Journal Issue
Share
Article

Cabo Verde: Staff Report for the 2014 Article IV Consultation

Author(s):
International Monetary Fund. African Dept.
Published Date:
September 2014
Share
  • ShareShare
Show Summary Details

Developments and Challenges Ahead

A. The Long-Term Setting

1. Over the last two decades, Cabo Verde has made impressive strides in economic and social development. Rapid economic growth, driven in large part by an expansion in tourism and public investment, helped the country graduate to middle-income country status in 2007. It has also dramatically reduced poverty—from 49 percent in 1989 to 25 percent in 2011—and raised living standards, such that achievement of all Millennium Development Goals by 2015 is within reach.

2. Now, to sustain its progress over the medium term, Cabo Verde must identify new drivers of growth. The large-scale Public Investment Program (PIP) is beginning to wind down, and tourism may grow less rapidly as limits to market share are reached. In addition, with total factor productivity in Cabo Verde having fallen over the last decade, structural reforms that boost competitiveness are critical to support job-creating and inclusive growth (Appendix).1

3. At the same time, fiscal consolidation remains essential to ensure debt sustainability. During the last few years, the combination of weaker revenue performance and higher capital expenditure has driven up public debt to 98 percent of GDP at end-2013—a rise of 40 percentage points since 2008. Even though debt financing has been highly concessional, there are risks to debt sustainability if progress on fiscal consolidation stalls.2

B. Current Conditions

4. During 2013, the economy continued to face significant headwinds from the anemic recovery in Europe and weak domestic confidence (Table 1 and Figure 1).

Figure 1.Cabo Verde: Recent Economic Developments

Sources: Cabo Verdean authorities and IMF staff.

Table 1.Cabo Verde: Selected Economic Indicators, 2011–17
2011201220132014201520162017
Est.Proj.
(Annual percent change)
National accounts and prices1
Real GDP4.01.20.53.03.54.04.0
GDP deflator2.71.92.52.52.52.52.5
Consumer price index (annual average)4.52.51.52.02.52.52.5
Consumer price index (end of period)3.64.10.12.52.52.52.5
External sector
Exports of goods and services17.37.25.16.88.99.39.3
Of which: tourism26.521.48.69.510.310.310.3
Imports of goods and services17.9−8.1−6.911.99.97.25.0
(Change in percent of broad money, 12 months earlier)
Money and credit2
Net foreign assets−7.74.66.93.52.20.20.5
Net domestic assets12.21.74.43.18.19.07.5
Net claims on the central government4.03.31.81.41.11.31.1
Credit to the economy10.80.01.35.16.06.25.8
Broad money (M2)4.66.311.36.610.39.28.0
(Percent of GDP, unless otherwise indicated)
External sector
External current account (including official transfers)−16.3−11.3−4.5−9.1−10.8−10.9−9.2
External current account (excluding official transfers)−20.0−14.6−7.5−10.7−12.4−12.2−10.5
Overall balance of payments−2.72.73.53.22.20.60.8
Gross international reserves (months of prospective imports of
goods and services)3.54.24.44.64.64.54.4
Government finance
Revenue25.623.023.725.524.725.125.4
Tax and nontax revenue22.721.221.322.622.923.524.1
Grants2.91.82.42.91.81.61.3
Expenditure33.332.931.532.931.230.830.0
Overall balance (incl. grants)−7.7−9.9−7.8−7.4−6.5−5.7−4.6
External financing6.07.56.25.74.73.52.6
Domestic financing1.62.31.61.71.82.22.0
Onlending−3.6−3.7−5.4−4.3−4.0−3.2−2.3
Total financing (incl. onlending)11.213.613.211.710.48.96.9
Public debt stock and service3
Total nominal government debt77.890.297.6104.1107.4108.4107.5
External government debt56.167.574.079.281.982.080.5
Domestic government debt21.622.623.624.925.526.427.0
External debt service (percent of exports of goods and
services)4.14.34.64.54.54.44.1
Present value of external debt
Percent of GDP (risk threshold: 50%)42.645.847.848.548.2
Percent of revenue (risk threshold: 300%)199.5203.0208.7205.9199.9
Percent of exports (risk threshold: 200%)95.0101.2102.9101.898.8
Memorandum items:
Nominal GDP (billions of Cabo Verde escudos)147.9152.6157.2166.0176.2187.9200.3
Gross international reserves (€ millions, end of period)263.3299.3347.5395.9431.2440.6454.9
Sources: Cabo Verdean authorities; and IMF staff estimates and projections.

Last data available for national accounts is for 2012.

Adjusted for data inconsistency in December 2011.

Public debt data for 2013 are preliminary estimates.

Sources: Cabo Verdean authorities; and IMF staff estimates and projections.

Last data available for national accounts is for 2012.

Adjusted for data inconsistency in December 2011.

Public debt data for 2013 are preliminary estimates.

  • Real GDP growth is estimated at 0.5 percent for 2013, a further slowdown from the 1.2 percent growth registered in 2012 and 4 percent in 2011. While tourism—which accounts for about a fifth of the economy—continued to do well, private consumption and investment remained very weak, and credit to the economy grew by only 1 percent. Unemployment was 16½ percent at end-2013 (about the same as in 2012, and up from 12 percent in 2011), with youth unemployment double that rate. Average inflation fell to 1½ percent, reflecting weak economic conditions and contained global price developments.

  • The balance of payments was once again in small surplus (Table 2). The current account deficit narrowed considerably, to about 4½ percent of GDP, reflecting in particular a sharp decline in capital goods imports as investment declined. In the capital account, private flows continued to decline, reflecting a further contraction in FDI and in particular a reversal of capital flows to commercial banks and of other private debt-related flows. International reserves recovered to about 4½ months of prospective imports.

Table 2.Cabo Verde: Balance of Payments, 2011–17(Millions of euros, unless otherwise indicated)
2011201220132014201520162017
Est.Proj.
Current account balance (including official transfers)−218−156−64−137−173−185−167
Trade balance−609−557−470−552−623−665−687
Exports, f.o.b.152143149160170183197
Imports, f.o.b.−761−700−619−712−793−848−883
Consumer goods−222−211−209−234−261−280−293
Intermediate goods−145−122−112−139−155−166−174
Capital goods−128−124−59−73−82−88−92
Services (net)185254261285323359400
Receipt415465489522573629690
Of which: tourism253307333365402443489
Payment−229−211−228−237−249−270−289
Income (net)−53−55−47−55−62−70−77
Credit10101011111212
Debit−63−64−57−65−73−82−89
Government interest−7−10−13−13−14−15−16
Interest by other sectors−24−27−32−35−39−42−47
Income on direct investment and other income−32−27−12−18−21−25−26
Current transfers (net)258202192185189191195
Government50464325252323
Private208156148160164168172
Capital and financial account (net)201218139185209195182
Capital account91054555
Of which: Grants81044555
Financial account192208134181204190176
Direct investment75452740505560
Portfolio investment0−100000
Other investment116163107141154135116
Central government12915614515113811490
Disbursements145172161169158134111
Amortization−16−16−16−18−19−20−21
Other investments, noncentral government−137−38−10152126
Monetary authority−1−6−2−1−100
Commercial banks−47−7−216666
Nonbank flows3620−15−15101520
Errors and omissions1−21−25−250000
Overall balance−3837504835914
Financing38−37−50−48−35−9−14
Gross international reserves (− = accumulation)32−37−50−48−35−9−14
Exceptional financing7000000
Financing gap0000000
Memorandum items:
Current account (incl. official transfers, percent of GDP)−16.3−11.3−4.5−9.1−10.8−10.9−9.2
Current account (excl. official transfers, percent of GDP)−20.0−14.6−7.5−10.7−12.4−12.2−10.5
Overall balance (percent of GDP)−2.92.73.53.22.20.60.8
Gross international reserves263299347396431441455
Months of current year’s imports of goods and services3.23.94.95.05.04.74.7
Months of next year’s imports of goods and services3.54.24.44.64.64.54.4
External public debt7539341,0551,1921,3091,3971,462
External aid (grants and loans; percent of GDP)15.216.414.713.211.79.57.7
Sources: Bank of Cabo Verde; and IMF staff estimates and projections.

