Following a severe economic crisis in 2008, Seychelles pursued ambitious and wide-ranging reforms aimed at stabilizing the economy and reorienting fiscal and monetary policies to lift and sustain stronger growth.
The Seychellois economy has made significant progress under the recently completed 4-year EFF-supported program. Under the program, GDP growth averaged 5 percent, inflationary pressures moderated, the exchange rate remained stable, public debt declined sharply, official reserves were gradually rebuilt, and importantly, macroeconomic stability was restored. These outcomes were underpinned by the removal of exchange controls and the floating of the exchange rate, and tighter monetary and fiscal policies. The exemplary performance throughout the program is a testament to the strength of the authorities’ ownership of the program and their related commitment to implement difficult reforms. It also highlights the significant extent to which IMF policy advice has gained traction with policy makers, as well as the broad-based public support for the program which the authorities have been able to garner.
Economic fundamentals in the Seychelles remain stronger today, but the reform process remains unfinished. Public debt remains high and the Seychellois economy remains highly vulnerable to external shocks, owing to its reliance on tourism and imports, which are inherent features of its small, highly open economy. To consolidate the recovery, provide policy continuity, and support the multi-year reform efforts, the authorities are requesting a successor 3-year EFF arrangement (105 percent of quota). As noted in the Memorandum of Economic, Financial and Structural Policies for 2014-16, the successor program will focus on strengthening macroeconomic stability and fiscal and external sustainability; further reducing public debt to below 50 percent of GDP by 2018; accumulating additional international reserves; and intensifying structural reforms in a number of key areas, including taxation, public finance management, banking and the financial system, management and oversight of state owned enterprises (SOEs), and supporting private sector development.
The Seychellois authorities are committed to locking in and building upon the hard-won policy gains that they achieved under the last program. They are particularly committed to persevering with structural reforms to modernize the economy, and upgrade supporting policy frameworks.
Recent Economic Developments and Outlook
Despite challenging economic conditions, Seychelles continued to record robust growth, supported by prudent policies and the implementation of key reforms. In 2013, real GDP growth accelerated to 3.5 percent and the primary fiscal surplus reached 4.7 percent of GDP.
By the end of 2013, inflation fell to 3.4 percent (from 5.8 percent at end 2012) and official reserves reached 3.8 months of imports through opportunistic purchases in the market.
Looking forward, prospects for growth are positive, with GDP growth expected to average 3¾ percent in 2014 and 2015, before moderating to 3½ percent over the medium-term. Inflation is forecast to remain steady at around 3 percent and unemployment is expected to remain low. With reserves recently reaching adequate levels, the authorities will continue to gradually strengthen external buffers in line with staff’s recommendations for safeguarding the Seychellois economy. An improvement in the external environment from an ongoing recovery in Europe, as well as ongoing diversification into non-traditional tourist markets should support overall growth of the all-important tourism sector. More broadly, successful efforts by the authorities to encourage private sector led growth could help to unlock further growth.
The Seychellois authorities remain deeply committed to continuing their disciplined approach to fiscal sustainability. This commitment has been demonstrated by the large primary fiscal surpluses recorded in recent years. Further reducing public debt is a core component of the new program. While public debt remains high, the pace of the decline in debt has been strong and steady and it remains on track to meet the debt target of below 50 percent of GDP by 2018. The pace and composition of fiscal adjustment will continue to be closely monitored by the Seychellois authorities.
Despite lower-than-expected revenues from business and income tax in the past year, the primary fiscal surplus reached 4.7 percent of GDP owing to tight control over current spending. The authorities concur with staff that following the successful implementation of comprehensive tax reforms in recent years, efforts should now be directed towards improving tax administration, streamlining exemptions, enhancing audits and strengthening compliance. The authorities recognize that improving the financial performance of parastatals will be important for fiscal sustainability.
In terms of expenditure, spending on critical infrastructure, such as water, electricity and sewerage will be key priorities for the government given pent-up demand following a period of underinvestment. To ensure the timely completion of investments, the Seychellois authorities are aware of the need to lift institutional capacity and strengthen policy implementation capabilities. The alignment of the Medium-Term Fiscal Framework (MTFF) with priority investments set out in the Medium-Term National Development Strategy (MTNDS - discussed in greater detail below) will also be important to ensure the optimal allocation of resources and sufficient funding. Both the MTFF and the MTNDS (which are structural benchmarks for the new program) are currently under development.
