I. Better Preparedness is Helping to Weather Global Economic Challenges
1. While global economic challenges have created some difficulties, so far they have been manageable because the authorities are in a position of strength. Strong economic performance in recent years provided buffers to weather the global financial crisis and slowdown. Growth continues to be solid and inflation remains in single digits despite high food and fuel prices during much of 2008. A faster than planned reduction of domestic debt and build-up of reserves provided the buffers to absorb shocks (text Figure). As a result, all end-June 2008 quantitative targets were met, although net international reserves were narrowly above the program floor.
Cape Verde has built sizeable macroeconomic buffers:
Source: National authorities, and IMF staff estimates.
1/ The PSI started in 2006.
2. Despite a better preparedness, risks remain and thus discussions during the fifth review of the PSI focused on preserving macroeconomic stability through:
Judicious use of the buffers created under the PSI to accommodate shocks, taking into account potential transmission channels;
Prudent execution of the 2009 budget to support a steady buildup of reserves and sound public debt and financial management; and
Stronger monetary management to smooth short-term capital flows against the background of the global financial turmoil.
3. As the PSI arrangement enters its final year, the government has signaled its desire to continue with the program. The authorities believe the PSI has served the country well and intend to request an extension of the arrangement by a year (see Letter of Intent attached).
II. Current Economic Setting and Performance Under the PSI
4. Growth continues to be generally resilient, albeit moderating, and inflation pressures remain contained.
Leading indicators like the confidence barometer point to some moderation in economic activity. Despite substantial growth in tourism and foreign direct investment (FDI) in the first half of 2008, the latest data on hotel bookings portend some softening in tourism flows in the second half. There is also evidence that construction of new real estate projects has decelerated because developers are having difficulty securing external financing as liquidity tightens globally.
Inflation seems to be receding. While headline inflation rose to about 9 percent through September 2008, mainly because of food and fuel prices, core inflation has leveled off.1 The general appreciation of the escudo against the U.S. dollar has also provided relief for imports priced in U.S. dollars.
Economic activity has moderated in recent months.
Inflation has increased reflecting external price shocks, but core inflation has leveled off.
5. All the end-June 2008 assessment criteria were met, but net international reserves were barely above the program floor because of the external shocks.
As noted in the authorities’ mid-year budget review (a PSI assessment criterion), fiscal performance was strong in the first half of 2008, thanks to tax revenue overperformance and continued spending restraint (Figure 1). Thus, the net domestic borrowing ceiling was observed by a wide margin, and domestic debt was further reduced by about 1 percent of annual GDP in the first half of 2008.
The floor on net international reserves (NIR) was observed with a narrow margin. During March–September 2008, NIR declined owing to lower remittances, difficulties in rolling over private external debt, and the belated decision of the Bank of Cape Verde (BCV) to align domestic interest rates with rates in the euro area and the country’s risk premium (Text Figure and Figure 2). Corrective actions by the BCV have stemmed the loss in reserves since September.
Figure 1.Cape Verde: Fiscal Performance, 2004–09
Source: Cape Verdean authorities and IMF staff estimates.
Figure 2.Cape Verde: Monetary Developments, 2007–08
Source: Cape Verdean authorities and IMF staff estimates.
6. Progress on structural reforms is steady despite delays on many measures. The AML/CFT legislation was submitted to the National Assembly in November. The Economic Regulatory Agency (ARE) finalized the new fuel pricing formula in November. The revised formula will be more transparent and easier to administer, and regular price adjustments will ensure that no further liabilities accrue, thus reducing fiscal risks. In early 2009, the new income tax codes and a new tax exemptions code will be submitted to the National Assembly.
III. Report on the Discussions—Adjusting to the External Shocks
7. The main topic of discussion was how best to smooth the shocks and preserve macroeconomic stability.
The program’s macroeconomic framework was revised in view of the changes in the external environment. The 2009 budget and recent measures to strengthen monetary management are mutually consistent to preserve domestic and external stability.2
The authorities have built buffers in recent years in the form of faster-than-planned reduction in domestic debt and accumulation of reserves. Staff noted that the authorities could use these buffers judiciously to smooth global shocks.
|Structural Assessment Criterion|
|Complete a formal mid-year review of revenue and expenditure developments that allows for taking corrective actions if necessary.||End-Aug. 2008||Met|
|Submit the new General Tax Code to the National Assembly (MEFP ¶5).||End-Dec. 2007||Implemented in Aug. 2008|
|Submit the new Code on Judicial Process to the National Assembly (MEFP ¶5).||End-Dec. 2007||Implemented in Aug. 2008|
|Submit the draft individual and corporate income tax bills to the National Assembly (MEFP ¶5).||Oct. 2008||Postponed to early 2009|
|Finalize and publish a revised mechanism for adjusting petroleum prices (MEFP ¶5).||End-Mar. 2008||To be implemented in Nov. 2008|
|Submit to the National Assembly legislation to criminalize financing of terrorism and facilitate the combating of financing of terrorism (MEFP ¶5).||End-Mar. 2008||Implemented in Nov. 2008|
|Submit to the National Assembly legislation to strengthen the framework for combating money laundering (MEFP ¶5).||End-Mar. 2008||Implemented in Nov. 2008|
|Public Financial Management|
|Submit a simplified medium-term fiscal framework (MTFF) to the Council of Ministers in the 2009 budget preparation cycle and publish it on the Ministry of Finance website (MEFP ¶8).||Nov. 2008||Met|
A. Adjusting PSI Targets to Ensure Cautious Use of Buffers
8. Staff and authorities agreed that while Cape Verde’s preparedness has served it well, the rapidly changing external environment has implications for the program. There was general consensus that, while the medium-term effects of the global financial turmoil on Cape Verde are difficult to gauge, the near-term direct impact of the credit crisis is likely to be limited (the main local banks have ample liquidity, little exposure to private foreign lending and hardly any direct exposure to subprime assets).3 However, to the extent that protracted deleveraging in the financial sector in Europe translates to weaker FDI and tourism flows, this indirect impact of financial and trade linkages could significantly affect Cape Verde’s growth and balance of payments. Already, the financial turmoil has affected the United Kingdom, Ireland, and Spain—all sources of FDI and tourism for Cape Verde. Nevertheless, the debt-generating inflows needed to finance the current account deficit will be largely unaffected should FDI drop given the self stabilizing dynamics of the current account relative to FDI (imports would decline in tandem with FDI thanks to its high import content). Thus:
With risks significantly tilted to the downside, real GDP growth is projected to moderate from 7 percent in 2007 to 6 percent in 2008 and 2009, which is below trend. Staff’s partial equilibrium analysis based on a long sample period shows that, if real GDP growth in the euro area is 1 percentage point lower than projected, growth in Cape Verde would be around ½ - ¾ percentage points lower reflecting weaker tourism demand and lower remittances. However, this elasticity range does not take into account the large shifts in the structure of Cape Verde’s economy in recent years as well the offsetting policy measure that potentially could mitigate the effects of weaker demand. Specifically, the authorities noted that the recent opening of new hotels and flights and the increase in public investments in 2009 will support economic activity, notwithstanding the small fiscal multipliers in a highly open economy.
Inflation is projected to decline to about 6.5 percent in December 2008 (end of period) and about 4.1 percent in 2009 (text figure), tracking the recent decline of food and fuel prices.4 Staff and authorities agreed that moderating international commodity prices and the rainfall that resulted in a bumper harvest of domestically produced food in 2008; below-trend real GDP growth; weak wage indexation, and continued fiscal restraint should firmly anchor inflation expectations in 2009 and limit second-round inflation effects.
Understandings have been reached to revise downwards the program ’s floor for net international reserves for year-end 2008 and projections for 2009 to partly accommodate the impact of shocks. Staff supports the authorities’ request for this modification and for the corresponding modification of the target for net domestic assets of the central bank for year end-2008. Despite the solid fiscal performance expected for 2008, the current account deficit in 2008–09 is projected to increase relative to the June staff report because current transfers and tourism flows have moderated, reducing private savings. Staff and the authorities agreed on the need for cautious use of the reserve buffers to absorb shocks. Thus, the original target for net international reserves of € 299 million for end-2008 is now expected to be reached by September 2009. Recent measures the BCV has taken to strengthen monetary management (Section C) will help rebuild reserves during 2009. This level of reserves which is above 3 months of import cover will also provide cushion in the event of large shocks such as the type described in the sensitivity analysis noted above (first bullet).5
Cape Verde inflation is projected to increase in 2008 as a result of food and fuel price shocks, and then fall during 2009 in line with Euro area inflation.