Including banks’ delays on trade credit reporting.

Sources: Bank of Cabo Verde; and IMF staff estimates and projections.

Including banks’ delays on trade credit reporting.

5. As a result of the authorities’ budget reprogramming exercise, fiscal performance in 2013 was less expansionary than originally budgeted (Text Table 1, page 12; and Table 3b). This was in line with the Fund’s policy advice.

Text Table 1.Cabo Verde: Medium-Term Fiscal Adjustment(Percent of GDP)
201320142017Fiscal Adj: 2013-17
Budget1Est.MTFF 2Staff Adj.MTFFStaff Adj.MTFFStaff Adj.
Revenue (incl. grants)26.823.725.525.525.425.41.71.7
Of which: tax revenue20.117.818.818.820.320.32.52.5
Total expenditure34.231.534.533.631.327.7−0.2−3.7
Current24.022.426.025.324.224.21.81.8
Capital10.29.18.58.47.13.5−2.0−5.5
Overall balance−7.5−7.8−9.0−8.1−5.9−2.31.95.4
Onlending−8.0−5.4−4.4−3.2−2.3−1.43.14.0
Total financing (incl. onlending)−15.5−13.2−13.4−11.3−8.2−3.74.99.5
Total nominal public debt97.6104.6101.9112.198.614.51.0
PV of external public debt42.645.644.349.343.66.71.0
Memorandum item:
Public investment (incl. onlending)18.314.512.911.69.54.9−5.0−9.6
Sources: Cabo Verdean authorities and IMF staff estimates and projections.

Budget projections as presented in the 2012 Article IV Staff Report.

Uses staff projections for revenue, and the authorities’ MTFF projections for spending, with the exception of interest payments on debt.

Sources: Cabo Verdean authorities and IMF staff estimates and projections.

Budget projections as presented in the 2012 Article IV Staff Report.

Uses staff projections for revenue, and the authorities’ MTFF projections for spending, with the exception of interest payments on debt.

Table 3a.Cabo Verde: Statement of Operations of the Central Government, 2011–17 1(Millions of Cabo Verde escudos)
2011201220132014201520162017
Est.Proj.
Revenue37,91635,05037,25942,38043,52647,18050,921
Taxes29,58127,51528,03131,19133,66037,06040,677
Taxes on income and profit8,6788,6268,5418,9989,59010,27311,000
Taxes on goods and services13,84012,44313,12315,23217,11319,32921,832
Taxes on international trade6,2285,7785,7006,1296,0716,5066,829
Other taxes8356676688328879501,017
Grants4,3422,7683,7084,8893,1592,9492,579
Other revenue3,9934,7685,5206,3006,7077,1717,665
Of which: Fees and penalties2803654301,1051,1941,2921,398
Expenditure49,65050,11849,46954,67354,90157,88560,114
Current expenditure34,73834,16635,20041,16442,45044,79446,523
Compensation of employees15,67915,80116,11018,15918,96319,77720,627
Use of goods and services5,2484,4984,3967,1496,8006,9646,763
Interest2,2772,8663,4043,6014,0864,8485,593
Subsidies994274101170449451451
Current transfers4,3094,0544,0795,3715,2495,5485,632
Social benefits3,7163,9164,1413,9864,1554,3754,560
Other expense2,5152,7562,9682,7292,7482,8322,897
Net acquisition of nonfinancial assets14,91215,95214,26913,50912,45013,09113,590
Overall balance−11,734−15,067−12,210−12,294−11,374−10,705−9,193
Net financing11,73415,06712,21012,29411,37410,7059,193
Net foreign borrowing for the budget8,93311,5119,7239,4618,2216,5405,205
Net domestic credit22,1112,8351,8802,8323,1534,1653,987
Of which: Capitalization of SOEs−46−1,044−600−947000
Net errors and omissions2827222,4350000
Net other liabilities−5,304−5,714−10,322−7,112−7,032−6,000−4,700
Of which: Onlending−5,304−5,714−8,495−7,112−7,032−6,000−4,700
Total financing (incl. onlending)17,03820,78222,53219,40618,40616,70513,893
Memorandum items:
Net foreign borrowing (incl. onlending)14,23717,22518,21816,57415,25312,5409,906
Net acquisition of nonfinancial assets (incl. onlending)20,21621,66622,76420,62219,48219,09218,291
Sources: Cabo Verdean authorities and IMF staff estimates and projections.

Includes budgetary central government (BCG) and extrabudgetary central government (ECG), but excludes social security funds.

Includes capitalization of state owned enterprises.

Sources: Cabo Verdean authorities and IMF staff estimates and projections.

Includes budgetary central government (BCG) and extrabudgetary central government (ECG), but excludes social security funds.

Includes capitalization of state owned enterprises.

Table 3b.Cabo Verde: Statement of Operations of the Central Government, 2011–17 1(Percentage of GDP)
2011201220132014201520162017
Est.Proj.
Revenue25.623.023.725.524.725.125.4
Taxes20.018.017.818.819.119.720.3
Taxes on income and profit5.95.75.45.45.45.55.5
Taxes on goods and services9.48.28.39.29.710.310.9
Taxes on international trade4.23.83.63.73.43.53.4
Other taxes0.60.40.40.50.50.50.5
Grants2.91.82.42.91.81.61.3
Other revenue2.73.13.53.83.83.83.8
Of which: Fees and penalties0.20.20.30.70.70.70.7
Expenditure33.632.931.532.931.230.830.0
Expense23.522.422.424.824.123.823.2
Compensation of employees10.610.410.210.910.810.510.3
Use of goods and services3.52.92.84.33.93.73.4
Interest1.51.92.22.22.32.62.8
Subsidies0.70.20.10.10.30.20.2
Current transfers2.92.72.63.23.03.02.8
Social benefits2.52.62.62.42.42.32.3
Other expense1.71.81.91.61.61.51.4
Net acquisition of nonfinancial assets10.110.59.18.17.17.06.8
Overall balance−7.9−9.9−7.8−7.4−6.5−5.7−4.6
Net financing7.99.97.87.46.55.74.6
Net foreign borrowing for budget6.07.56.25.74.73.52.6
Net domestic credit21.41.91.21.71.82.22.0
Of which: Capitalization of SOEs0.0−0.7−0.4−0.60.00.00.0
Net errors and omissions0.20.51.50.00.00.00.0
Net other liabilities−3.6−3.7−6.6−4.3−4.0−3.2−2.3
Of which: Onlending−3.6−3.7−5.4−4.3−4.0−3.2−2.3
Total financing (incl. onlending)−11.5−13.6−13.2−11.7−10.4−8.9−6.9
Memorandum items:
Net foreign borrowing (incl. onlending)9.611.311.610.08.76.74.9
Net acquisition of nonfinancial assets (incl. onlending)13.714.214.512.411.110.29.1
GDP at current market prices (billions of CVEsc) 3147.9152.6157.2166.0176.2187.9200.3
Sources: Cabo Verdean authorities and IMF staff estimates and projections.

Includes budgetary central government (BCG) and extrabudgetary central government (ECG), but excludes social security funds.

Includes capitalization of state owned enterprises.

Uses staff projections for nominal GDP. The Ministry of Finance’s GDP projections are higher (by about 8 percent by 2017).

Sources: Cabo Verdean authorities and IMF staff estimates and projections.

Includes budgetary central government (BCG) and extrabudgetary central government (ECG), but excludes social security funds.

Includes capitalization of state owned enterprises.

Uses staff projections for nominal GDP. The Ministry of Finance’s GDP projections are higher (by about 8 percent by 2017).