Significant steps are also being taken to strengthen public financial management, particularly enhancing the reporting arrangements and transparency of public finances and improving the oversight and compliance of SOEs. Technical assistance from the IMF and the World Bank has been extremely valuable to support these efforts.
Monetary Policy and Reserves
Strengthening the monetary framework through adopting a more forward looking regime is a key objective of the Central Bank of Seychelles (CBS). The authorities recognize the importance of improving the transmission mechanism and the need to develop a credible anchor for inflation. While work has been underway for some time to enhance the flexibility of monetary policy, a key milestone was reached in the first quarter of 2014, with a formal agreement between the Ministry of Finance and the CBS to issue SR800 million Treasury bonds for monetary policy purposes. To complement the evolution of monetary policy, the government remains firmly committed to maintaining the independence of the central bank.
The Seychellois authorities share staff’s view that reserves should remain slightly above that implied by the reserve adequacy metric given Seychelles’ small and open economy. The authorities have been steadily rebuilding reserve buffers over a number of years, and intend to accumulate reserves to a level slightly higher than four months of import coverage in the period ahead. Reserve management will be strengthened by improving the capabilities of the CBS through staff training with the Crown Agent Investment Management (an investment management company). The authorities support staff’s proposed move to averaging (quarterly) reserve money targets under the program. This will help strengthen liquidity management through greater flexibility, and support the transition to a more forward looking framework for monetary policy.
The government has embarked on a number of initiatives to develop the financial sector and to strengthen the credit channel to support private sector growth. A Financial Sector Development Implementation Plan and a collateral registry are currently being developed and work is underway to establish a modern payment systems. In addition to supporting monetary policy, the issuance of longer term instruments, will contribute to financial deepening, provide alternative investment options, and help shore up market confidence.
In late April 2014, the CBS established a Corporation Agreement with the International Finance Corporation (IFC) to assist with the development of the main regulations under the Financial Leasing Act (recently enacted). The IFC will assist with a sensitization campaign and capacity building to local authorities.
The Seychellois authorities will continue to work closely with commercial banks to strengthen the financial sector and to create a competitive business environment to foster growth in small and medium enterprises. The authorities recognize that there are challenges posed by a lack of scale in generating sufficient competition in the banking sector. To mitigate risks in the financial sector, the authorities will complete the development of a macroprudential policy framework by the end of 2015 and will improve the supervision of non-banking financial services through the newly created Financial Service Authority.
The economic reform agenda is well advanced but far from complete. Wide-ranging structural reforms will continue to feature heavily in the new program as the government seeks to build on the recent reform momentum. As noted in the staff report, the previous wave of structural reforms was aimed at restoring growth and stabilizing the economy as it emerged from a deep recession, while the next wave will look to entrench growth and achieve external debt sustainability.
Over the medium term, the economy will be guided by the National Development Strategy, which will aim to (i) promote a coordinated approach to medium term growth, (ii) prioritize various strategies and reform initiatives, and (iii) integrate public sector investment needs. The MTNDS will be anchored to the medium-term fiscal framework to ensure its feasibility and macroeconomic relevance, and with the aim to improve the allocation of resources with policy priorities and strategic objectives. A broad range of policy matters will be covered in the MTNDS, including economic, government, environment and social matters. The completion and validation of the report is expected by September 2014, with cabinet approval expected by October 2014.
The Seychellois authorities place a high priority on ensuring the efficiency of SOEs, given the critical role they play in small island economies. While recognizing their centrality to the economy, the government is conscious of limiting their footprint in order to promote the development of the private sector and to encourage healthy competition. To this end, the government is taking active steps to strengthen oversight and to improve the transparency and accountability of SOEs, including through the establishment of annual performance objectives with well-defined mandates for all SOEs, and the submission of quarterly reports from the Public Enterprise Monitoring Commission on the performance of SOEs to the Minister of Finance. The authorities will continue to pursue policies to improve productivity and increase value-added in key export sectors, such as tourism and fisheries.
Finally, the Seychellois authorities would like to express their appreciation for the support of management, and the IMF mission team for the valuable and frank discussions and their hard work in helping Seychelles develop a comprehensive economic reform program.