Sources: National Institute of Statistics, Central Bank, staff projections.
|Original Program||Revised Program|
|Inflation (end period)||2.6||2.3||6.5||4.1|
|(Percent of GDP)|
|External current account||-9.4||-9.9||-11.7||-11.2|
|Gross reserves 1||3.8||3.9||3.4||3.8|
|Overall fiscal balance2||-4.2||-5.0||-1.2||-5.4|
|Public domestic debt||16.4||15.0||13.5||11.8|
B. Implementing Fiscal Policy to Smooth Shocks
9. The 2009 budget and the authorities’ medium-term fiscal framework (MTFF) are generally appropriate. The budget aims to reduce domestic debt to below 12 percent of GDP to support the reserves buildup. That would also reduce the burden on monetary management and provide insurance against shocks. The budget keeps total debt broadly unchanged (in NPV terms) and, adjusting for cyclical effects and other volatile components of the budget, the estimated implied fiscal impulse is relatively small. In addition, the composition of public debt will continue to shift from domestic to mostly concessional external debt, which will keep the risk of debt distress low (see Debt Sustainability Analysis Supplement). The authorities noted that the 2009 budget relies on both revenue-neutral tax measures and expenditure containment, especially wage restraint (MEFP ¶ 7). The budget maintains the planned expansion of direct cash transfers to the poorest to continue progress toward the MDGs. The MTFF, which underpins the DSA, will anchor fiscal policy for the medium term. Given the planned increase in growth-promoting infrastructure spending, it will also help improve the quality of public investment.
|Foreign financing, net||2.1||4.6|
|Domestic financing, net||-1.4||0.8|
|Implicit grant element in foreign financing||0.4||0.9|
|Overall balance adjusted with implicit grant element||-0.8||-4.5|
|NPV of public debt||38.0||38.9|
|NPV of external debt||24.5||27.0|
|Net domestic debt||13.5||11.8|
10. However, the decline in public debt has paused because of an increase in public investment. The authorities are concerned that infrastructure bottlenecks continue to constrain growth. Thus, the 2009 budget features expansion of the three largest ports, financed partly with grants and concessional funds and partly with nonconcessional funds. They argue that financing growth-promoting infrastructure projects warrants flexibility in the PSI program’s debt ceiling. Thus, understandings have been reached to modify the PSI ceiling on nonconcessional borrowing to $90 million. This will allow for the 20-year nonconcessional loan by the European Investment Bank (EIB) to be onlent to the port operator, Enapor, to expand the port of Palmeira in Sal island, the tourism hub in Cape Verde. Staff supports the authorities’ request for this modification. The EIB has done due diligence through extensive technical analyses to confirm the growth-promoting potential of this port (MEFP ¶10). In addition, the analysis concluded that Enapor will generate enough revenues to ensure debt repayment capacity thereby limiting fiscal risk. The change in the ceiling by itself will only alter the composition of the debt towards nonconcessional loans and not the total debt stock. The DSA concludes that this level of nonconcessional external borrowing will not jeopardize sustainability even if the expected positive spillovers from the project to the broader macroeconomy do not materialize.
The risk of debt distress remains low, but there is a pause in the recent decline of public debt owing to the acceleration of public investments.
11. Strengthening debt and public financial management are the key priorities for the authorities’ structural reform agenda (MEFP). Given plans to increase infrastructure spending, accelerating reforms in these areas will enhance implementation capacity and improve the quality of public investment.
The authorities emphasized that a strategy for firming up debt management would underpin their borrowing program and the MTFF (Box 1). This is needed because the 2009 budget implies a pause in the decline in public debt. Consolidated statistics of state-owned enterprises will be compiled in 2009 and assessment of contingent liabilities (new PSI benchmarks) will help contain fiscal risks (MEFP ¶ 9). To support these reform efforts, the World Bank and the Fund are coordinating their technical assistance to improve public debt management.
The PSI program continues to support improvements in public financial management. Thus, the authorities committed to a new PSI benchmark of placing financial controllers in line ministries to ensure proper budget execution (MEFP ¶ 7) by preventing double payments and the accumulation of arrears.
Box 1.Cape Verde—Strengthening Public Debt Management
The Cape Verdean authorities consider it a priority to strengthen debt management. Notable progress has already been made:
Debt sustainability analyses (DSAs) are now conducted annually. The Ministry of Finance and the Bank of Cape Verde (BCV) recently conducted a joint DSA applying the Bank-Fund Debt Sustainability Framework. The exercise benefited from assistance from Debt Relief International (DRI) and UNDP. The next DSA will be conducted in early 2009 at the beginning of the preparation of the 2010 budget to help determine the borrowing envelope consistent with debt sustainability.
Internal controls have been substantially improved. Software from the Commonwealth Secretariat was upgraded and now records state guarantees as well as debt. With the assistance of the Crown Agents, the system will be fully operational by year-end. The software will allow for currency decomposition of the debt stock, be linked to the Government’s Financial Control Network (SIGOF), and allow for compilation of debt data in the new chart of public accounts (PNCP).
The authorities intend to further strengthen their debt management practices:
The institutional framework for debt management will be adapted. The organic law of the Ministry of Finance will be amended to give the debt management office a clear mandate, and the budget execution law will be changed to allow the Treasury to manage debt efficiently.
A new debt management strategy will be embedded in the procedures manual of the debt management office.
The domestic market for Treasury securities will be developed. With MCC financing, Treasury securities will be easily available for purchase by nonbanks to make the market more efficient and liquid and reduce borrowing costs.
Capacity in the debt office will be reinforced. A new financial analyst was hired in September, and another will be hired in 2009. Portugal trained four staff in debt management in September.
C. Strengthening Monetary Management to Safeguard Financial Stability
12. Staff called for enhancing the implementation of monetary operations to minimize the risk of disruptive capital flows. While international reserves served their purpose of absorbing the shocks, weaknesses in monetary management exacerbated their decline. The belated realignment of domestic interest rates with the euribor, the ceiling on the BCV bill rate, and the volume cap on weekly auctions distorted incentives in the auctions and made it hard to roll over BCV bills. These technical weaknesses in monetary management made it difficult to stem the decline in reserves, as became evident under the stress of large external shocks. In normal times the problems would not have been apparent because Cape Verde has a sound fiscal position and ample reserves.
13. The BCV concurred and reiterated its commitment to promptly realign domestic rates if external market developments warrant it. Nevertheless, the authorities argued that it may take time for banks to respond to the rate increase, and thus the reserves target should be conservative. The BCV raised its rate by 100 basis points during September and October, and so far it has since been successfully rolling over maturing securities, reversing the net redemptions of its securities in July and August. In addition, the Monetary Policy Committee is meeting monthly to closely monitor market developments and promptly adjust BCV rates as needed.6
14. The BCV also noted that the ongoing FSAP mission is taking place at an opportune time, given the global financial turmoil. Banks are making progress toward meeting the new prudential requirements, and work on the new insurance regulation is also proceeding (MEFP ¶ 15).7 Besides examining ways to strengthen the BCV’s system for auctioning securities, the FSAP exercise should help to strengthen the authorities’ hand on macrofinancial linkages.
15. The exchange rate peg has served Cape Verde well as an anchor for financial stability and is supported by domestic policies. The real effective exchange rate (REER) is broadly in line with fundamentals (Country Report 08/248). It has fluctuated within a 5 percent band around a constant trend for the last several years; deviations from trend largely reflect supply-side-driven inflation differentials. The recent appreciation of the dollar has helped limit the appreciation of the REER in 2008.
Effective Exchange Rate Dec 1999 - Sep 2008
Source: IMF, Information Notice System.
IV. Program Monitoring
16. Assessment criteria, benchmarks, and indicative targets for the last review are in Tables 1 and 2 of the MEFP. The floor on net international reserves (NIR) and the ceiling on net domestic assets (NDA) for end-December 2008 have been revised, the ceiling on contracting nonconcessional external loans was raised, and three new structural benchmarks were proposed for the sixth review, which, based on end-2008 assessment criteria, is planned for March 2009 (Table 8).