  • Total revenue increased by about ¾ percentage point of GDP, considerably less than originally budgeted. While tax revenue edged down about ¼ percentage point, grants increased by ½ percentage point. Other non-tax revenue increased by the same amount, bolstered by additional resources from other state agencies that have been brought into the central budget through the creation of the Single Treasury Account.

  • Current expenditure and public investment were reduced significantly during the mid-year budget reprogramming exercise, in light of revenue shortfalls and delays in some external financing.3 Current expenditure is estimated as 1½ percentage points of GDP lower than budgeted, while public investment (including onlending) was 4 percentage points of GDP lower. The authorities were able to safeguard social spending from these containment measures.

  • The fiscal deficit fell by about 2 percentage points of GDP, to 7¾ percent. Including onlending, total financing was 13.2 percent of GDP—about ½ percentage point less than in 2012.

6. Monetary conditions eased over the course of the year, as reflected in the build-up of excess liquidity in banks (Table 4a and Figure 2). Since May 2013, when the BCV adopted a market-based process for placing central bank bills, rates on these instruments (and also on short-term government securities) have fallen below 1 percent—significantly below the 5.75 percent policy rate. Other interest rates have been relatively sticky at higher levels. For deposits, higher rates partly reflect ongoing competition between banks to secure emigrant funds. And for loans, higher rates are related to continued risk aversion by banks, against the backdrop of high NPLs. Looking at liquidity conditions, while banks overall are in a situation of excess, this has not yet translated into credit growth. In the absence of a functioning interbank market and given the relatively high cost of BCV overdraft facilities, banks do not want to risk getting caught short. In addition, given the sharp rise in NPLs, banks have become more risk averse in the extension of new credit.

Table 4a.Cabo Verde: Monetary Survey, 2011–17(Millions of Cabo Verde escudos, unless otherwise indicated)
2011201220132014201520162017
Proj.
Net foreign assets19,98625,37533,85438,61941,90742,29643,172
Foreign assets40,46652,72568,04173,38177,27678,31479,884
Of which: gross international reserves29,03433,00738,31243,65247,54648,58550,155
Foreign liabilities−20,481−27,350−34,187−34,763−35,369−36,019−36,713
Net domestic assets96,10298,034103,450107,773119,569134,048147,316
Net domestic credit120,308124,093128,159137,204147,689159,911172,252
Net claims on general government (net)21,95425,69428,13830,13131,83034,05736,203
Investment in TCMFs 110,80211,49911,49911,49911,49911,49911,499
Net claims on the central government9,99313,76915,98317,87219,44921,53223,525
Credit to central government19,40719,83722,94425,22127,24929,85132,394
Deposits of central government−9,414−6,069−6,961−7,348−7,800−8,320−8,869
Of which: project deposits−14−21−29−277−277−277−277
Net claims on local government and other agencies 21,1594266567598821,0261,179
Credit to the economy98,35498,400100,021107,073115,858125,854136,049
Other items (net)−24,205−26,059−24,708−29,431−28,119−25,863−24,937
Broad money (M2)116,088123,410137,305146,391161,476176,343190,488
Narrow money (M1)43,72845,64852,56454,14959,72965,22870,460
Currency outside banks8,3767,8958,0969,1259,96610,83011,649
Demand deposits35,35237,75444,46845,02449,76254,39858,811
Quasi-money67,86273,07080,18986,67795,609104,411112,786
Foreign currency deposits4,4984,6924,5525,5666,1396,7047,242
(Change in percent of broad money, 12 months earlier)
Net foreign assets−4.24.66.93.52.20.20.5
Net domestic assets6.51.74.43.18.19.07.5
Net domestic credit8.23.33.36.67.27.67.0
Netclaims on the central government3.03.31.81.41.11.31.1
Credit to the economy 36.30.01.35.16.06.25.8
Other items (net)−1.8−1.61.1−3.40.91.40.5
Broad money (M2)2.26.311.36.610.39.28.0
Memorandum items:
Emigrant deposits41,85345,45449,07056,58762,43468,19173,668
Emigrant deposits/total deposits (percent)38.939.338.041.241.241.241.2
Excess reserves/total deposits (percent)−2.51.74.7
Money multiplier (M2/M0)4.83.83.63.43.43.63.8
Credit to the economy (percent change) 38.00.01.67.18.28.68.1
Broad money (M2 in percent of GDP)78.580.987.388.291.693.895.1
Sources: Bank of Cabo Verde; and IMF staff estimates and projections.

TCMFs (Títulos Consolidados de Mobilização Financeira) are government bonds in escudos maturing in 2018 and backed by a trust fund managed by the Banco de Portugal.

Includes Cabo Verde’s National Pension Institute (INPS).

Staff adjusted variables presented in annual change, reflecting data discontinuity in December 2011.

Sources: Bank of Cabo Verde; and IMF staff estimates and projections.

TCMFs (Títulos Consolidados de Mobilização Financeira) are government bonds in escudos maturing in 2018 and backed by a trust fund managed by the Banco de Portugal.

Includes Cabo Verde’s National Pension Institute (INPS).

Staff adjusted variables presented in annual change, reflecting data discontinuity in December 2011.

Figure 2.Cabo Verde: Monetary Developments and Credit Growth

Sources: Cabo Verdean authorities and IMF staff.

7. Financial stability has been weakened by the slowdown in growth (Table 5). The NPL ratio peaked at 20 percent in September 2013, though fell back to 16 percent by year-end.4 Capital adequacy appears to remain solid for the banking system as a whole, with the ratio of capital to risk-weighted assets (CAR) reaching 13 percent at end-2013, comfortably above the 10 percent regulatory minimum. However, in one bank the CAR has fallen just below the regulatory minimum. In addition, given that provisioning has not kept up with the rise in NPLs (the coverage ratio is 48 percent, down from 52 percent a year ago), there is a risk that actual capital (if impaired loans are properly provisioned) could be lower.

Table 4b.Cabo Verde: Central Bank Survey, 2011–17(Millions of Cabo Verde escudos, unless otherwise indicated)
2011201220132014201520162017
StaffProj.Proj.Proj.
Net foreign assets26,64431,22436,81942,23746,19347,26248,832
Of which: net international reserves28,48032,64138,14143,55947,51548,58450,154
Foreign assets29,03433,00738,31243,65247,54648,58550,155
Of which: gross international reserves29,03433,00738,31243,65247,54648,58550,155
Foreign liabilities−2,391−1,782−1,492−1,414−1,354−1,323−1,323
Net domestic assets−2,2051,3551,6089641,0421,4701,848
Net domestic credit2713,4023,0453,0103,0883,5173,895
Investment in TCMFs 14,7394,8724,8734,8734,8734,8734,873
Credit to central government (net)−3,414−200−611−645−685−730−778
Credit to commercial banks (net)−1,740−1,989−1,997−1,998−1,884−1,413−991
Credit to the economy686719780780784788792
Other items (net)−2,475−2,047−1,437−2,047−2,047−2,047−2,047
Reserve money (M0)24,43932,58038,42743,20147,23448,73250,680
Currency issued9,8469,82910,09611,33013,80714,86515,778
Deposits of commercial banks14,59322,75128,33128,96334,04937,45540,720
Memorandum items:
Gross international reserves (millions of euros)263.3299.3347.5395.9431.2440.6454.9
Net international reserves (millions of euros)258.3296.0345.9395.0430.9440.6454.8
(months of next year’s imports)3.54.24.44.64.64.54.4
Reserve money (12-month change in percent)−5.733.317.912.49.33.24.0
Sources: Bank of Cabo Verde; and IMF staff estimates and projections.

TCMFs (Títulos Consolidados de Mobilização Financeira) are government bonds in escudos maturing in 2018 and backed by a trust fund managed by the Banco de Portugal.

Sources: Bank of Cabo Verde; and IMF staff estimates and projections.

TCMFs (Títulos Consolidados de Mobilização Financeira) are government bonds in escudos maturing in 2018 and backed by a trust fund managed by the Banco de Portugal.

