6.6-0.9-12.6-5.9-36.2-0.9-1.6-9.7-0.9-0.3-0.8
Identified net debt-creating flows1.53.23.32.72.73.93.23.23.84.54.1
Non-interest current account deficit2.63.66.53.95.55.55.35.34.45.04.95.35.1
Deficit in balance of goods and services22.219.73.826.827.326.725.924.923.525.821.918.721.0
Exports12.514.92.510.511.111.712.313.013.712.114.916.415.3
Imports34.734.64.337.338.438.438.238.037.237.936.835.136.3
Net current transfers (negative = inflow)-19.5-14.54.3-22.9-21.8-21.1-20.4-19.5-18.9-20.8-17.0-13.4-15.9
Other current account flows (negative = net inflow)-0.1-0.80.40.00.00.0-0.1-0.2-0.2-0.1-0.10.0-0.1
Net FDI (negative = inflow)-0.5-0.40.2-0.5-0.7-0.7-0.7-0.8-0.8-0.7-0.8-0.8-0.8
Endogenous debt dynamics2/-0.6-0.2-1.6-2.1-1.9-0.6-0.5-1.1-0.3-0.1-0.2
Contribution from nominal interest rate0.70.60.40.30.30.10.10.30.00.00.0
Contribution from real GDP growth-3.3-0.9-2.0-2.4-2.2-0.7-0.6-1.5-0.3-0.1-0.3
Contribution from price and exchange rate changes2.0
Residual (3-4) 3/-8.1-4.0-15.8-8.6-38.9-4.9-4.7-12.8-4.8-4.8-4.8
o/w exceptional financing0.00.0-21.30.0-32.50.00.0-9.00.00.00.0
NPV of external debt 4/52.351.834.731.89.18.47.823.95.53.14.7
In percent of exports419.4493.2310.9271.874.064.556.7211.936.818.731.4
NPV of PPG external debt52.351.834.731.89.18.47.823.95.53.14.7
In percent of exports419.4493.2310.9271.874.064.556.7211.936.818.731.4
Debt service-to-exports ratio (in percent)16.826.512.718.620.814.412.85.34.712.72.60.72.0
PPG debt service-to-exports ratio (in percent)16.818.620.814.412.85.34.712.72.60.72.0
Total gross financing need (billions of U.S. dollars)0.00.00.00.00.00.00.00.00.00.10.0
Non-interest current account deficit that stabilizes debt ratio9.24.818.111.541.56.26.014.75.85.65.8
Key macroeconomic assumptions
Real GDP growth (in percent)4.22.51.61.23.04.54.54.54.03.64.04.04.0
GDP deflator in US dollar terms (change in percent)-2.53.411.63.43.03.03.03.03.03.13.03.03.0
Effective interest rate (percent) 5/0.91.00.20.90.70.60.60.70.60.70.50.30.4
Growth of exports of G&S (US dollar terms, in percent)0.22.919.8-11.912.613.013.413.612.68.97.88.58.4
Growth of imports of G&S (US dollar terms, in percent)8.44.415.512.59.37.47.17.05.08.06.56.76.7
Grant element of new public sector borrowing (in percent)56.956.956.956.956.956.956.956.956.956.9
Memorandym item:
Nominal GDP (billions of US dollars)0.40.40.40.40.50.50.50.81.5
Source: Staff simulations.

Includes both public and private sector external debt.

Derived as [r - g - r(1+g)]/(1+g+r+gr) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and r = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that NPV of private sector debt is equivalent to its face value.

Current-year interest payments devided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Source: Staff simulations.

Includes both public and private sector external debt.

Derived as [r - g - r(1+g)]/(1+g+r+gr) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and r = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that NPV of private sector debt is equivalent to its face value.