|(Annual percentage change)|
|National accounts and prices|
|Real GDP per capita||8.8||5.0||4.0||4.1||4.9||5.0||4.8||4.6|
|Consumer price index (annual average)||4.8||4.4||6.5||4.2||2.5||2.0||2.0||2.0|
|Consumer price index (end of period)||5.8||3.4||6.5||4.1||2.5||2.0||2.0||2.0|
|Exports of goods and services||35.0||14.1||15.8||13.6||15.5||14.0||13.4||14.1|
|Of which: tourism||82.5||40.6||21.3||16.6||18.1||15.8||15.1||15.5|
|Imports of goods and services||23.4||17.9||8.6||15.5||9.0||12.5||12.5||12.2|
|Real effective exchange rate (annual average)||2.5||2.5||…||…||…||…||…||…|
|Terms of trade (minus = deterioration)||-4.4||-1.1||-6.0||1.9||1.2||1.1||1.1||1.1|
|Total revenue (excluding grants)||19.6||17.0||10.5||11.0||9.3||8.6||12.3||11.9|
|Capital expenditure||12.1||-1.4||23.6||40.7||5.1||5.9 5||12.2||1.5|
|Money and credit|
|Net foreign assets||15.1||22.9||1.9||19.4||14.9||15.0||14.6||13.5|
|Net domestic assets||19.3||5.7||7.2||7.3||11.3||10.7||11.6||11.9|
|Of which: net claims on the central government||1.2||-42.3||0.0||-37.2||-63.4||-27.9||-28.3||-14.8|
|credit to the economy1||30.0||25.5||9.7||14.5||17.4||11.9||12.4||12.2|
|Broad money (M2)||18.0||10.8||5.5||11.2||12.5||12.2||12.7||12.5|
|Domestic broad money (M2X)||22.9||13.3||10.3||16.1||17.3||16.8||15.6||12.5|
|Income velocity (GDP/M2)2||1.34||1.29||1.36||1.39||1.37||1.34||1.34||1.32|
|Reserve money (M0)||3.5||10.0||3.4||10.6||12.3||12.3||12.8||12.6|
|(Percent of GDP)|
|Gross capital formation||43.0||42.6||43.8||45.8||46.5||48.4||48.4||48.2|
|Gross national savings||38.0||33.4||32.2||34.6||35.8||37.8||37.9||37.9|
|Of which: government||9.3||9.9||10.7||10.4||7.8||9.0||7.9||7.5|
|External current account (including official current transfers)||-5.0||-9.2||-11.7||-11.2||-10.7||-10.7||-10.5||-10.3|
|Total domestic revenue||23.9||25.5||24.7||24.8||24.5||24.2||24.3||24.4|
|Total external grants||5.5||4.8||4.7||5.0||3.7||2.4||2.7||2.6|
|Overall balance before grants||-10.4||-5.5||-5.9||-10.7||-8.4||-6.6||-7.9||-7.0|
|Overall balance (including grants)||-4.9||-0.7||-1.2||-5.4||-4.7||-4.2||-5.1||-4.4|
|External financing (net)||3.0||2.0||2.1||4.6||3.5||3.8||3.6||3.0|
|Domestic financing (net)||2.9||-0.8||-1.4||0.8||1.2||0.5||1.5||1.4|
|Financing gap/statistical discrepancy||-0.9||-0.5||0.5||0.0||0.0||0.0||0.0||0.0|
|Total nominal government debt3||72.6||62.5||52.2||51.5||51.3||51.5||50.7||49.4|
|External government debt4||47.2||42.7||38.7||39.6||39.2||39.2||38.7||37.6|
|Domestic government debt, net of deposits||25.4||19.8||13.5||11.8||12.0||12.2||12.0||11.9|
|External current account (excluding official current transfers)||-9.1||-13.5||-16.1||-16.6||-13.8||-13.9||-13.7||-13.2|
|Overall balance of payments||4.7||6.1||0.7||4.1||3.4||3.6||3.6||3.4|
|External current account (€ millions, including official transfers)||-47.7||-96.4||-139.7||-148.0||-156.0||-172.1||-188.5||-206.4|
|Gross international reserves (€ millions, end of period)||194.9||259.5||268.3||323.2||373.2||430.8||495.5||564.6|
|Gross international reserves to reserve money||1.0||1.2||1.2||1.4||1.4||1.4||1.4||1.5|
|Gross international reserves (months of prospective imports of goods and services)||3.1||3.8||3.4||3.8||3.9||4.0||4.1||4.2|
|External debt service (percent of exports of goods and services)||5.7||4.7||4.5||4.3||3.9||3.7||4.0||4.3|
|Nominal GDP (billions of Cape Verde escudos)||105.6||116.1||132.1||146.2||161.6||178.1||198.9||221.7|
|Exchange rate (Cape Verde escudos per US$)|
|Revenue, grants, and net lending||31,044||35,131||38,551||17,854||38,918||43,639||45,602||47,280||53,781||59,897|
|Domestic revenue (incl. net lending)||25,255||29,559||31,286||15,897||32,670||36,267||39,645||43,049||48,351||54,121|
|Income and profit taxes||6,952||7,656||8,462||4,368||8,677||8,900||9,368||10,585||11,865||13,273|
|International trade taxes||4,889||5,592||5,583||2,739||5,889||5,917||6,587||7,251||8,153||9,044|
|Primary recurrent expenditure||16,967||20,428||22,896||8,509||21,815||25,892||28,423||38,326||34,375||38,326|
|Wages and salaries||11,547||12,491||14,245||5,839||13,471||15,950||16,897||17,506||20,873||23,274|
|Goods and services||1,197||1,853||2,335||500||2,140||2,964||2,603||2,623||3,192||3,559|
|Transfers and subsidies||3,464||5,219||4,453||1,730||4,318||4,914||5,283||4,848||6,211||6,924|
|Of which: energy subsidies||208||1,802 2||0||0||199||0||0||0||0||0|
|Domestic interest payments||1,398||1,361||1,487||643||1,487||1,570||1,350||1,132||1,262||1,404|
|External interest payments||522||519||566||285||566||722||1,167||1,446||1,766||2,091|
|Capital expenditure||12,415||12,237||17,581||5,062||15,120||20,956 3||22,360||23,680||26,572||26,964|
|Other expenditures (incl. arrears clearance)||4,950||1,440||1,500||1,790||1,509||2,460||-28||-72||42||904|
|Of which: energy subsidies||204||0||0||0||0||0||0||0||0|
|Overall balance, including grants (budget basis)||-5,208||-855||-5,481||1,566||-9,793||-7,961||-7,669||-7,553||-10,235||-9,793|
|Net domestic borrowing||1,638||-2,567||-172||-2,593||-3,568||1,925||2,100||2,370||2,142||2,384|
|Privatization and other sales of assets||456||3,598||2,493||537||1,684||-720||-151||-1,551||867||737|
|Accounts payable (atrasados), net||933||-1,919||…||0||0||…||0||0||0||0|
|Net errors and omissions||-949||-582||0||709||709||0||0||0||0||0|
|Overall balance, including grants (excluding clearance of arrears and accounts payable)||-4,129||2,321||-3,980||2,289||-70||-5,501||-7,669||-9,793||-10,235||-9,793|
|Net domestic borrowing, excluding clearance of arrears and net accounts payable||559||-5,743||-1,673||-5,077||-5,077||-535||2,100||2,370||2,142||2,384|
|Primary balance (including grants)4||-3,288||1,025||-3,427||2,493||474||-5,669||-5,152||-4,975||-7,207||-6,298|
|Recurrent domestic balance5||6,368||7,250||6,335||6,460||8,801||8,083||8,705||11,825||10,948||12,300|
|Net external flows6||8,919||7,898||10,425||1,738||9,002||14,128||11,677||12,447||12,657||12,447|
|External debt service (percent of domestic revenue)||9.9||7.9||8.3||7.7||8.0||7.9||7.5||7.5||8.1||8.9|
|Domestic debt (including arrears and accounts payable, net of deposits)||26,851||22,929||21,256||…||17,851||17,316||19,416||21,787||23,929||26,313|
V. Staff Appraisal
17. Cape Verde continues to make important economic strides, and the effects of the recent global financial turmoil and slowdown have so far been relatively contained. GDP growth continues to be resilient, inflation pressures are contained, and all assessment criteria for the fifth PSI review were met. While growth is expected to moderate in the near term, public investment could partly offset the expected decline in net external demand as both tourism and FDI slow. Inflation is expected to revert to low single digits in 2009.
18. The sound economic management in recent years that led to faster-than-planned reduction in domestic debt and accumulation of reserves is helping to weather external shocks. The exchange rate peg also continues to serve Cape Verde well as an anchor for financial stability, and the REER is in line with fundamentals. Because of continuing risks, however, vigilance is required in the implementation of domestic policies, especially considering the slowdown of remittances and FDI flows. Continued fiscal restraint and alignment of domestic rates with the euribor and risk premium will be critical to safeguarding the exchange rate peg and reducing Cape Verde’s vulnerability to shocks.
19. Prudent execution of the 2009 budget is needed to rebuild international reserves and ensure gradual reduction of the domestic debt. The 2009 budget expands spending on infrastructure, which will pause the decline in public debt. Nevertheless, the budget is appropriate: infrastructure bottlenecks have been an obvious constraint on growth, the tax measures in the budget tend to be revenue-neutral, and recurrent spending is again restrained. The budget would also reduce domestic debt and keep the risk of debt distress low. The authorities should press ahead with structural reforms; in particular, better public debt and financial management should improve the quality of public investment and limit fiscal risks.
20. The recent measures taken by the BCV to strengthen monetary management, which have stemmed the decline in international reserves, are welcome. Measures taken to correct the distorted incentives in the auction system will enhance the sale of BCV securities and help smooth short-term capital inflows. Given the rapidly changing external environment, to safeguard reserves the BCV needs to react more promptly to market developments.
21. Staff recommends completion of the fifth review of the PSI program. Based on the strength of the authorities’ policies, staff supports the modifications to the program’s end-December 2008 assessment criteria.