Table 4c.Cabo Verde: Deposit Money Bank Survey, 2011–17(Millions of Cabo Verde escudos, unless otherwise indicated)
2011201220132014201520162017
StaffProj.Proj.Proj.
Net foreign assets−6,658−5,849−2,965−3,619−4,286−4,966−5,660
Foreign assets11,43219,71829,72929,72929,72929,72929,729
Foreign liabilities 1−18,090−25,567−32,694−33,348−34,015−34,695−35,389
Net domestic assets114,365121,352132,168140,885155,795170,479184,499
Net domestic credit134,984144,435155,259165,362181,374196,825212,294
Net claims on general government20,63021,02123,87625,90327,64229,91432,109
Investment in TCMFs 26,0646,6266,6266,6266,6266,6266,626
Net claims on central government13,40713,96816,59418,51720,13322,26224,304
Net claims on local government2,4021,6652,1252,2432,3812,5402,708
Credit to the economy97,66797,68199,241106,293115,074125,066135,257
Net claims on the Bank of Cape Verde16,68725,73332,14233,16638,65841,84544,927
Other items (net)−20,619−23,084−23,092−24,477−25,578−26,346−27,795
Deposit liabilities to nonbank residents107,707115,502129,203137,266151,510165,514178,839
Local currency deposits103,209110,811124,651131,701145,371158,809171,597
Demand deposits35,34737,74144,46245,02449,76254,39858,811
Time deposits67,86273,07080,18986,67795,609104,411112,786
Foreign currency deposits4,4984,6924,5525,5666,1396,7047,242
Memorandum items:
Emigrant deposits (ratio to total deposits)0.390.390.380.410.410.410.41
Other deposits (ratio to broad money)0.640.630.630.630.630.630.63
Composition of emigrant deposits
Local currency0.970.970.970.970.970.970.97
Foreign currency0.030.030.030.030.030.030.03
Sources: Bank of Cabo Verde; and IMF staff estimates and projections.

The large increase in foreign liabilities in 2012 and 2013 reflects the inclusion of three new banks in the monetary survey statistics.

TCMFs (Títulos Consolidados de Mobilização Financeira) are government bonds in escudos maturing in 2018 and backed by a trust fund managed by the Banco de Portugal.

Sources: Bank of Cabo Verde; and IMF staff estimates and projections.

The large increase in foreign liabilities in 2012 and 2013 reflects the inclusion of three new banks in the monetary survey statistics.

TCMFs (Títulos Consolidados de Mobilização Financeira) are government bonds in escudos maturing in 2018 and backed by a trust fund managed by the Banco de Portugal.

Table 5.Cabo Verde: Financial Soundness of the Banking Sector, 2009–13(End-year; percent unless otherwise indicated)
20092010201120122013
Capital adequacy
Regulatory capital to risk-weighted assets11.415.615.212.113.3
Regulatory Tier 1 capital to risk-weighted assets11.214.415.911.811.5
Asset quality
Nonperforming loans to total loans (end year)8.88.411.814.016.4
Nonperforming loans net of provisions3.02.35.16.78.5
Provisions to nonperforming loans65.873.056.652.047.9
Earnings and profitability
Return on assets0.70.70.40.30.2
Return on equity9.89.15.63.92.3
Interest margin to gross income72.077.776.275.575.9
Noninterest expenses to gross income65.467.068.576.576.5
Liquidity1
Liquid assets to total assets16.412.513.28.221.2
Liquid assets to short-term liabilities49.237.443.128.227.9
Additional indicators
Government deposits over total deposits3.69.57.69.7−5.4
Emigrant deposits over total deposits35.235.037.137.139.8
Emigrant deposits over total assets27.827.327.026.525.4
Demand deposits over total deposits42.242.643.442.045.4
Credit to private sector over total deposits76.379.285.978.980.2
Personnel cost over cost of operations47.349.049.950.147.3
Spread (90 day lending - time deposit rate)9.17.55.27.97.1
Spread (emigrant deposits - euro area deposit rate)2.52.21.81.42.6
Source: Bank of Cabo Verde.

Liquid assets include cash in vault and marketable securities. Short-term liabilities include demand deposits.

Source: Bank of Cabo Verde.

Liquid assets include cash in vault and marketable securities. Short-term liabilities include demand deposits.

8. Policy implementation in 2013 was broadly in line with the Fund’s policy advice. As recommended in the last Article IV, capital and current spending was curtailed compared to the original budget. However, the Fund’s recommendation to adopt an ambitious medium-term fiscal consolidation plan was not adopted. The Fund had also recommended a neutral monetary policy stance to support a rebuilding of reserves. The BCV kept rates on hold through 2013. There has also been further progress in strengthening supervision, as called for by the Fund in order to enhance Cabo Verde’s financial stability framework.

9. On the political front, the next parliamentary and presidential elections are expected in 2016. Prime Minister Jose Maria Neves, who began his third consecutive term in February 2011, represents the PAICV (Partido Africano da Independência de Cabo Verde). President Jorge Carlos Fonseca, in power since August 2011, is from the main opposition party, the MpD (Movimento para a Democracia). These two parties have been central in Cabo Verdean politics since independence in 1975, with each party having ruled for about a decade and now alternating power regularly.

C. External Assessment

10. While the external position has improved somewhat, Cabo Verde remains vulnerable due to its increasing external debt and challenges to competitiveness (Box 1). International reserves have recovered to about 4½ months of prospective imports, and are projected to remain around this level over the medium term. This reflects a healthy outlook for goods and services exports, and significant official financing flows (already committed). The exchange rate is assessed as broadly in line with fundamentals, as found in the last assessment (undertaken in March 2013). However, Cabo Verde’s high dependence on tourism and remittances points to significant external vulnerabilities. In addition, business sector surveys indicate that competitiveness remains a challenge. Cabo Verde is ranked 122nd out of 148 countries on global competitiveness by the World Economic Forum, with labor market efficiency, financial market development, and macroeconomic environment found to be particular challenges.

Box 1.External Stability Assessment1

An external stability analysis suggests that the real effective exchange rate (REER) is broadly in line with medium-term fundamentals. However, competitiveness remains weak, on account of inefficiencies in the labor market and access to financing. Improving the business environment and increasing the productivity of human and physical capital remain critical for bolstering medium-term growth.

Over the last decade, Cabo Verde’s balance of payments has been characterized by a relatively stable current account deficit (of about 16 percent of GDP), mostly used to finance investment. As grants and FDI have declined, the deficit has been financed increasingly by government borrowing, leading to a rise in external public debt from 39 percent of GDP in 2008 to 74 percent of GDP in 2013. After decreasing to 3.4 months of imports in 2011, at end-2013 international reserves had recovered to 4.4 months of imports—within the estimated optimal range of 3.7–5 months2—where they are projected to remain in the medium term. Exports of goods and services have increased steadily over 2003–12 (from about 30 to 45 percent of GDP), but remain heavily dependent on tourism and related travel, which represent about two thirds of the total.

Cabo Verde: Global Competitiveness Indicators, 2013–14
2012–13

(Out of 144)
2013–14

(Out of 148)
Change 1
Overall Rank122122No change
Basic requirements (40%)100103−3
nstitutions5769−12
infrastructure114116−2
Macroeconomic environment121128−7
Health and primary education7175−4
Efficiency enhancers (50%)128130−2
Higher education and training99945
Goods market efficiency105112−7
Labor market efficiency126129−3
Financial market development121127−6
Technological readiness9091−1
Market size143148−5
Innovation and sophistication factors (10%)1191181
Business sophistication118121−3
Innovation1201164
Source: World Economic Forum.

Negative sign indicates worsening score; otherwise indicates improvement.

Source: World Economic Forum.

Negative sign indicates worsening score; otherwise indicates improvement.