Current-year interest payments devided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

12. The specifics of arrears rescheduling can have an important impact on liquidity. A relatively short arrears rescheduling without a grace period would imply relatively high near-term debt service. For the DSA in the adjustment scenario, it is assumed that arrears are rescheduled over fifteen years for all bilateral and multilateral creditors except the AfDB, where arrears are assumed to be cleared through a combination of own payments and external assistance.5

Debt Service Due Under Alternative Arrears Clearance
Average (2007-2009)Average (2010-2016)
BaselineAdjustmentBaselineAdjustment
External debt service due
Scenario I
In percent of exports18.113.35.83.8
In percent of revenues13.89.84.63.1
Scenario II
In percent of exports38.534.03.92.6
In percent of revenues29.524.93.12.1

13. Since two-thirds of Comoros’s external debt is owed to the AfDB group and the World Bank, the country could benefit substantially from the MDRI. Under the MDRI, it is assumed for 2009 that almost all debt to IDA is cancelled, as is debt to the African Development Fund, which is about 71 percent of all debt to the AfDB group.

Arrears rescheduling and HIPC/MDRI debt relief would have a strong impact on Comoros NPV of external debt

(in percent of exports).

HIPC/MDRI debt relief would have a strong impact on debt service

(in percent of government revenues).

III. Debt Sustainability Analysis

14. In the baseline scenario, Comoros’s external debt situation remains unsustainable. With continuous accumulation of arrears and low economic growth, 20 years from now the NPV would still be close to 250 percent of exports—more than twice the policy-dependent low-income DSA threshold and still well above the HIPC threshold. Comoros would effectively remain in default, given its large stock of arrears. Any stress test would worsen the situation further. In the most extreme stress test, defined as a shock to exports in 2007–08, the NPV of external debt would reach almost 800 percent of exports of goods and services (Figure 1).

Figure 1.Comoros: Indicators of Public and Publicly Guaranteed External Debt Under the Baseline and Alternative Scenarios, 2006-2026

(In percent)

Source: Staff projections and simulations.

15. In the adjustment scenario, with HIPC and MDRI debt relief in 2009, external debt indicators would improve substantially (Table 1a). Arrears clearance in 2007 would sharply reduce the NPV-to-exports ratio, to 311 percent. At the completion point, the NPV of external debt would fall further, to 74 percent of exports, well below the HIPC threshold and also below the policy-dependent low-income DSA threshold. Interim assistance would help decrease the debt service-to-exports ratio to 14 percent in 2008. In 2010, the debt service ratio would become 5 percent of exports.

16. The debt dynamics in the adjustment scenario would be sustainable in a variety of stress tests (Table 1b). To see whether HIPC and MDRI debt relief can bring debt to sustainable levels, shocks are applied to the post-debt relief period of 2010 and 2011. Given Comoros’s low level of exports, the NPV-to-export ratio is the indicator that is most vulnerable to shocks. For instance, a cumulative decline in exports of 40 percent over the two years, would raise the NPV of debt to 163 percent of exports in 2011 (from 57 percent in the adjustment scenario), and it would take 8 years to reduce the NPV to the policy-dependent threshold of 100 percent of exports (Figure 2). By contrast, the NPV-to-GDP ratio and debt service-to-export ratio would remain well below policy-dependent thresholds.