Figure 3.Cape Verde: External Sector 2004–09
Source: Cape Verdean authorities and IMF staff estimates.
|Revenue, grants, and net lending||29.4||30.3||30.32||13.5||29.5||29.9||28.2||26.5||27.0||27.0|
|Domestic revenue (incl. net lending)||23.9||25.5||23.7||12.0||24.7||24.8||24.5||24.2||24.3||24.4|
|Income and profit taxes||6.6||6.6||6.4||3.3||6.6||6.1||5.8||5.9||6.0||6.0|
|International trade taxes||4.6||4.8||4.2||2.1||4.5||4.0||4.1||4.1||4.1||4.1|
|Primary recurrent expenditure||16.1||17.6||17.3||6.4||16.5||17.617||17.6||16.1||17.3||17.3|
|Wages and salaries||10.9||10.8||10.8||4.4||10.2||10.9||10.5||9.8||10.5||10.5|
|Goods and services||1.1||1.6||1.8||0.4||1.6||2.0||1.6||1.5||1.6||1.6|
|Transfers and subsidies||3.3||4.5||3.4||1.3||3.3||3.4||3.3||2.7||3.1||3.1|
|Of which: energy subsidies||0.2||1.6 2||0.0||0.0||0.2||0.0||0.0||0.0||0.0||0.0|
|Domestic interest payments||1.3||1.2||1.1||0.5||1.1||1.1||0.8||0.6||0.6||0.6|
|External interest payments||0.5||0.4||0.4||0.2||0.4||0.5||0.7||0.8||0.9||0.9|
|Capital expenditure||11.8||10.5||13.3||3.8||11.4||14.3 3||13.8||13.3||13.4||12.2|
|Other expenditures (incl. arrears clearance)||4.7||1.2||1.1||1.4||1.1||1.7||0.0||0.0||0.0||0.4|
|Of which: energy subsidies||0.2||0.0||0.0||0.0||0.0||0.0||0.0||0.0||0.0||0.0|
|Overall balance, including grants (budget basis)||-4.9||-0.7||-4.1||1.2||-1.2||-5.4||4.1||-4.2||-5.1||-4.4|
|Net domestic borrowing||1.6||-2.2||-0.1||-2.0||-2.7||1.3||1.3||1.3||1.1||1.1|
|Privatization and other sales of assets||0.4||3.1||1.9||0.4||1.3||-0.5||-0.1||-0.9||0.4||0.3|
|Accounts payable (atrasados), net||…||-1.7||…||…||0.0||…||0.0||0.0||0.0||0.0|
|Net errors and omissions||-0.9||-0.5||0.0||0.5||0.5||0.0||0.0||0.0||0.0||0.0|
|Overall balance, including grants (excluding clearance of arrears and accounts payable)||-3.9||2.0||-3.0||1.7||-0.1||-3.8||-4.7||-4.2||-5.1||-4.4|
|Net domestic borrowing, excluding clearance of arrears and net accounts payable||0.5||-4.9||-1.3||-2.5||-3.8||-0.4||1.3||1.3||1.1||1.1|
|Primary balance (including grants)4||-3.1||0.9||-2.6||1.9||0.4||-3.9||-3.2||-2.8||-3.6||-2.8|
|Recurrent domestic balance5||6.0||6.2||4.8||4.9||6.7||5.5||5.4||6.6||5.5||5.5|
|Net external flows6||8.4||6.8||7.9||1.3||6.8||9.7||7.2||6.2||6.4||5.6|
|Domestic debt (including arrears and accounts payable, net of deposits)||25.4||19.8||16.1||…||13.5||11.8||12.0||12.2||12.0||11.9|
|Nominal GDP (Millions of Escudos)||105,625||116,070||132,095||132,095||132,095||146,179||161,585||178,081||198,906||221,747|
|Current account balance (including official transfers)||-48||-55||-96||-48||-140||-148||-156||-172||-189||-207|
|Of which: tourism||173||114||244||127||295||344||407||471||542||626|
|Interest by other sectors||-22||-7||-15||-9||-18||-16||-15||-15||-16||-17|
|Income on direct investment and other income||-24||-10||-17||-18||-20||-23||-26||-30||-34||-39|
|Current transfers (net)||231||101||225||98||176||226||214||237||267||289|
|Capital and financial account (net)||99||106||198||91||167||203||206||230||253||276|
|Direct investment (net)||88||41||94||73||102||106||117||137||161||183|
|Other investments, central government||21||9||18||-2||25||65||52||61||66||61|
|Net official flows||21||9||18||-2||25||65||52||61||66||61|
|Other investments, non-central government||-24||49||61||13||-9||-22||-12||3||-5||-3|
|Commercial banks (net)||-23||-9||13||15||5||0||0||0||0||0|
|Commercial credit (net)||2||4||4||3||0||0||0||0||0||0|
|Net errors and omissions||-6||-2||-38||-18||-18||0||0||0||0||0|
|Gross international reserves (- accumulation)||-46||-53||-65||-24||-9||-55||-50||-58||-65||-69|
|Of which: IMF (net)||-1||-1||-1||-1||-2||-2||-2||-1|
|Current account (including official transfers; percent of GDP)||-5.0||-5.2||-9.2||-4.0||-11.7||-11.2||-10.7||-10.7||-10.5||-10.3|
|Current account (excluding official transfers; percent of GDP)||-9.1||-6.4||-13.5||-7.1||-16.1||-16.6||-13.8||-13.9||-13.7||-13.2|
|Overall balance (percent of GDP)||4.7||4.8||6.1||2.0||0.7||4.1||3.4||3.6||3.6||3.4|
|Gross international reserves||194.9||248.2||259.6||285.4||285.4||323.3||373.3||430.9||495.6||564.7|
|Months of current year’s import of goods and services||3.6||3.9||4.1||4.2||3.9||4.1||4.3||4.4||4.5||4.6|
|Months of next year’s import of goods and services||3.1||3.6||3.8||3.6||3.4||3.8||3.9||4.0||4.1||4.2|
|External public debt||452.3||…||449.9||…||463.1||525.5||575.0||633.6||697.8||755.2|
|External aid (grants and loans; percent of GDP)||9.6||3.5||9.5||4.1||11.7||15.4||10.8||9.4||9.5||8.7|
|(Millions of Cape Verde escudos, unless otherwise specified)|
|Net foreign assets||25,267||30,883||31,049||32,110||31,654||37,798||43,448||49,969|
|Of which: foreign reserves||21,495||29,128||28,627||31,344||29,593||35,653||41,164||47,518|
|Net domestic assets||60,174||66,134||63,579||68,219||68,149||73,145||81,406||90,128|
|Net domestic credit||71,318||76,266||76,426||82,912||81,909||87,640||96,557||105,966|
|Net claims on general government||25,993||20,465||19,530||19,066||19,514||16,196||12,648||12,062|
|Claims on the Trust Fund (TCMFs)||111,038||11,038||11,038||11,038||11,038||11,038||11,038||11,038|
|Net claims on the central government||15,393||10,226||8,887||8,068||8,884||5,578||2,044||1,473|
|Credit to central government||19,471||15,709||16,082||16,255||17,740||15,254||13,396||14,288|
|Deposits of central government||-4,078||-5,483||-7,195||-8,186||-8,856||-9,677||-11,352||-12,815|
|Of which: project deposits||-1,398||-277||…||…||-277||-277||-277||-277|
|Net claims on local government||-341||-311||-310||-40||-322||-335||-349||-363|
|Net claims on other government agencies (INPS)||-97||-488||-85||0||-85||-85||-86||-87|
|Credit to the economy||45,325||55,801||56,896||63,846||62,394||71,445||83,909||93,904|
|Of which: excluding purchase of a Portuguese credit to Electra and subsequent off-loading on the domestic securities market||40,461||…||…||…||…||…||…||…|
|Credit to public enterprises||1,498||678||1,337||1,169||1,390||1,460||1,533||1,610|
|Credit to private sector||43,811||55,108||55,553||62,675||60,998||69,979||82,370||92,289|
|Claims on nonbank financial institutions||16||16||6||1||6||6||6||6|
|Other items (net)||-11,144||-10,133||-12,847||-14,694||-13,760||-14,495||-15,151||-15,838|
|Broad money (M2)||85,441||97,017||94,628||100,328||99,803||110,943||124,855||140,098|
|Narrow money (M1)||38,810||40,673||43,021||45,356||42,553||47,302||53,234||59,733|
|Currency outside banks||7,731||8,769||8,399||7,611||8,728||9,608||10,739||11,992|
|Foreign currency deposits||4,856||4,731||5,967||6,748||6,297||7,000||7,878||8,840|
|(Change in percent of broad money 12 months earlier)|
|Net foreign assets||4.6||6.7||6.8||2.3||0.6||6.2||5.1||5.2|
|Net domestic assets||13.4||6.7||4.0||8.4||4.8||5.0||7.4||7.0|
|Net domestic credit||14.2||6.8||6.0||11.1||5.8||5.7||8.0||7.5|
|Net claims on the central government||0.3||-6.0||-7.6||-4.1||0.0||-3.3||-3.2||-0.5|
