On behalf of our Tunisian authorities, we would like to express our appreciation of staff hard work and the constructive dialogue during the discussions of the Third Review under the Stand-by Arrangement. The authorities are also grateful to management and the Executive Board for their continued support.
Program implementation has continued to advance at a broadly satisfactory pace given the difficult domestic and international environment and the constraints and challenges related to the political transition. The authorities remain fully committed to the program objectives. A strategic orientation for all banks with public participation (prior action) was approved by the Council of Ministers. Two out of three end-December quantitative performance criteria (QPC) were missed by a smaller margin than originally estimated in the last review, and all end-march 2014 QPCs are expected to have been met. On the structural reforms, four out of eight benchmarks were realized, and progress has been made towards increasing haircuts for loans used as collateral for refinancing operations, as well as on the design of a plan to modernize tax administration. Moreover, additional fiscal adjustment of about 0.4 percent of GDP in 2014 was agreed during this review.
The democratic transition is gaining momentum within a firmly established consensus among political parties and civil society, and has received overwhelming expressions of support on the part of the international community. Following the adoption of the new constitution, and the formation of a new technocratic government, a road map for the last phase of the democratic transition has been agreed, involving inter alia, the appointment of members of the Independent High Electoral Commission and the expected adoption of the electoral law, thereby paving the way for holding free and democratic elections by year-end.
Recent economic developments and outlook
Economic performance in 2013 was mixed, given the persistent headwinds from the external environment and the still uncertain domestic context. Weak tourism activity, strikes in the mining and the manufacturing sectors, and a below average cereal harvest, adversely impacted the pace of the recovery in 2013. Growth remained positive, however, at 2.6 percent, and unemployment was brought down from the peak of 18.3 percent in 2011 to 15.3 percent, even though it remains unacceptably high, in particular for young graduates and women. Headline CPI inflation eased to 5 percent in March 2014 from 6 percent in December 2013, while core inflation remained low at 4 percent. The overall fiscal deficit on a cash basis reached 6.1 percent of GDP at the end of 2013, in line with the estimate under the previous review. On the external side, however, weak demand from Europe, lower exports of phosphates, and the increase in the cost of energy imports exacerbated pressures on the current account, while significant shortfalls in external financing worsened the overall balance of payments outcome.
The outlook for 2014 is promising. With the transition expected to smoothly reach its final stage, and the firming up of the economic recovery in Europe, Tunisia’s growth prospects are expected to improve on account of strengthened confidence, which will reverse investors’ wait-and-see attitude. Exports and tourism activities are likely to rebound, and external financing is expected to be better than last year. Growth is projected to increase moderately to about 2.8 percent and inflation to decline to 5.3 percent on average. The current account is projected to narrow to 7.2 percent of GDP in 2014 and 6.3 percent in 2015. While downside risks remain, growth could possibly surprise on the upside, should confidence strengthen more than expected.
Fiscal policy and reforms
The 2013 fiscal deficit turned out to be lower than programmed. While revenue was higher than envisaged during the second program review, savings on the wage bill and under-execution of social and capital spending lowered the primary fiscal deficit on a cash basis to 2.7 percent of GDP, and the overall deficit to 6.1 percent of GDP, against a program target of 7.3 percent. As explained in the MEFP, the under-execution of capital and social spending reflected implementation capacity constraints at the regional level rather than a deliberate decision. Overall, the structural fiscal deficit, which is a better gauge of the underlying fiscal position, declined to 4.6 percent of GDP against 5 percent foreseen in the program.
The authorities are committed to continued fiscal adjustment, which will be gradual and will involve a combination of short-term measures and structural reforms. Since January, they have identified a package of additional fiscal measures of about 0.4 percent of GDP, including mostly revenue measures, which will be included in a supplementary budget, with the objective of achieving a structural deficit of 4.9 percent of GDP in 2014. The authorities are determined to contain the wage bill through a wage freeze, which is already in place, and limited net recruitment in the civil service, except for the security, education, and health sectors. A civil service reform task force has been set up, and work is underway to carry out an evaluation of the civil service hiring system and salary structure with World Bank assistance by September 2014 (MEFP ¶5).
The energy subsidy reform is being implemented. First steps of this reform, which are estimated to yield budgetary savings of about 0.9 percent of GDP in 2014, consist of increases in prices of electricity and natural gas for cement companies by 35 percent and 47 percent, respectively, in addition to a 10 percent increase in electricity tariffs for household and industrial users. A second round of electricity and gas price adjustment is planned for June 2014 to fully eliminate subsidies for cement companies, while fuel prices will also be adjusted by 6 percent in July. The new formula for automatic adjustment of fuel prices, which was adopted early this year, should insulate the budget from the effects of large increases in international oil prices. Vulnerable groups will be protected from these increases through social programs already included in the 2014 budget, as well as through the recently introduced lifeline electricity tariff (for households consuming less than 100 kw/h per month). In addition, a household targeting strategy, expected to take effect on July 1, 2014, will increase the number of beneficiary families, broaden the population groups eligible for one-off and temporary aid to mitigate the impact of the fuel price increases, and raise social allowances for school children and university students (MEFP ¶33). To ensure broad support for the energy subsidy reform, the authorities intend to launch a new communication campaign ahead of price increases.