Table 1b.Comoros: Sensitivity Analyses for Key Indicators of Public and Publicly Guaranteed External Debt, 2006-26(Adjustment scenario)
Projections
200620072008200920102011201220162026
NPV of debt-to-GDP ratio (in percent)
Adjustment523532988753
A. Alternative Scenarios
A1. Key variables at their historical averages in 2007-26 1/523532988862
A2. New public sector loans on less favorable terms in 2007-26 2/5235321098875
B. Bound Tests
B1. Real GDP growth at historical average minus one st. deviation in 2010-11523532998863
B2. Export value growth at historical average minus one st. deviation in 2010-11 3/523532910121195
B3. US dollar GDP deflator at historical average minus one st. deviation in 2010-115235329910974
B4. Net non-debt creating flows at historical average minus one st. deviation in 2010-11 4/523532910121195
B5. Combination of B1-B4 using one-half st. deviation shocks5235329121716147
B6. One-time 30 percent nominal depreciation relative to the baseline in 2010 5/523532912111084
NPV of debt-to-exports ratio (in percent)
Adjustment493311272746457513719
A. Alternative Scenarios
A1. Key variables at their historical averages in 2007-26 1/493311272746458534212
A2. New public sector loans on less favorable terms in 2007-26 2/493313275786962564428
B. Bound Tests
B1. Real GDP growth at historical average minus one st. deviation in 2010-11493311272746457513719
B2. Export value growth at historical average minus one st. deviation in 2010-11 3/4933112727410416314911556
B3. US dollar GDP deflator at historical average minus one st. deviation in 2010-11493311272746457513719
B4. Net non-debt creating flows at historical average minus one st. deviation in 2010-11 4/493311272748185786029
B5. Combination of B1-B4 using one-half st. deviation shocks4933112727410716014711556
B6. One-time 30 percent nominal depreciation relative to the baseline in 2010 5/493311272746457513719
Debt service ratio (in percent)
Adjustment1921141355431
A. Alternative Scenarios
A1. Key variables at their historical averages in 2007-26 1/1921151355431
A2. New public sector loans on less favorable terms in 2007-26 2/1921151355432
B. Bound Tests
B1. Real GDP growth at historical average minus one st. deviation in 2010-111921151355431
B2. Export value growth at historical average minus one st. deviation in 2010-11 3/1921151379964
B3. US dollar GDP deflator at historical average minus one st. deviation in 2010-111921151355431
B4. Net non-debt creating flows at historical average minus one st. deviation in 2010-11 4/1921151355532
B5. Combination of B1-B4 using one-half st. deviation shocks1921151367754
B6. One-time 30 percent nominal depreciation relative to the baseline in 2010 5/1921151355431
Memorandum item:
Grant element assumed on residual financing (i.e., financing required above baseline) 6/565656565656565656
Source: Staff projections and simulations.

Variables include real GDP growth, growth of GDP deflator (in US$ terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the adjustment., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Source: Staff projections and simulations.

Variables include real GDP growth, growth of GDP deflator (in US$ terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the adjustment., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Figure 2.Comoros: Indicators of Public and Publicly Guaranteed External Debt Under the Adjustment and Alternative Scenarios, 2006-2026

(In percent)

Source: Staff projections and simulations.

IV. Conclusion

17. Comoros would remain in debt distress under unchanged policies, but could achieve sustainable debt indicators in an adjustment scenario with higher growth and arrears clearance and HIPC and MDRI debt relief. The analysis shows that after the completion point debt would be sustainable even under a variety of shocks. A near-term challenge will be to agree on arrears clearance schemes that do not jeopardize the country’s liquidity position yet open the way for a PRGF-supported arrangement and HIPC and MDRI debt relief.

ATTACHMENT I

UNION DES COMORES

Unité–Solidarité–Développement

September 19, 2006

Mr. Rodrigo de Rato

Managing Director

International Monetary Fund

Washington, D.C. 20431

Dear Mr. de Rato,

The Union of the Comoros held its presidential elections in April and May 2006, leading to the first democratic power transfer in over a decade and bringing to an end the long process of national reconciliation started in 2001. The overwhelming support for President Sambi and his message of change mean that the new Union government finds itself with a strong popular mandate across all islands, but also has the heavy responsibility of meeting the aspirations of peace and prosperity of all Comorians. Accordingly, we attach the highest priority to improving economic and social conditions as envisioned in Comoros’s 2005 Interim Poverty Reduction Strategy Paper (I-PRSP), which the new government fully endorses and will strive to implement.