|Credit to the economy||14.5||12.8||13.5||14.8||5.8||9.1||11.2||8.0|
|Credit to public enterprises||0.7||0.1||-0.2||-0.3||0.1||0.1||0.1||0.1|
|Credit to private sector||13.8||12.7||13.7||15.1||5.8||9.0||11.2||7.9|
|Other items (net)||-0.8||-0.1||-2.0||-2.7||-1.0||-0.7||-0.6||-0.6|
|Broad money (M2)||18.0||13.4||10.8||10.6||5.5||11.2||12.5||12.2|
|Income velocity of money 1||1.34||1.26||1.29||1.30||1.36||1.39||1.37||1.34|
|(as percent total deposits)||40.3||38.6||36.2||35.2||31.9||28.6||25.3|
|Excess reserves/total deposits (percent)||1.3||1.5||2.3||2.9||1.4||1.3||1.3||1.3|
|Money multiplier (M2/M0)||3.91||4.19||3.9||4.0||4.0||4.0||4.0||4.0|
|Credit to the economy (percentage change)||30.0||24.4||25.5||26.6||9.7||14.5||17.4||11.9|
|Country Report 08/37|
|(Millions of Cape Verde escudos, unless otherwise specified)|
|Net foreign assets||20,489||28,287||27,688||30,413||28,824||34,999||40,681||47,235|
|Of which: net international reserves||20,357||28,113||27,572||30,357||28,669||34,844||40,526||47,079|
|Net domestic assets||1,372||-5,128||-3,647||-5,621||-3,965||-7,507||-9,796||-12,564|
|Net domestic credit||3,596||-3,023||-1,323||-3,420||-1,705||-5,202||-7,444||-10,165|
|Trust Fund claims||4,605||4,605||4,605||4,605||4,605||4,605||4,605||4,605|
|Net claims on central government||1,748||239||-607||-1,224||-2,268||-3,089||-4,764||-6,227|
|Credit to central government||3,739||3,739||3,739||3,738||3,739||3,739||3,739||3,739|
|Deposits of central government||-1,990||-3,500||-4,346||-4,963||-6,007||-6,827||-8,503||-9,966|
|Credit to the economy||1,225||1,271||1,162||1,142||1,168||1,174||1,180||1,186|
|Credit to public enterprises||0||47||0||0||0||0||0||0|
|Credit to private sector||1,216||1,215||1,159||1,142||1,165||1,170||1,176||1,182|
|Claims on nonbank financial institutions||9||9||3||0||3||3||3||3|
|Credit to commercial banks||-3,982||-9,137||-6,483||-7,942||-5,209||-9,729||-8,465||-9,729|
|Other items (net)||-2,224||-2,104||-2,325||-2,202||-2,260||-2,305||-2,351||-2,398|
|Reserve money (M0)||21,861||23,160||24,041||24,792||24,860||27,492||30,885||34,671|
|Deposits of commercial banks||12,673||13,219||14,058||15,687||14,446||16,008||18,034||20,307|
|Gross international reserves (€ millions)||194.9||264.1||259.6||284.3||268.4||323.2||373.3||430.9|
|Net international reserves (€ millions)||184.6||254.9||250.1||275.3||260.0||316.0||367.5||427.0|
|(months of imports)||3.1||3.8||3.4||3.8||3.9||4.0|
|Reserve money (12-month change in percent)||3.5||6.0||10.0||7.7||3.4||10.6||12.3||12.3|
|Country Report 08/37|
|(Millions of Cape Verde escudos, unless otherwise specified)|
|Net foreign assets||4,778||2,596||3,361||1,697||2,830||2,799||2,767||2,735|
|Of which: excluding the effect of a purchase of a Portuguese credit to Electra||8,346||…||…||…||…||…||…||…|
|Of which: nonresident deposits||-3,579||-5,057||-5,198||-5,532||-5,614||-5,727||-5,841||-5,958|
|Net domestic assets||72,929||85,652||82,859||91,014||88,245||98,536||111,348||125,371|
|Net domestic credit||81,903||93,678||93,628||102,314||99,745||110,726||124,148||138,810|
|Net claims on general government||19,571||15,622||15,984||15,686||13,684||14,680||12,807||13,684|
|Trust Fund claims||6,433||6,433||6,433||6,433||6,433||6,433||6,433||6,433|
|Other government deposits (INPS)||-97||-488||-85||…||-85||-85||-86||-87|
|Net claims on central government||13,644||9,987||9,494||9,293||11,152||8,667||6,808||7,700|
|Claims on central government||15,732||11,971||12,343||12,516||14,001||11,516||9,658||10,550|
|Deposits of central government||-2,088||-1,983||-2,849||-3,224||-2,849||-2,849||-2,849||-2,849|
|Net claims on local government||-341||-311||-310||-40||-322||-335||-349||-363|
|Claims on local government||241||277||295||603||307||320||332||346|
|Deposits of local government||-582||-588||-605||-643||-630||-655||-681||-708|
|Credit to the economy||44,099||54,531||55,733||62,704||61,226||70,271||82,729||92,719|
|Of which: excluding purchase of a Portuguese credit to Electra and subsequent off-loading on the domestic securities market||39,705||…||…||…||…||…||…||…|
|Credit to public enterprises||1,498||631||1,337||1,169||1,390||1,460||1,533||1,609|
|Credit to private sector||42,595||53,893||54,394||61,533||59,834||68,809||81,194||91,107|
|Claims on nonbank financial institutions||6||6||2||1||2||2||2||2|
|Net claims on the Bank of Cape Verde||18,233||23,525||21,911||23,924||21,341||25,776||28,611||32,407|
|Other items (net)||-9,043||-8,026||-10,317||-11,300||-12,800||-12,190||-12,800||-13,439|
|Deposit liabilities to nonbank residents||77,707||88,248||86,220||92,711||91,075||101,335||114,115||128,106|
|Local currency deposits||72,852||83,517||80,253||85,963||84,778||94,335||106,238||119,266|
|Of which: emigrant deposits||4,043||4,586||4,838||4,821||4,668||4,705||4,750||4,719|
|Of which: emigrant deposits||26,148||29,658||27,187||27,577||26,234||26,441||26,695||26,519|
|Foreign currency deposits||4,856||4,731||5,967||6,748||6,297||7,000||7,878||8,840|
|Of which: emigrant deposits||965||1,250||1,081||1,041||1,194||1,203||1,215||1,207|
|Emigrant deposits (ratio to total deposits)||0.40||0.40||0.39||0.36||0.35||0.32||0.26||0.23|
|Other deposits (ratio to broad money)||0.54||0.63||0.56||0.59||0.68||0.71||0.74||0.77|
|Composition of emigrant deposits||1.00||1.00||1.00||1.00||1.00||1.00||1.00||1.00|
|Mission Date||Purpose||Board Review|
|February 2009||Sixth (last) PSI review against December 2008 assessment criteria.||May 2009|
November 26, 2008
Mr. Dominique Strauss-Kahn
International Monetary Fund
700 19th Street N.W.
Washington DC 20431 USA
Dear Mr. Strauss-Kahn:
Discussions for the fifth review of the Policy Support Instrument (PSI) were held in Praia during September 22–October 3, 2008. The attached Memorandum of Economic and Financial Policies (MEFP) reviews implementation to date of the Cape Verde government’s macroeconomic and structural program under the country’s three-year PSI, which was approved by the IMF Executive Board in July 2006. It describes economic and policy developments since the fourth review of the PSI and prospects for the remainder of 2008 and for 2009. The sixth (and final) review is scheduled for May 2009.
The government of Cape Verde reaffirms its commitment to the policy priorities of the PSI and firmly believes that it will provide solid support for macroeconomic stability and the exchange rate peg, and promote growth. It will support our efforts to create adequate fiscal space to finance the much needed upgrading of the country’s infrastructure, provide buffers against external shocks, and reduce poverty. The government of Cape Verde considers that the PSI has served the country well and intends to request an extension of the PSI program for one year after the expiration in July 2009 as a bridge to request another 3-year PSI in 2010.