Cabo Verde still does relatively poorly on competitiveness. Based on the World Economic Forum (WEF), Cabo Verde ranks 122nd out of 148 countries on global competitiveness, with market size, labor market efficiency, macroeconomic environment, and financial market development found to be particularly weak (see Table). In WEF business surveys, access to financing, labor market issues (cited under several factors), and inadequate supply of infrastructure feature among the most problematic factors for doing business (see Chart). Structural reforms aimed at improving the business climate therefore remain critical for bolstering competitiveness and attracting private investment.

Cabo Verde: The Most Problematic Factors for Doing Business

Source: World Economic Forum.

Turning to the exchange rate, all three approaches based on Consultative Group on Exchange Rates (CGER)-type methodologies indicate that Cabo Verde’s real exchange rate is broadly in line with its fundamentals. Even though all three measures indicate possible undervaluation, the results are below the 10 percent threshold required for the assessment to be deemed statistically significant. The assessment has changed little since the 2012 Article IV assessment.

Cabo Verde: Quantitative Exchange Rate Assessment Results
Current Account

(Percent of GDP)
CA Elasticity1, 2REER misalignment3
NormUnderlying
Equilibrium Real Effective Exchange Rate−7.9
Macroeconomic Balance−9.2−6.7−0.385−6.5
External Sustainability−9.7−6.7−0.385−7.8
Source: IMF staff estimates.

CA elasticity = [Export elasticity * Share of exports in GDP]-[(Import elasticity-1) * Share of imports in GDP].

Tokarick (2010) estimates Cape Verde’s export and import elasticities of 0.36 and 1.41, respectively.

In percentage, “+” = overvaluation.

Source: IMF staff estimates.

CA elasticity = [Export elasticity * Share of exports in GDP]-[(Import elasticity-1) * Share of imports in GDP].

Tokarick (2010) estimates Cape Verde’s export and import elasticities of 0.36 and 1.41, respectively.

In percentage, “+” = overvaluation.

1 A more detailed assessment of Cabo Verde’s external balance was presented in Appendix 1 of the 2012 Article IV Staff Report.2 Marcio Ronci, “Cape Verde: Assessing International Reserve Adequacy” (2012 Article IV Staff Report).

D. Outlook and Risks

11. Staff forecasts a modest economic recovery in 2014, with GDP growth of 3 percent. The improving outlook for the euro area bodes well for remittances, FDI, and tourism (although competition from destinations in North Africa could increase in 2014). Better external conditions and continued strength in tourism are expected to help consumer and business sentiment recover. There are also encouraging signs that a number of stalled FDI projects in tourism will resume in 2014. As monetary conditions have eased and NPLs are gradually being resolved, banks should also be in a stronger position to increase credit to the private sector. Over the medium term, and drawing on the experience of other small middle-income countries, staff sees growth of about 4 percent as consistent with a lower middle-income economy that still faces challenges on the competitiveness front (Appendix Table 1). The balance of payments is forecast to again reach a small surplus in 2014. While imports are expected to rebound, reflecting a recovery in consumer sentiment and investment, strong remittances and public capital flows (as well as an uptick in FDI) should allow international reserves to cover about 4½ months of prospective imports.

12. The outlook remains subject to both upside and downside risks (Table 7).

Table 6.Cabo Verde: Implementation Status for the Recommendations of the 2009 FSAP
RecommendationTimeframeStatus
Financial Sector Soundness, Supervision and Regulation
Reducing vulnerabilities in domestic banks
  • Encourage banks to raise capital above the regulatory minimum and strictly avoid forbearance in case of even temporary shortfalls

  • Further enhance the framework for financial soundness analysis

  • Enhance credit risk assessment framework

Short term

Short term

Short term
Done



In process

In process
Mitigating risks in the offshore sector
  • Determine whether to wind down IFI sector or reform it to conform to international standards of regulation, supervision and integrity

  • If reform is chosen, implement international standards of regulation, strengthen supervisory powers, and adopt stricter licensing standards

Short term

Short term
Done



In process
Enhancing banking supervision
  • Improve supervision of onshore and offshore banks

  • Improve the legislative and regulatory framework for supervision

Short term

Short term
In process

In process
Establishing a crisis management framework
  • Create well-defined guidelines for the management of problem financial institutions and financial crises

  • Review law and develop implementing regulations outlining lender of last resort arrangements

  • Assess desirability of instituting system of deposit insurance, taking into account costs, benefits, and structure of the financial system

Short term



Short to medium term

Short term
Done



In process



Done
Issues in Systemic Liquidity and Monetary Management
Enhancing the framework for monetary operations
  • Streamline monetary operations decision making process

  • Use predetermined long-term intervention program to implement program targets and short-term operations to manage daily liquidity conditions at banks.

  • Release Board monetary meeting minutes with a lag

  • Use t-bills for monetary operations as much as possible

  • Improve coordination of monetary and fiscal operations between BCV and the Treasury

  • Harmonize tax treatment of BCV securities and treasuries

Medium term

Short term

Medium term

Medium term

Short term.

Short term
Done

In process



Not initiated In process

Done



Not initiated
Developing the money market
  • More actively manage bank liquidity through daily auctions

  • Apply less punitive and symmetric rates to standing facilities

  • Allow wider secondary market trading in BCV securities

  • Use repos to implement all of BCV’s short-term interventions (standing facilities and auctions)

Short term

Medium term

Short term

Medium term
In process

Not initiated

Not initiated

In process
Challenges for the Development of the Financial Sector
Access to Finance
  • Promote technical assistance to SME’s to implement proper accounting systems to facilitate lending decisions

  • Implement a more comprehensive credit reporting system

  • Do not allow deposit-taking by microfinance institutions

Short term



Short term

Short term
Not initiated



In process

In process
Pension and insurance
  • Strengthen the governance and transparency of the INPS

  • Evaluate additional parametric reforms to the INPS to ensure long-term viability

  • Evaluate the costs, benefits, and risks of allowing INPS to place part of its assets abroad

  • Consider tax deferral of contributions and investment gains in employer contributions as expenses for purposes of corporate and personal income tax

  • Modernize the legal and regulatory framework for insurance

Short term



Medium term

Short term



Medium term

Medium term
In process

In process



Not initiated

Not initiated

Not initiated
Legal and judicial issues
  • Finish the process of replacing the Code of Civil Procedure

  • Implement further steps to promote mediation

  • Promote improved corporate governance practices that impact firms’ ability to obtain credit

  • Draw lessons from experience of other countries in replacing the bankruptcy code