We view the support of Comoros’s international partners as crucial to the success of our social and economic policies. The IMF in particular has supported the authorities’ efforts to conduct sound economic policies through an intensive policy dialogue and technical assistance. Comoros embarked in 2005 on a Staff-Monitored Program (SMP), which helped preserve economic stability in the face of severe external shocks, although several important program objectives were not achieved. The SMP was extended through June 2006 to build a track record of policy implementation that would allow Comoros to enter a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF), which in turn could pave the way for eventual debt relief under the enhanced HIPC Initiative and MDRI.

Unfortunately, budget execution in the first half of this year derailed in the electoral context. Government revenues fell well short of the program target, reflecting governance problems in customs administration and state enterprises. Revenues were diverted away from the established treasury accounts and the interisland revenue-sharing mechanism broke down in a climate of mistrust. In addition, spending significantly exceeded program targets. As a result, salary and external arrears increased sharply, government borrowing increased more than envisaged, and the financial position of public enterprises deteriorated markedly. Structural reforms were put on hold as it became clear that political change was imminent.

The new government moved quickly to redress the situation. The first priority was to reestablish trust and cooperation between the Union and the three island governments in the conduct of public finances. To that effect, the mechanism for sharing fiscal revenues was revised in June with a view to ensuring full transparency and self-compliance. Simultaneously, the government appointed four special enquiry commissions (on customs and tax administration and on the fuel and rice parastatals) to assess the full extent of revenue underperformance and address the underlying causes. To make clear that corrupt practices and political interference will no longer be tolerated, legal action has been taken in cases where misconduct is suspected, including the detention of former officials and state enterprise managers.

Starting in July, we have implemented a package of emergency measures in close coordination between the Union and island governments:

  • A supplementary budget for the Union and three island governments was approved by parliament on August 23. It aims to bring public finances back in line with the thrust of the original 2006 budget and SMP objectives by introducing measures to boost revenues and achieve the flow targets for the second half of the year. It also significantly curtails expenditures in the second half of the year. A key objective is to fully reverse the domestic arrears accumulation of the first half of the year, although this will require additional donor support.

  • To restore revenue collections, the government has (i) replaced most senior managers of the customs administration in the port of Moroni; (ii) begun implementing a new structure for tax and customs administration that ensures transparency and accountability; (iii) strictly prohibited customs clearance without full payment of assessed taxes and duties; (iv) increased the specific rate of the forfeit regime for imported containers; (v) enforced the elimination of customs exemptions not included in the customs code; (vi) restricted the use of offsets for customs payments; and (vii) begun enforcing customs registration and tax settlement of imports by public enterprises, in line with procedures for all other imports.

  • To curtail spending, we have consolidated several ministries, eliminated many high-level advisor positions, and curtailed foreign travel for public officials. We also plan to keep discretionary spending to a minimum and reduce administrative positions in all ministries except health and education by 2 percent by yearend, to start reducing the wage bill in order to safeguard resources for health and education.

  • To restore the financial viability of public enterprises, we have replaced senior managers and taken steps to ensure that (i) the Union and island governments remain current on their utility bills, (ii) rice imports are based on competitive tenders, and (iii) retail prices for rice and fuel reflect international prices. We are seeking donor support to finance external audits in preparation for wider-ranging reforms.

Looking ahead, the Comorian authorities request a further extension of the SMP through December 2006 to establish the policy implementation record that would allow entering into discussions on a PRGF arrangement before end-2006. The policies set forth in the March 31, 2006, Memorandum of Economic and Financial Policies and the objectives of the 2006 program remain broadly consistent and adequate, and we believe that the corrective actions taken by the new government have laid the foundation for safeguarding the fiscal situation and macroeconomic stability this year. We have updated fiscal targets for the second half of 2006 (Table 1), in line with the revised 2006 budget, and will accelerate efforts to reach understandings with external creditors on arrears clearance. We are also following through on key structural reforms aimed at boosting the capacity of fiscal institutions that had been delayed in the election context (Table 2). Much more needs to be done to strengthen public institutions and boost economic growth, and we intend to intensify structural reforms in 2007, with the support of our international development partners.