The government of Cape Verde requests the modification of the program’s targets for end-December 2008 for net international reserves, net domestic assets of the central bank, and ceiling on the contracting of nonconcessional long-term external debt. The modifications of the monetary targets result mainly from the global slowdown and the high food and fuel prices during most of 2008 (Table 1). Three new fiscal structural benchmarks were included to improve public financial management and strengthen debt management (Table 2).
|Stock||Cumulative Flows from End-December, 2007||Cumulative Flows from End-June, 2008|
|Actual||Target||Criteria||Criteria with adjusters||Actual||Targets Crite||Criteria||Targets||Targets|
|Quantitative targets||(Billions of Cape Verde escudos)|
|Ceiling on net domestic borrowing of the central government3||…||-0.4||-0.8||-0.3||-3.3||…||-1.3||-1.7||-2.1||-2.2|
|Ceiling on net domestic assets of the central bank4||-3.6||-0.1||-0.2||-0.3||-2.0||-5.6||-0.4||-0.4||0.7||-0.1|
|Ceiling on the accumulation of new domestic payment arrears by the central government||…||0.0||0.0||0.0||0.0||…||0.0||0.0||0.0||0.0|
|(Millions of U.S. dollars)|
|Ceiling on the accumulation of new external payment arrears by the central government5||…||0.0||0.0||0.0||0.0||…||0.0||0.0||0.0||0.0|
|Ceiling on the contracting or guaranteeing of non-concessional external debt with original maturity of more than one year by the central government6||…||5.0||21.0||21.0||13.1||…||28.0||90.0||8.8||17.5|
|Ceiling on the outstanding stock of nonconcessional external debt with a maturity of less than one one year by the central government5,7||…||0.0||0.0||0.0||0.0||…||0.0||0.0||0.0||0.0|
|(Millions of euros)|
|Floor on net international reserves of the Bank of Cape Verde (BCV)8||250.0||2.9||25.3||26.5||26.7||275.3||7.3||10.0||-2.2||10.8|
|Memorandum item:||(Billions of Cape Verde escudos)|
|Nonproject external financial assistance, including credit line (program assumption)||…||0.6||1.2||…||1.3||…||1.8||2.4||2.1||2.9|
|External debt service||…||0.7||1.3||…||1.2||…||2.0||2.6||1.6||2.2|
|Clearance of end-2006 stock of domestic arrears||…||0.4||0.8||…||0.7||…||1.1||1.5||1.4||2.0|
|Structural Assessment Criterion|
|Improve fiscal policy execution||Complete a formal mid-year review of revenue and expenditure developments that allows for taking corrective actions if necessary.||End-Aug. 2008||Met|
|Strengthen tax base||Submit the new General Tax Code to the National Assembly (MEFP¶14).||End-Dec. 2007||Implemented in Aug. 2008|
|Strengthen tax base||Submit the new Code on Judicial Process to the National Assembly (MEFP ¶14).||End-Dec. 2007||Implemented in Aug. 2008|
|Reduce fiscal risks||Finalize and publish a revised mechanism for adjusting petroleum prices (MEFP ¶5).||End-Mar. 2008||To be implemented in Nov. 2008|
|Strengthen financial regulation||Submit to the National Assembly legislation to criminalize financing of terrorism and facilitate the combating of financing of terrorism (MEFP ¶5).||End-Mar. 2008||Implemented in Nov. 2008|
|Strengthen financial regulation||Submit to the National Assembly legislation to strengthen the framework for combating money laundering (MEFP ¶5).||End-Mar. 2008||Implemented in Nov. 2008|
|Strengthen tax base||Submit the draft individual and corporate income tax bills to the National Assembly (MEFP ¶5).||Oct. 2008||Postponed for 2009|
|Promote domestic and external stability||Submit a simplified medium-term fiscal framework (MTFF)2 to the Council of Ministers in the 2009 budget preparation cycle and publish it on the Ministry of Finance website (MEFP ¶8).||Nov. 2008||Met|
|Promote financial stability||Prepare a quarterly report on developments on balance of payments flows, including an assessment of interest sensitivity of non-resident flows into the banking system.||Dec. 2008|
|New structural benchmarks|
|Strengthen public financial management||Place financial controllers in each line ministry to monitor the budget execution as specified in Regulatory Decree 2/2007 of 15 January.||End-Mar. 2009|
|Strengthen debt management||Compile:||End-Mar. 2009|
|Strengthen debt management||Submit to the Council of Ministers a report on contingent liabilities of the state assessing potential risks based on the 2007 or more recent data, including those risks arising from state-owned enterprises. (MEFP ¶9).||End-Mar. 2009|
Under the PSI, the government will regularly update the IMF on economic and policy developments and will provide the data needed for adequate monitoring of the program. During the period of the PSI, Cape Verde will consult with the IMF on the adoption of any measures that may be appropriate at the initiative of the government or whenever the Managing Director of the IMF requests such a consultation. We authorize the IMF to publish this letter of intent, the attached MEFP, and the related staff report.
Minister of Finance
|Attachments:||– Memorandum of Economic and Financial Policies|
|– Technical Memorandum of Understanding|
Attachment I—Memorandum of Economic and Financial Policies
1. Cape Verde’s economic and policy performance remains strong. Economic growth continues to be driven by the strength of tourism exports and related FDI flows, and average inflation remains in single digits. Public debt has declined as a share of GDP and international reserves remain adequate despite the high food and fuel prices. Important progress was made towards the structural objectives of the program namely improving public sector management, strengthening the financial sector and reforming energy pricing regulation. These prudent polices have catalyzed investment and export growth, particularly in tourism and other services.
2. The government will continue to focus on enhancing macroeconomic stability and implementing structural reforms to unleash growth and reduce poverty. Fiscal policy and monetary management are consistent with the program goals and supportive of the exchange peg. Domestic public debt will continue do decline as a share of GDP and international reserves are expected to increase further. This will create additional fiscal space to increase infrastructure spending and absorb external shocks. The 2009 program aims at promoting reforms especially in public financial management and strengthening the financial sector.
Recent developments and program performance
3. Economic activity was solid in the first half of 2008 albeit with some moderation reflecting the global slowdown, and food and fuel prices pushed up inflation. Although overall economic activity remains on the strong side, leading indicators like the confidence barometer and imports of capital goods suggest it is moderating. While food and fuel prices have pushed 12-month inflation to 8 percent in August, second round effects on prices have so far been limited. This reflects the credible peg and weak wage indexation which continue to anchor firmly inflation expectations, and moreover economic activity is moderating. Recent rainfall should have a favorable effect on supply of some domestic food items. After the recent increase, we also expect core inflation (which excludes food and energy) to come down gradually in 2009 in line with core inflation in the euro area.
4. The June 2008 program quantitative targets were observed (Table 1).
Domestic borrowing was significantly below its ceiling, and domestic debt was further reduced. The mid-year review of the budget conducted in August (a PSI assessment criterion) identified that fiscal performance was broadly in line with budget projections, reflecting strong tax revenues, and strict control of recurrent spending.
International reserve target was met albeit with a narrow margin. Notwithstanding the strong fiscal performance, reserves accumulation moderated owing to disappointing external current transfers as well as private debt repayments in the first half of the year. The deceleration of remittances reflects the U.S. dollar depreciation and the economic slowdown in Europe and the U.S. where most of our diaspora resides. The ongoing international credit crisis triggered by the subprime mortgage crisis is yet to have a direct impact on Cape Verde given banks limited exposure to subprime assets. However, some anecdotal evidence suggests we may be beginning to experience the indirect impact through the tightening of liquidity conditions in Europe, which has slowed down the execution of tourists related real-estate projects. Moreover, the financial turmoil appears to have had some impact in the United Kingdom, Ireland and Spain which are important sources of FDI, and tourism flows for Cape Verde.
5. Progress on structural reforms has been steady. The new tax codes were submitted to National Assembly in August. The Economic Regulatory Agency (ARE) will finalize the new fuel pricing formula in November and the AML/CFT laws have been submitted to National Assembly in November (Table 2). The simplified medium-term fiscal framework (PSI benchmark) has been submitted to National Assembly with the 2009 budget and posted in the Ministry of Finance’s website in November. Following the approval of the new income tax bills by the Council of Ministers planned for 2009, we intend to submit them to the National Assembly together with the forthcoming legislation rationalizing tax exemptions.
Macroeconomic Objectives and Policies
6. Growth is expected to average 6 to 7 percent in 2008 and 2009, underpinned by further growth in tourism and by public infrastructure investments. Average inflation is expected to peak at about 6.5 percent in 2008 reflecting food and fuel price shocks before declining to 4 percent in 2009 consistent with the recent decline in international oil prices, the exchange peg and Euro area inflation. The program quantitative targets for end-December 2008 were modified downward in light of the global slowdown and high food and fuel prices. Gross reserves are targeted to increase by 0.4 months of imports in 2009 reestablishing the original program reserves level for end-2008 by September 2009. The specific program objectives for the remainder of 2008 and for the first half of 2009 are set out in Table 1.
7. Continued fiscal consolidation remains key to our macroeconomic program and the 2009 budget aims at a further reduction of the domestic debt-to-GDP ratio to build up international reserves. The fiscal space created in previous years will permit to address external shocks and ease infrastructure bottlenecks while further reducing the debt ratios. Fiscal consolidation in 2009 will rely on both revenue and expenditure measures. A tax exemptions code will be introduced to eliminate unjustified exemptions and broaden the revenue base, thereby offsetting the expansion of spending on infrastructure, direct transfers to the poor to help cushion the food and fuel price increases, and the reduction of corporate and personal income taxes. The government is committed to contain expenditures through continued wage restraint. While the wage bill is budgeted to increase slightly in 2009 this is not a result of nominal wage increases, rather it is due to new hiring of professionals in vital sectors such as health and education sectors as well as hiring and placing financial controllers to improve public financial management in government departments (a new PSI benchmark). The budget also implements decentralization of payroll management. The government has taken the decision that it will adjust electricity and water tariffs only after a careful assessment of the impact of the current high energy prices on the poor and vulnerable.