Short term

Short term

Short to medium term

Medium term
In process

In process

In process

In process
Source: IMF Article IV, March 2014. Updated by IMF staff in March 2014.
Source: IMF Article IV, March 2014. Updated by IMF staff in March 2014.
Table 7.Risks Assessment Matrix1
Sources of risksLikelihood of realization in next 1-3 yearsImpact if realized
External (exogenous) risks
Protracted period of slower growth in euro area economiesHighHigh
The outlook for the euro area is for a modest recovery. However, the area remains subject to downside risks of prolonged stagnation.Prolonged stagnation would depress exports, remittances, and FDI, and consequently domestic demand. It could also lower grants and other donor financing. These would have a significant impact on economic growth and foreign reserves.
Surges in global financial market volatilityHighMedium
Bouts of market volatility and higher-than-expected increases in long-term rates could occur as a result of advanced countries exiting from UMP.Although Cabo Verde is relatively insulated from global financial markets, higher interest rates in the US and the euro area could depress remittances and put pressure on international reserves.
Financial stress in Euro area (and in particular Portugal) re-emergesMediumMedium
Financial stress could re-emerge as a result of stalled or incomplete delivery of national and euro policy commitments.A sharp deterioration in the Portuguese banking system could have a serious impact on Cabo Verde, given the dependence of the latter’s banks on Portuguese capital (three of the four largest banks are Portuguese subsidiaries).
Internal (endogenous) risks
Delays in fiscal consolidationHighHigh
While the authorities have committed to medium-term fiscal consolidation, the 2014 budget is expansionary and 2015 is a pre-election year.A perceived lack of commitment to fiscal consolidation could seriously undermine investor perceptions of macroeconomic stability, reducing capital inflows and weakening confidence in the peg. It could also reduce concessional support from development partners, who have underscored the importance of fiscal consolidation.
Surge in imports or shortfall in capital inflowsMediumHigh
The outlook is for reserves coverage to remain at about 4½ months of imports over the medium term. However, a sharper-than-expected increase in imports or shortfall in capital inflows could weaken the balance of payments.A decline in the reserves coverage could undermine confidence in the peg, which could lead to a further decline in private inflows and remittances. A policy response of tightening monetary policy would weaken the recovery, while an imposition of capital controls would undermine investor confidence.
Financial instabilityMediumMedium
NPLs have risen significantly in the last two years, reflecting the decline in economic activity but also intensified supervision. With the economy still weak, NPLs could rise further. Associated bank losses could result in capital shortfalls.The banking system as a whole is fairly well capitalized, which reduces the potential cost of a bank failure. In addition, with most banks having majority foreign ownership, outside capital would likely be available to recapitalize a failed bank. However, there is little fiscal space to finance any public bail-out.
Delays in state-owned enterprise reformsMediumMedium
The authorities have adopted a detailed agenda to reform SOEs. However, implementation could be delayed due to political economy challenges.Financial weaknesses in some of the largest SOEs represent contingent liabilities for the government. As of end-2012, the debt of SOEs amounted to 27 percent of GDP. Persistent weak financial performance of SOEs could crowd out public investment and threaten fiscal sustainability.
Failure to increase productivityMediumMedium
Implementation of needed structural reforms could be delayed due to political economy concerns, especially in the labor market (where Cabo Verde is particularly uncompetitive, and which matters greatly for service sector productivity).Cabo Verde’s long-term growth depends critically on bolstering productivity. Delays in advancing the structural reform agenda hinder external competitiveness, potential GDP growth and employment.

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline scenario path discussed in this policy note, which is the scenario most likely to materialize in the view of IMF staff. The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding this baseline.

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline scenario path discussed in this policy note, which is the scenario most likely to materialize in the view of IMF staff. The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding this baseline.

  • On the upside, a more rapid resumption of FDI in both stalled and new projects could bolster growth. And over the longer term, the public investment program and the successful implementation of the government’s wide-ranging structural reform program could increase productivity and raise potential growth.

  • On the downside, Cabo Verde faces both external and domestic risks. Externally, its high dependence on tourism and remittances makes it vulnerable to a further delay in the European recovery. In addition, its strong financial ties to Portugal—three of the four largest banks in Cabo Verde are owned by Portuguese groups—make it vulnerable to a resurfacing of financial stress in the euro area. Domestic risks are primarily fiscal in nature, given high public debt. Risks in the financial sector have increased with the economic downturn, and NPLs could aggravate the cycle through their adverse effect on growth (Box 2).

Box 2.NPLs and Economic Growth

The economic downturn in Cabo Verde has led to a significant increase in non-performing loans (NPLs). The experience of other countries shows that high NPLs can exert a drag on economic growth. To mitigate this impact, the central bank should take action to help arrest the rise in NPLs, and ideally also resolve them.

Since the onset of the global financial crisis, Cabo Verde has experienced a sharp increase in NPLs. Since 2009, the ratio of NPLs to total loans has increased significantly, peaking at 20 percent in September 2013 (though easing to 16 percent by December 2013). Corporates account for about two-thirds of the NPL stock, with NPLs concentrated in tourism, transport, business and construction. Households account for the remaining third of the NPL stock, with the impaired portfolio concentrated in mortgages.

Economic studies have found a link between high NPLs and economic growth, with intermediation declining as impaired assets rein in bank profitability. A number of empirical studies have established a strong, albeit short-lived feedback effect from bank losses on economic activity. To cite a few results, Espinoza and Prasad (2010) found an elasticity of 0.4 for NPLs on non-oil growth in the Gulf Cooperation Council (1995–2008). Nkusu (2011) found an elasticity of 0.6 over three years looking at the experience of 26 advanced countries (1999–2009). And Klein (2013) found an elasticity of 0.6 over two years in a group of Central Eastern and South Eastern Europe (1998–2011). While caution is warranted in applying these results to Cabo Verde, they do suggest that the recent increase in NPLs entails risks for growth.

The BCV has taken an active role in addressing the NPL situation in Cabo Verde. Following the sharp run-up in NPLs in 2012, the BCV conducted a detailed review of the quality of assets for the top clients of the largest banks, with the aim of assessing their provisioning and NPL disclosure practices. The BCV established that procedures were not standard across the banks and asked all banks to adopt stringent IFRS compliant definitions. They developed a credit impairment index to encourage transparency on NPLs and asked banks to cease dividend payments in 2013. The BCV also undertakes post-balance sheet submission adjustments to enforce provisioning standards.

The pace of write-offs has been slow so far, reflecting the weak economic situation, lengthy foreclosure processes, and underdeveloped markets for distressed real estate assets. While speeding up the reduction of NPLs is desirable, the capacity of banks to absorb further losses is limited. High NPLs are exerting pressure on banks’ balance sheets, with profitability, as proxied by return on equity, declining to 2.3 percent in 2013 from 9.1 percent in 2010. Capital adequacy dropped from a comfortable cushion of 15.6 percent in 2010 to 12.1 percent in 2012, before recovering to 13.3 percent in 2013.

The BCV is encouraged to take the following steps to support the resolution of the NPL overhang:

  • continue to monitor banks closely, and intervene preemptively to reinforce resilience of their positions;

  • encourage banks to strengthen and enforce loss recognition and provisioning standards;

  • provide proper guidance on loan restructuring, collateral valuation and asset classification;

  • align current accounting and disclosure practices on loan quality and provisioning to best practices; and

  • study backlogged cases and develop an action plan to tackle delays in judicial processes.

Policy Discussions

Policy discussions focused on four key challenges facing Cabo Verde today. First, with public debt already at high levels, can fiscal policy still play a major role in supporting long-term growth? Second, given monetary policy’s primary objective of safeguarding the peg, is there scope to loosen the monetary policy stance in support of the recovery? Third, how has the downturn affected financial stability? And fourth, what can be done to increase competitiveness and improve the long-term outlook for growth? These issues are central to ensuring macroeconomic and debt sustainability in the near term, and for helping Cabo Verde shift to a productivity-led growth strategy over the medium term.

A. Balancing Fiscal Consolidation with Support for Long-Term Growth

13. The challenge for fiscal policy is to strike the right balance between supporting growth and preserving macroeconomic stability and debt sustainability. The IMF has supported Cabo Verde’s strategy to use concessional resources to finance public investment that boosts the country’s long-term growth potential. It has also seen a role for public investment to cushion the impact of the global downturn. However, as noted in the 2012 Article IV consultation, ambitious medium-term fiscal consolidation is essential to secure debt sustainability and rebuild fiscal positions. With public debt now approaching 100 percent of GDP, ambitious fiscal adjustment has become even more urgent (Text Figure 1). This view is shared by the World Bank and other members of the Budget Support Group.5 It is also shared by rating agencies. In March 2014, Fitch downgraded Cabo Verde’s long-term foreign and local currency ratings from B+ to B, citing a significant deterioration in the fiscal outlook and a weaker outlook for economic growth.

Text Figure 1.Cabo Verde: Revenue, Expenditure and Public Debt

Sources: Cabo Verdean authorities and IMF staff.

14. The authorities’ 2014 budget entails an increase in the deficit and total financing needs, while their medium-term fiscal plans set out a relatively small consolidation effort.6 For 2014, the budget entails a deficit of about 9 percent of GDP, over 1 percentage point higher than in 2013 (Text Table 1).78 Including onlending, total financing needs would reach 13½ percent of GDP. For 2015–17, the MTFF’s expenditure plans (including onlending) would cause public debt to exceed 110 percent of GDP by 2017.