Throughout the duration of the program, the government will consult with the IMF Managing Director, on its own initiative or at your request, to discuss the economic and financial policies of the Union of the Comoros. We will provide the staff with information it requests for monitoring progress in program implementation.

Sincerely yours,

/s/

Hassani Hamadi

Minister of Finance, Budget, Economy, and Planning, in charge of Employment Promotion

/s/

Ahamadi Abdoulbastoi

Governor of the BCC

Table 1.Comoros: Quantitative Targets Under the Staff-Monitored Program 1/ January 2006-December 2006(In millions of Comorian francs, cumulative since the beginning of the year)
2006
MarchJuneSeptemberDecember
SMPActualsSMPPrelim.IndicativeNew SMPIndicativeNew SMP
Targets 4/Targets 4/Targets 4/Targets 5/Targets 4/Targets 5/
(a) Floor on the domestic primary balance105-617936-2,1882,276-8731,373-548
(b) Floor on total domestic revenues4,6504,47911,6009,65618,07516,13124,40022,456
(c) Ceiling on the wage bill3,3003,2476,5006,7199,6509,86912,79912,900
(d) Ceiling on expenditures made by cash advances (without prior budget commitment)100358200557399657400657
(e) Ceiling on the net accumulation of domestic arrears 2/01,06001,348-300911-7000
(f) Ceiling on new nonconcessional external debt contracted or guaranteed by the state 3/00000000
(g) Ceiling on new short-term external debt contracted or guaranteed by the state 3/00000000
(h) Ceiling on accumulation of multilateral external debt service arrears0262072007200720

Definitions of targets and adjusters are provided in the Technical Memorandum of Understanding (TMU), see Country Report No. 05/77.

Ceilings will be adjusted upward by the amount of the shortfall in budget support relative to the projection of CF 2,104 million assumed for the second half of 2006.

Excluding trade credits.

Based on the January - June 2006 SMP and indicative targets for the remainder of the year, see Country Report No. 06/193.

New targets under SMP extension through December 2006, based on end-June 2006 preliminary outturn.

Definitions of targets and adjusters are provided in the Technical Memorandum of Understanding (TMU), see Country Report No. 05/77.

Ceilings will be adjusted upward by the amount of the shortfall in budget support relative to the projection of CF 2,104 million assumed for the second half of 2006.

Excluding trade credits.

Based on the January - June 2006 SMP and indicative targets for the remainder of the year, see Country Report No. 06/193.

New targets under SMP extension through December 2006, based on end-June 2006 preliminary outturn.