8. Strengthening our debt management is also a high priority. A strengthened debt management strategy will underpin the government’s borrowing program and the country’s medium-term fiscal framework submitted to the National Assembly in October (a PSI benchmark for November). In this context, the government is reforming debt management and would welcome IMF technical assistance in the areas of asset liability management. We have already made notable progress in this area as we upgraded our debt software and we now conduct debt sustainability analyses (DSA) regularly. Our next DSA to be conducted in early 2009 will inform the preparation of the 2010 budget to ensure that the expansion of borrowing for infrastructure will not endanger debt sustainability.
9. Reinforcing vigilance over state-owned enterprises will be an important aspect of our debt and asset management.
To this end, the government is making the commitment to a new PSI benchmark of compiling the official statistics of Other Economic Flows for the general public sector arising from the holding gains with our five largest state-owned enterprises to allow for prompt detection of balance-sheet vulnerabilities and adoption of corrective actions.
Official statistics will also report the consolidated assets and liabilities of these five large state-owned corporations detailing their debt by maturity, currency, residency and state guarantees. This will allow monitoring of their debt in the context of a comprehensive debt management strategy for the public sector.
The institutional framework for debt management and the debt management strategy will be strengthened to limit fiscal risks. The strategy will be consistent with the medium-term fiscal framework and debt sustainability, and will be embedded in the mandate of the debt management office.
Capacity of the debt management office will be reinforced. New staff will be hired and will receive training in the context of the PicatFin cooperation agreement with Portugal.
The coordination between the Ministry of Finance and the BCV will be enhanced, including for improving management of the securities market.
Finally, to keep a close monitoring of contingent liabilities and fiscal risks, we have included a new PSI structural benchmark in the program (Table 1) on submitting a report to the Council of Ministers on an assessment of the contingent liabilities for the state budget by March 2009.
10. The government’s reform program has been successful in preparing the country for the decline in concessional financing following the graduation from Least Developed Country status in 2008. While the government will continue to give priority to mobilizing concessional financing, raising the PSI ceiling for nonconcessional external financing is justified to allow for a nonconcessional loan approved by the European Investment Bank (EIB). This € 47 million loan is fully earmarked to expand the port of Palmeira, will be disbursed until 2011, and will be repaid in 20 years with a 4-year grace period. Extensive technical analyses by international consultants since 2005 concluded that the project has the potential to promote growth, which warrants the application of the principles of the 2008 Nouakchott Declaration of African Governors of making nonconcessional ceilings flexible in this case. Furthermore, the 2008 Joint Bank-Fund DSA concludes that this nonconcessional loan will not jeopardize debt sustainability even under the pessimistic scenario where the expected positive spillovers do not materialize.
11. Monetary management should continue to smooth short-term capital flows to stabilize flows and to support the exchange rate peg to the Euro. In the short-run, the BCV will continue to monitor the domestic liquidity situation and external flows closely and assess its implications for domestic interest rates, credit growth, and external flows, and timely adjust domestic rates in line with the Euribor and market risk premium. Thus, the BCV raised its 14-day bill rate by 50 basis points in September and by another 50 basis points in October to 5¼ percent to synchronize its policy rate with rates in the euro area. To this end, the BCV will prepare quarterly reports on developments on balance of payments flows, including an assessment of interest sensitivity of non-resident flows into the banking system (a PSI benchmark).
12. Liquidity management in the short run will continue to be implemented through the issuance of central bank bills and the interest rate offered on the 14-day bill constitutes the BCV’s official policy rate. Over the medium-term, fiscal policy will support monetary management by accumulating government deposits at the central bank to contain domestic demand thereby allowing a build up of foreign exchange reserves in line with the program goal to support the exchange rate peg. The BCV will lift the rate ceiling on the central bank bills, and raise the official policy rate. The BCV will continue to stand ready to timely adjust rates further as needed in line with developments in international markets and risk premia. To this end, the Monetary Policy Committee will meet monthly to closely monitor and promptly react to new market developments.
Public sector financial management
13. The government remains fully committed to its program of strengthening public financial management. Our efforts evolve around expanding SIGOF, our home-made budget management technology platform, which is internationally recognized as a model for public financial management. In particular, the Ministry of Finance is:
Preparing a simplified medium-term fiscal framework for the 2009 budget (a PSI benchmark) within SIGOF. This tool will allow us to anchor fiscal policy in a medium term perspective.
Decentralizing payroll management. In 2009, personnel management will be done by each line unit. This will allow better budget discipline and efficient labor allocation.
Introducing a new chart of public accounts (PNCP) that will align our fiscal statistics with international best practice.
14. The government will continue to update and strengthen the tax framework. Drafts of the revised General Tax Code, Code on Judicial Processes, and Forced Tax Collection code were submitted to the National Assembly in August 2008. In addition, to further reduce and streamline the tax incentives and exemptions, the government will prepare a new tax exemption code with technical assistance from both the IMF and other external consultants. The government intends to submit this legislation to the National Assembly in early 2009. Pending the passage of this legislation, a moratorium has been put in place on the granting of new tax exemptions.
Financial Sector Issues
15. Following the introduction of new banking regulation in 2007 and AML/CFT in November 2008, the BCV is now focusing on strengthening supervision of the financial sector. In particular:
The BCV will continue to enforce the new banking regulations through onsite and offsite inspections. For an adequate management of credit risk, it is crucial that banks follow the new risk classification of their assets and make adequate provisions.
Given the recent experience with international sub-prime mortgage crisis, the BCV will also continue to closely monitor bank credit in various sectors and alert banks when excessive exposure in a particular sector may not be prudent which could lead to boom-burst cycles in the economy.
The BCV will also begin to extend its supervision coverage to other non-bank financial intermediaries, particularly those exposed to the real estate sector.
The government will promote the development of the insurance and capital markets to support economic development in Cape Verde. A new insurance sector regulation is being modernized to cover both life and non-life aspects of the insurance industry. Although the basic infrastructure on capital markets is in place, the operational and legal aspects are not yet fully developed and modernized including the Securities Code and the Company’s Act.
16. The above measures to strengthen the financial sector will support the BCV’s strategy of further gradual opening of the capital account. Gradual liberalization will support the ongoing economic and financial development of Cape Verde, including access to international financial markets. The government is working to take further measures to minimize risks to the financial system before moving further with liberalization of other financial flows.
Energy Sector Reform
17. The government is carrying out a comprehensive strategy to ensure that the energy sector is able to support the growth and development of Cape Verde. Working within the framework of public and private partnerships in the sector, the government’s strategy emphasizes:
Investment to increase capacity and efficiency, including improvements in electricity generation and transmission, higher water production capacities, and development of alternative energy sources;
Increased private sector participation in the sector’s management and investment activities; and
Formation of a joint logistics company to handle importation, storage and inter-island distribution of oil products.
18. The government’s efforts to reform the energy sector are being supported by external donors. We have negotiated with the World Bank a US$ 44 million IBRD loan specifically directed to the energy sector. This should accelerate progress in the implementation of the government’s energy sector reform agenda.
Attachment II. Technical Memorandum of Understanding1
1. This memorandum sets out the understandings between the Cape Verdean authorities and the IMF staff regarding the definition of assessment criteria and indicative targets and reporting requirements for the fifth and sixth reviews under the Policy Support Instrument.
I. Quantitative Assessment Criteria and Indicative Targets
A. Net Domestic Borrowing Excluding for Clearance of Arrears and Net Late Payments
2. Net domestic borrowing excluding for clearance of arrears and net late payments is defined as the cumulative change since the start of the calendar year of the net credit to the central government from the banking and nonbanking sectors less (1) the cumulative clearance during the calendar year of the stock of arrears as of the end of the previous year and (2) the cumulative payments during the first three months of the calendar year of expenses authorized by the previous year’s budget, plus the expenses accrued during the current year that will be paid during the first three months of the next calendar year as provisioned for in the budget law (late payments or atrasados). The ceiling will be adjusted downward (upward) by the cumulative downward (upward) deviations in external debt service and upward (downward) by the cumulative downward (upward) deviations in nonproject external financial assistance and land sales relative to program assumptions.
3. Net credit to the central government from the banking and nonbanking system is defined as the overall position of the main central government institutions vis-à-vis the banking and nonbanking system—that is, the stock of all outstanding claims on the central government (loans, advances), and all other government debt instruments, such as long-term government securities, held by the central bank, commercial banks, and nonbank institutions, less all deposits held by the central government with the central bank and with commercial banks. The INPS is not included in central government accounts. Net credit to the central government excludes claims on the Trust Fund (TCMFs).