The authorities are taking steps to improve the execution of public investment projects and strengthen public financial management (PFM). A new public procurement decree was adopted, with implementation to start in June 2014, to strengthen public procurement and simplify the tendering process, while devolving more responsibilities to the regional authorities for project execution. This, together with improved oversight of public investment projects and better control of current spending, will improve the quality of expenditure. Important steps are being taken to strengthen PFM, including the setting of a single treasury account, the shortening of the complementary budget period, the ongoing work on a new organic budget law, and the planned adoption of a functional budget classification in June 2014.
A comprehensive tax reform is under preparation to promote equity, efficiency, and transparency of the tax system. The authorities have already included some measures in the 2014 budget, which halved the corporate tax wedge between the on-shore and off-shore sectors, introduced a 10 percent tax on dividends, and raised tax exemption thresholds for low-income individuals. National consultations on the planned reform will take place in June 2014 to build consensus and pave the way for the adoption of a new tax code by the Council of Ministers in September 2014 (structural benchmark). On revenue administration, progress has been made on the unification of different functions of the large taxpayer unit (LTU), while a strategic plan for modernizing tax administration will be adopted in June 2014, based on the results of the IMF Technical assistance recommendations.
Monetary and exchange rate policies
The monetary policy stance remains appropriate. Staff and the authorities agree that following the December 2013 increase in the policy rate by 50 basis points, the current policy rate remains appropriate, given that core inflation is stable, headline inflation is declining, and a negative output gap remains. The CBT stands ready to further tighten the monetary stance, as needed. To further improve monetary policy transmission channel and facilitate access to credit by small and medium-sized enterprises, the authorities have completed a study with World Bank assistance on options for the modification or elimination of existing caps on banks’ lending rates, and consultations are underway between the CBT and the relevant ministerial departments to this effect.
Steps are being taken to reduce commercial banks’ reliance on central bank refinancing A new haircut of 10 percent on bank loans eligible for CBT refinancing has been introduced, and will be increased in June to 25 percent, in conjunction with the planned introduction of a lender of last resort facility (structural benchmark) to allow solvent, but illiquid, banks’ use of the facility, as needed, at penalty rates. Furthermore, the share of government securities used as collateral for central bank refinancing will be increased later this year to reduce risks to the CBT’s balance sheet.
Exchange rate policy has remained flexible, to reflect market developments and to build international reserves. Earlier pressures on the exchange market eased in the first months of 2014, reflecting increased disbursement of budget support, stricter enforcement of existing regulations for the holders of professional accounts in foreign currency, and the confidence generated by the improvement of the political situation. The resulting appreciation of the Tunisian Dinar partly reversed the earlier depreciation in 2013. The CBT has limited its interventions in the market to smoothing excessive exchange rate fluctuations. An electronic bank interlinking platform was introduced which, together with the entry into force of the Market Maker Agreement, will facilitate the establishment of a weekly foreign exchange auction mechanism.
Financial Sector Issues
Addressing the vulnerabilities of the financial sector remains the authorities’ key priority. As detailed in the report and the MEFP, a multi-pronged strategy is being deployed aimed at: addressing capital adequacy shortfalls in six banks that fall below the statutory minimum requirement; aligning prudential rules with international norms; strengthening bank supervision, including improving offsite procedures and onsite inspections before moving to risk-based methods; and upgrading the reporting and ratings system. Adequate progress has been made in these areas, as indicated in the report.
A major undertaking will be the recapitalization and restructuring of public banks. The authorities have adopted a strategic orientation of the role of the state in public banks (a prior action for this review), which defines the objectives, guiding principles, and modalities of government intervention in the financial sector. Moreover, based on completed audit reports for two public banks, restructuring plans for these banks (STB and BH) will be approved in July 2014 and the necessary resources for bank recapitalization will be mobilized. The 2014 budget already incorporates an amount equivalent to 1.2 percent of GDP for this purpose. Efforts are also directed at the establishment of an Asset Management Company to address the NPL problem in the tourism sector, with the necessary legal framework to be submitted to the National Assembly by June 2014.
The authorities are cognizant of the need for a comprehensive reform strategy to improve the business climate. The National Assembly is reviewing the investment code, the competition law, and a law on public-private partnership, which should encourage private sector investment and growth and foster the development of disadvantaged regions. The authorities are also preparing a strategy to reform public enterprises. An audit of three energy companies has been completed and efforts are underway to improve their efficiency. On labor market reform, the tripartite dialogue between labor unions, the business association, and the government has been revived to review a draft national employment strategy, with the objective of adopting specific actions in this area after the elections.
Our Tunisian authorities are steadfastly moving forward in implementing their ambitious reform agenda, and are grateful to their partners for their reinvigorated support in difficult times. They thank Executive Directors and management for their keen interest in the Tunisian experience, as demonstrated during the recent visit to Washington by the Prime Minister, and continue to highly value their support and policy advice. As mentioned to the Managing Director by the Prime Minister during his visit, Tunisia is a ‘democracy start-up’ that needs to be supported by the international community.