15. Staff recommended more ambitious fiscal consolidation to reduce the risk of debt distress, support investor confidence, and bolster international reserves. By reducing the need for domestic financing, there would be more room for credit to the economy, which would support the shift to private-sector led growth. In addition, by winding down the public investment program more quickly, external debt would grow less rapidly, thereby reducing external vulnerabilities and bolstering investor confidence. The impact on the balance of payments would likely be positive, with private capital flows picking up as external risk declines.

16. Staff’s recommendations would deliver steady deficit reduction over the coming years, thereby demonstrating the authorities’ commitment to fiscal consolidation. For 2014, staff recommended expenditure cuts of about 1 percentage point of GDP, and a similar reduction in public investment financed by onlending. Staff also recommended that major new public investment projects meet stringent tests of value-for-money. With current expenditure budgeted to increase by 4 percentage points of GDP, staff saw scope to contain spending, especially in the area of goods and services. For 2015–17, staff recommended a more cautious public investment plan and slower growth in some current expenditure items (while protecting social spending). Staff’s proposed path would reduce the fiscal deficit by over 5 percentage points of GDP between 2013 and 2017, and total financing by 9½ percentage points—about 4½ percentage points more than envisaged in the authorities’ plans. Public debt would be considerably lower in the adjustment scenario, falling below 100 percent of GDP by 2017. In light of the weaker growth outlook, the consolidation path recommended by staff is more gradual than had been proposed in the last Article IV Consultation.

17. Further efforts to enhance domestic resource mobilization will be critical to support consolidation, and also to prepare Cabo Verde for the phasing out of concessional financing. Staff welcomed the many important achievements during 2013, including the harmonization and streamlining of VAT rates, the passage of three new tax codes, and the launch of a large taxpayer office. The authorities have also focused on enhancing the efficiency of tax administration, by reforming the Directorate of Contributions and Taxes (DCI). Further improvements in taxpayer services and a smooth merger of customs and revenue administration remain important priorities. Staff welcomed plans to resolve sizeable tax arrears (about 4 percent of GDP), as well as outstanding claims for tax refunds (about 1½ percent of GDP).9

18. With regards to public financial management, the authorities have also made considerable progress. They have developed sound fiscal forecasting tools, introduced a medium-term fiscal framework, aligned their budget and planning processes, and introduced program-based budgeting. As recommended by FAD, more prioritization amongst the ongoing reforms, as well as detailed implementation arrangements, would contribute towards their success. Strengthening the coordination unit at the Ministry of Finance and Planning would also help. FAD has noted that under current procurement practices, which devolve such responsibilities to line ministries, there is a risk of unmonitored arrears. For this reason, they have recommended introducing robust commitment controls and improving the monitoring of arrears.

19. The performance of state-owned enterprises (SOEs) is improving, but further reforms are needed to increase efficiency and reduce contingent financial liabilities for the government. In 2012, the six largest SOEs registered total losses of 0.7 percent of GDP and debt of 27 percent of GDP. Preliminary estimates indicate that performance in 2013 was better. The national electricity and water provider (ELECTRA) has adopted a cost-based pricing mechanism and a results-based management contract—the first amongst the SOEs. The national airline (TACV) aims to complete the sale of its baggage handling branch by end-2014, but needs further urgent reforms to reduce losses and resolve sizeable domestic arrears. At the housing agency IFH, potential contingent fiscal liabilities arising from the social housing program “Casa Para Todos” (with a total program cost of €170 million over 2011–17, or 11 percent of 2014 GDP) require careful monitoring.10 In light of the potential financial risks of the program, the authorities should take a careful, phased approach to its development.

Authorities’ views and recent measures

20. The authorities underscored their commitment to preserving macroeconomic stability. As noted in their Growth and Poverty Reduction Strategy Paper III (GPRSP-III), Cabo Verde would not have been so successful if it had not prioritized macroeconomic stability as the core factor of good governance. Now, in the face of the country’s reduced capacity to borrow, it has become critical to bolster domestic revenue mobilization in order to ensure macroeconomic stability. A broad set of reforms has already been implemented to streamline and rationalize tax policies in line with international best practice, and efforts are underway to increase the efficiency of tax administration.

21. The authorities emphasized that as in previous years, expenditure containment measures would be taken if revenue underperformed. A budget re-programming exercise—covering 2014 and the medium term—will take place in the second quarter of this year, once revenue performance in the first quarter is known. After the mission, the authorities informed staff that they had already decided on preliminary expenditure containment measures for 2014–17 that will lower expenditure by about 1½ percentage points of GDP per year. About half of the reduction would be in goods and services, with the rest split evenly between other current expenditure and capital expenditure. The authorities also noted that further cuts could be taken, if needed.11

22. With regards to capital expenditure, the authorities highlighted the window of opportunity Cabo Verde still had to draw on concessional resources to finance critical infrastructure projects. By addressing key bottlenecks, the PIP is boosting the country’s long-term growth potential and has helped protect the economy from the global downturn. The authorities underscored that they are working closely with the World Bank to adopt a national investment review board, to ensure that approved projects meet stringent rate-of-return criteria.

Staff evaluation and debt sustainability analysis

23. While staff welcomes the authorities’ initial package of expenditure containment measures, a considerably greater consolidation effort will be needed to put public debt on a faster downward trajectory and reduce significant external vulnerabilities (Text Figure 2). The revised MTFF projections are based on the authorities’ revised nominal expenditure projections, including the containment measures, but using the Medium-Term Debt Strategy (MTDS) projections for debt service (Tables 3a and 3b). The baseline projections for GDP growth and revenue are those of staff; both are somewhat below those of the authorities. While this revised spending path does bring down financing needs, public debt would still peak at 108 percent of GDP in 2016–17. In staff’s recommended adjustment scenario, public debt would peak at 103 percent of GDP, and fall below 100 percent of GDP by 2017.

Text Figure 2.Cabo Verde: Financing Needs and Public Debt Under Different Consolidation Scenarios

Sources: Cabo Verdean authorities and IMF staff.

24. Based on the authorities’ revised expenditure projections, Cabo Verde’s external debt risk rating is assessed as “moderate” (Debt Sustainability Analysis Annex). While no threshold is breached under the baseline, both debt-to-GDP and debt service-to-revenue thresholds are breached in the one-time depreciation shock scenario. However, risks to overall debt sustainability remain high. The fact that the NPV of external debt peaks at 49 percent—just shy of the 50 percent threshold in the baseline—points to significant vulnerabilities. Cabo Verde is also vulnerable to contingent liabilities from the debt of SOEs. As discussed in the DSA Annex, having to take on even part of these liabilities through external loans (given legal constraints on domestic financing) would cause Cabo Verde’s risk rating to increase to “high”. Reducing the risk of debt distress will therefore depend critically on accelerating fiscal consolidation and advancing structural reforms to boost growth and enhance the efficiency of the public sector.

B. Balancing a Strong Peg with Support for the Recovery

25. Cabo Verde’s monetary policy is geared towards maintaining a level of foreign exchange reserves that is consistent with safeguarding the peg. Following a 150 basis points policy rate increase in January 2012, international reserves recovered from minimally adequate levels in 2012, to about 4¼ months of prospective imports at end-2013—within the range estimated as adequate by staff research. They also cover 70 percent of emigrant deposits (which account for 40 percent of total deposits) and 25 percent of M2. The peg has served the economy well, given Cabo Verde’s strong trade and financial ties to the euro area. An assessment using CGER-type methodologies indicates that the real exchange rate is broadly in line with fundamentals (Box 1).