Table 2.Structural Indicative Targets Under the 2006 SMP and Indicative Reform Agenda for 2007
SectorMeasureRevised Time FrameStatus
A. Structural Indicative Targets Under the SMP (originally for the period January - June 2006)
Budget reformEstablish accounting unit to compile and consolidate budget execution data from the Union and island governments (April 2006).Oct. 2006Legal framework has been prepared.
Conduct monthly meetings of the budgetary committee comprising representatives of the Union and all three islands (continuous from April 2006).Continuous from June 2006On track since June 2006.
Start issuing monthly reports on budget execution by the Union and islands to all Ministries of Finance, within 45 days after the end of each month (continuous from April 2006).Continuous from June 2006On track since June 2006.
Start issuing monthly reports on public external debt service by creditor to the Union Ministry of Finance, with breakdown of amortization and interest accrued and paid (continuous from April 2006).Continuous from Sep. 2006On track since June 2006.
Start compiling on a quarterly basis social expenditures for Union and island governments, within 2 months after the end of a quarter (continuous from May 2006).Mar. 2007In preparation.
Revenue reformCreate a large taxpayers unit responsible for registration, management, arrears collection, and audit of all large enterprises on the three islands (April 2006).Nov. 2006Legal framework under preparation.
Perform a census of enterprises with revenues above CF 20 millions on the three islands (April 2006).Oct. 2006Completed in Grande Comore. Under preparation in Anjouan and Moheli.
Private sector developmentSubmit investment law to parliament that includes the introduction of a one-stop shop for investors and provides for legal procedures that give investors recourse to the courts (April 2006).Dec. 2006Re-drafting in progress, based on IMF/World Bank comments.
Adopt strategy for introducing greater competition and private sector involvement in state- owned enterprises, including for telecommunications and hydrocarbons (Sep 2006).Dec. 2006Discussions with IFC/World Bank ongoing.
B. Additional SMP Measures For July-December 2006
Revenue reformImplement new revenue sharing accounts, based on the Proces Verbal of the four Ministers of Finance.July 2006Done (July).
Prevent imports clearing customs before full payment of assessed taxes and duties (abolishing provisional and partial settlement).July 2006Done (August).
Implement new structure for revenue administration at the Union and island levels, based on the Proces Verbal of the four Ministers of Finance.Oct. 2006In preparation.
Enforce customs registration and tax settlement of imports by state enterprises, in line with procedures for all other imports.Oct. 2006In preparation.
Enforce elimination of all discretionary customs exemptions.Aug. 2006Done (August).
Begin reporting of detailed monthly customs data of each island to the general customs directorate, within 15 days after the end of each month.Continuous from Aug. 2006Done (August).
Restrict the use of offsets for customs payments.Aug. 2006Done (August).
Increase the specific rate of the forfeit regime for imported containers.Aug. 2006Done (August).
C. Indicative Structural Reform Agenda for 2007
Budget reformAdopt template for a new chart of accounts for the public sector.
Report arrears by economic type and keep an auxiliary recording of actual cash payments by major category.
Include a budget estimate for tax expenditure related to customs exemptions in the annual budget law and monitor on a monthly basis the cost of costums exemptions.
Implement new budget nomenclature for health and education.
Revenue reformSimplify tax and customs code, based on uniform ad valorem import tariffs; a uniform ad valorem consumption tax (for imports—paid at customs; for domestic goods—paid by producer); excise taxes on key commodities, including fuel and luxury products.
Implement customs software on all islands.
Strengthen valuation of imports at customs, including by ensuring external valuation on all islands.
Expenditure reformComplete computerization of civil servant payment roster and staff the administration to monitor and control wage payments.
Adopt organic frameworks for Union and island ministries.
StatisticsRestructure the statistics office to expand its responsibilities to include the compilation and dissemination of Union and island-level data.
Develop a multi-sector action plan for enhancing the availability of economic and social statistics.
Financial sectorExtend banking supervision to expansion of financial services by the post office, including on- site supervision.
Extend banking supervision to entry of new banks, in line with MFD recommendations, including by adopting MoUs with home supervisors of foreign banks.
Extend banking supervision to all microfinance institutions.
Private sector developmentAdopt strategy for introducing greater competition and private sector involvement in state- owned enterprises, including for telecommunications and hydrocarbons.
Adopt an action plan to reduce financial losses and arrears of public electricity company.
Promulgate new investment code.

See Interim Guidance on the Preparation of Joint Fund-World Bank Debt Sustainability Assessments for Low-Income Countries (2005).

In the AfDB’s arrears clearance mechanism, for countries classified as postconflict, one-third of the debt is paid by the country, one-third is paid by a donor, and one-third is cancelled by the AfDB.

For further details on assumptions underlying the baseline scenario, see Table 2 and paragraph 15 of the staff report.

For further details on assumptions underlying the adjustment scenario, see Table 2 and paragraph 16-18 of the staff report.

In line with standard practice, all arrears clearance agreements would be explicitly linked to the HIPC initiative to ensure that Comoros’s contribution to arrears clearance does not reduce future debt relief and that creditors providing debt relief before the decision point are credited under the initiative.

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