4. Reporting requirements. Data on the implementation of the budget compiled by the Ministry of Finance and Public Administration will be provided on a quarterly basis, to be submitted no later than five weeks after the end of each quarter, including (i) government domestic revenue by category; (ii) external budget support grants; (iii) government expenditure, including primary current expenditure, domestic and external interest payments, and capital expenditure, including domestically and budget support financed capital expenditure and estimates of externally project financed capital expenditure; (iv) the gross payment and gross accumulation of domestic accounts payable (atrasados); (v) the gross payment and gross accumulation of domestic payments arrears; (vi) external loan receipts and principal payments; (vii) external arrears payments and accumulation; (viii) bank and nonbank financing; (ix) privatization and land sale receipts; and (x) any other revenue, expenditure, or financing not included above.
5. For the purposes of this memorandum, privatization and land proceeds will be understood to mean all monies received by the government from the sale or concessioning of a public company, organization, or facility to a private company or companies, organization(s), or individual(s), as well as any proceeds generated from the sale of government land and the liquidation of a public company, less restructuring costs.
B. Net Domestic Assets of the Central Bank
6. The ceiling on the cumulative change, from the beginning of calendar-year 2006, in net domestic assets of the BCV constitutes an assessment criterion. Net domestic assets (NDA) of the BCV are defined as reserve money minus net foreign assets of the BCV, evaluated at the current end-of-period exchange rates. The program ceilings for NDA will be adjusted downward (upward) by the cumulative downward (upward) deviations in external debt service and upward (downward) by the cumulative downward (upward) deviations in nonproject external financial assistance relative to program assumptions. For purposes of calculating the adjusters, these flows will be valued at current exchange rates. Reserve money comprises bank reserves and deposits of the monetary institutions and private sector with the central bank, as well as cash in circulation.
7. Reporting requirements. The preliminary monthly balance sheets of the BCV and the consolidated commercial banks will be transmitted on a monthly basis, with a maximum delay of five weeks. The definitive version of the monthly balance sheet of the BCV will be provided as soon as available.
C. Ceiling on Nonconcessional External Debt Contracted or Guaranteed by the Central Government
8. Under the program, ceilings on medium- and long-term, as well as on short-term, nonconcessional external debt constitute assessment criteria. The ceiling on medium- and long-term nonconcessional external debt is on a quarterly basis while the one on short-term nonconcessional external debt is on a continuous basis. Nonconcessional external debt is defined as debt contracted or guaranteed by the central government with a grant element of less than 35 percent, calculated using currency-specific commercial interest reference rates (CIRRs) published by the Development Assistance Committee of the Organization for Economic Cooperation and Development (OECD). Debt rescheduling and debt reorganization are excluded from the limits on nonconcessional external debt. The limits on new nonconcessional external debt contracted or guaranteed by the central government (excluding borrowing from the Fund) are specified in Table 1 of the Letter of Intent. The definition of short-term nonconcessional external debt excludes normal short-term (less than one year) import-related financing. The Portuguese government’s precautionary credit line in support of the exchange rate peg is also excluded from the definition of nonconcessional external debt. The assessment criterion on medium- and long-term nonconcessional external indebtedness applies not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-(00/85), 8/24/00) but also to commitments contracted or guaranteed for which value has not been received. With respect to the assessment criterion on short-term nonconcessional external indebtedness, the term “debt” has the meaning set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-(00/85), 8/24/00).
9. Reporting requirements. The government of Cape Verde will consult with Fund staff before assuming any liabilities in circumstances where they are uncertain whether the instrument in question falls under the assessment criterion. Details of all new external debt (including government guarantees), indicating terms of debt and creditors, will be provided on a quarterly basis within five weeks of the end of each quarter.
D. Net International Reserves of the Central Bank
10. The floor on the cumulative change, from the beginning of calendar-year 2006, in net international reserves (NIR) of the BCV constitutes an assessment criterion under the program. The NIR of the BCV are defined as gross international reserves of the BCV net of its external reserve liabilities, calculated at the current exchange rates. Gross reserves of the BCV are those that are readily available (i.e., liquid and marketable and free of any pledges or encumbrances), controlled by the BCV and held for the purposes of meeting balance of payments needs and intervening in foreign exchange markets. They include gold, holdings of SDRs, the reserve position at the IMF, holdings of foreign exchange and traveler’s checks, demand and short-term deposits at foreign banks abroad, fixed-term deposits abroad that can be liquidated without penalty, and any holdings of investment-grade securities. External liabilities of the BCV comprise liabilities to nonresidents contracted by the BCV with an original maturity of less than a year, any net off-balance-sheet position of the BCV (futures, forwards, swaps, or options) with either resident and nonresidents, any arrears on principal and interest to external creditors and suppliers, and purchases from the IMF. The program floors for the NIR will be adjusted upward (downward) by the cumulative downward (upward) deviations in external debt service and downward (upward) by the cumulative downward (upward) deviations in nonproject external financial assistance relative to program assumptions. For purposes of calculating the adjusters, these flows will be valued at current exchange rates.
11. Reporting requirements. A table on the NIR prepared by the BCV will be transmitted on weekly basis, with a maximum delay of two weeks.
E. Nonaccumulation of New Domestic Payments Arrears
12. As part of the program, the government will not accumulate any new domestic payments arrears. This will be monitored through the monthly execution of the cash-flow plan and the corresponding release of budget appropriations. For programming purposes, a domestic payment obligation to suppliers is deemed to be in arrears if it has not been paid within the normal grace period of 60 days (30 days for government salaries and debt service) or such other period either specified by the budget law or contractually agreed with the supplier after the verified delivery of the concerned goods and services, unless the amount or the timing of the payment is subject to good faith negotiations between the government and the creditor.
13. Reporting requirements. The Ministry of Finance and Public Administration, through the D.G.T., will submit on a quarterly basis a detailed table of the stock of domestic payments arrears, including the accumulation, payment, rescheduling and write-off of domestic payments arrears during the quarter. The data are to be provided within four weeks after the end of the quarter.
F. Nonaccumulation of External Payments Arrears
14. As part of the program, the government will not accumulate any new external payments arrears on a continuous basis. This will be monitored through the monthly execution of the cash-flow plan and the corresponding release of budget appropriations.
15. External arrears are defined as total external debt-service obligations of the government that have not been paid by the time they are due, except where agreements between the government and creditors explicitly provide for a grace period after such obligations falling due. External arrears exclude arrears on external debt, pending the conclusion of debt-rescheduling agreements.
16. Reporting requirements. Data on (i) debt-service payments; and (ii) external arrears accumulation and payments will be transmitted on a quarterly basis by the Ministry of Finance and Public Administration, within five weeks of the end of each quarter. In addition, the government will inform the Fund staff immediately of any accumulation of external arrears.
II. Other Data Requirements
17. Data on exports and imports, including volume and prices and compiled by the Director of Customs and the BCV, will be transmitted on a quarterly basis within five weeks after the end of each quarter. A preliminary quarterly balance of payments, compiled by the BCV, will be forwarded within five weeks after the end of each quarter.
18. The Statement of Other Economic Flows as defined in the IMF Manual GFSM2001 relative to holding gains/losses of the previous year with Enapor, Electra, ASA, TACV, and IFH will be transmitted on an annual basis within three months after the end of the following year (15 months after the closing date).
19. The consolidated balance sheet of Electra, Enapor, ASA, TACV and IFH relative to the previous year will be transmitted on an annual basis within three months after the end of the following year (15 months after the closing date).
The temporary rise in core inflation in the third quarter of 2008 was largely explained by a one-off increase in prices of clothing and shoes probably because of changes in the market structure.
In the attached Letter of Intent and Memorandum of Economic and Financial Programs, MEFP, the authorities reaffirm their commitment to the macroeconomic and structural reform objectives of the PSI.
Banks hold liquidity in the form of short term BCV bills, which can be quickly used to buy foreign currency from the BCV should that need ever arise. The outstanding stock of BCV bills held by banks totaled CVEsc 7.9 billion (6 percent of GDP) at end June 2008.
Moreover, while fuel has been adjusted broadly in line with import prices, the government is also temporarily subsidizing electricity and water (about 0.2 percent of GDP in 2008) to cushion the most vulnerable people with a well-targeted electricity and water price structure.
The BCV noted that if need were to arise, it would prefer to access its credit line with Portugal (€49 million).
Recent monetary easing by the ECB will to some extent reduce the need to increase policy rates in Cape Verde.
In November, a Portuguese bank (which has common shareholders with an offshore bank in Cape Verde) was nationalized by the government of Portugal, including due to losses with the offshore bank. The operations of the offshore bank were initially reported by the BCV to its counterpart in Portugal. This incident had no direct relationship with the current credit crisis and the offshore bank has no domestic operations. The onshore and offshore systems are also sufficiently separated to mitigate the risks for contagion to the onshore banking sector.
Updated from the Country Report No. 08/248. Section II was deleted. Section III was renumbered as section II. Paragraphs 18 and 19 were added.