26. Given weak economic growth, low inflation, and the stabilization of international reserves, staff saw scope for a cautious loosening of the monetary policy stance. A cut in the policy rate would send an important signal about the direction of monetary policy, even if weaknesses in the transmission mechanism would limit its impact on market rates. With regards to a possible negative impact on capital flows, staff noted that the very high spread between rates in Cabo Verde and in advanced economy markets made this unlikely. On the contrary, if a rate cut was seen as supporting a recovery in credit and growth, it could actually lead to higher inflows.12

27. Staff also recommended reducing the 18 percent minimum reserve requirement, which is relatively high compared to peers. This would free up liquidity and could support credit creation. Having said this, staff stressed the importance of close monitoring of liquidity conditions, and advised readiness to step up sterilization if international reserves came under pressure.

28. Strengthening the transmission mechanism remains an important objective to enhance the effectiveness of monetary policy. The policy rate is currently not playing the role of a reference rate. Strengthening the BCV’s liquidity management could help to align the policy rate with market rates. Reforms to develop the government securities market, with the aim of developing a (non-segmented) market-based term structure of interest rates, are also needed. In this regard, particular care should be taken so that large public institutions do not distort pricing when investing in this market. More broadly, reforms that enhance the framework for monetary operations would also contribute to enhancing the effectiveness of monetary policy (Table 6).

29. With regards to international reserves, the BCV sought to explore options to shore up Cabo Verde’s resilience to capital outflows. While emigrant deposits have shown welcome stability over many years, a confidence shock could result in significant emigrant capital flight and present risks to the financial system. One possible mechanism to shore up international reserves would be to make the foreign assets held by the “International Support for Cape Verde Trust Fund” accessible to the BCV, when needed. This is an avenue worth exploring further, and on which MCM stands ready to provide guidance.

Authorities’ views and recent measures

30. The BCV agreed with the staff’s recommendation to lower the policy rate, given less favorable economic conditions, and in the absence of imminent pressures on the balance of payments or consumer prices. The policy rate was cut by 150 basis points—to 4.25 percent—on March 1, 2014. The rediscount rate and the BCV’s lending facility rate were cut by the same amount, to 8.25 percent and 7.25 percent, respectively. The aim of these measures is to help stimulate financing for viable investment projects, and thereby support the recovery. The BCV emphasized that the impact of these measures will be enhanced if they are combined with structural measures that help reduce risks and bolster potential growth.

31. The BCV noted that the impact of a rate cut on lending rates was unlikely to be significant, given weaknesses in the transmission mechanism. In discussing the recent disappointing performance of the interbank market (with no trades since 2012), the BCV explained that this was due to the fact that all banks have excess liquidity. The BCV requested further TA on liquidity management, in particular for retaining control over the monetary base (and international reserves) when the BCV intervenes to help banks facing a short-term liquidity need.13

32. With regards to the minimum reserve requirement (MRR), the BCV was of the view that it should be maintained at 18 percent. The BCV considers the MRR an important prudential tool, whose level should be determined by the stage of development and potential fragilities of the financial sector. They also noted that it was not a good idea to change the MRR too frequently (and it had only just been increased 2 years ago). Viewed from a historical context, the BCV considers the current level of the MRR—at 18 percent—as not very high (though the BCV acknowledged that it is high compared to peers). Furthermore, the BCV noted the constraints that the fixed exchange rate regime places on monetary policy, in particular given that about 40 percent of the funding of banks consists of emigrant deposits.

Staff evaluation

33. With the recent cut in the policy rate, staff assesses the stance of monetary policy as appropriate. Over time, this lower policy rate should help bring down market rates, which in turn would catalyze credit creation and support growth. In addition, if banks are successful in reducing the NPL overhang and with improving growth prospects, risk aversion may come down, which could reduce the need for precautionary excess liquidity. Given the weak transmission of monetary policy (either through changes in the policy rate or by releasing required reserves) and existing excess liquidity, financial sector reforms that address this weakness remain urgent.

C. Reinforcing Financial Stability through the Economic Downturn

34. While financial stability risks have increased with the economic downturn, the BCV has acted on various fronts to address these risks. The central bank has adopted a more stringent definition of NPLs (using IAS/IFRS standards), has undertaken an asset impairment review for the top 100 clients of systemic banks, and has issued guidance to banks to suspend dividend payments (which was done for 2012, and may also be done for 2013). The BCV also issued new regulations that harmonize asset quality classification and provisioning standards, which are in effect as of December 2013. Cabo Verde is supported by MCM TA aimed at strengthening the financial stability framework (including bank supervision, crisis management and contingency planning; see Informational Annex). Progress continues to be made in implementing the recommendations of the 2009 Financial Sector Assessment Program (FSAP), especially in the areas of bank supervision and the legal and regulatory framework (Table 6). An important achievement was the recent enactment of the Basic Banking Law and the Financial Institutions Law, which will enhance the BCV’s powers to strengthen oversight (including of the offshore sector) and implement regulatory reforms. The new financial laws will also strengthen the framework for insolvency, by enabling the use of progressive enforcement measures, early intervention and a broad range of resolution and liquidation tools. The next step is to draw up implementing regulations, which will also provide the opportunity to address some recommendations provided by MCM on the new laws.14

35. Staff encouraged the BCV to press ahead with efforts to address remaining priorities from the FSAP agenda. Amongst these, staff considers enhancing banking supervision and putting in place robust policies for crisis management as particularly important. The BCV should step up further its supervision of banks (to ensure proper classification of NPLs and proper provisioning), and reach understandings with bank owners on how to deal with possible liquidity and/or solvency threats. In particular, it should work closely with the bank whose CAR has fallen just below the 10 percent minimum, to ensure that it rebuilds its capital quickly. Strengthening collaboration between the BCV and the Ministry of Finance—in particular by making the Financial Stability Committee fully operational—remains essential to enhance crisis preparedness at the institutional level. The BCV’s Financial Stability Report, which compares favorably with its peers, could be strengthened further by linking assessments over time (to clarify where the principal changes have taken place), strengthening the forward-looking orientation of the report by using early warning tools and qualitative surveys, and including more analytical topics (Box 3).

Box 3.Cabo Verde’s Financial Stability Report

The Banco de Cabo Verde (BCV) began publishing a Financial Stability Report (FSR) in 2008. The BCV’s FSR compares well with FSRs issued by peer countries, in particular with regards to the consistency of covering key stability risks, and also its increasing use of more sophisticated assessment tools like stress tests. Some suggestions for further enhancements are provided below, drawing on international best practices.

Over the last 20 years, Financial Stability Reports (FSRs) have come to play a key role as a financial sector surveillance tool. Since they are published on a regular basis, FSRs provide a good perspective on emerging risks and adverse trends that might threaten the financial system. By alerting financial institutions and market participants to the possible collective impact of their actions, FSRs can help prepare the ground for a collaborative and informed approach when confronted with a crisis. Publishing FSRs subjects the analysis of central banks to public scrutiny, which improves accountability and transparency. FSRs can also help encourage greater cooperation between central banks and ministries of finance, in particular if they are a regular agenda item of joint committees that focus on stability, crisis preparedness and management.

Most central banks are publishing FSRs. The first FSRs were issued in Europe in 1995; the first FSR in sub-Saharan Africa (SSA) was issued in 2004, by the South African Reserve Bank (SARB). The BCV launched its FSR in 2008 with the goal of identifying, analyzing and monitoring current and potential risks to the financial system. Like most central banks, the BCV publishes its FSR on a semi-annual basis, to capture in a timely manner emerging risks to financial stability. To assess the risks, most FSRs utilizes indicators related to macroeconomic aggregates, financial soundness, early warning, and market based and qualitative indicators.

The BCV’s FSR compares well to FSRs issued by peers in SSA. The BCV started publishing its FSR relatively early (about four years after the SARB), and in the absence of a financial crisis (unlike most peers). Using an approach based on the “CCC” framework (assessing the report’s clarity, consistency and coverage)1 FSRs published by the BCV (2008–13) were compared with those published by peer central banks of Ghana, Mauritius, Namibia and South Africa. As the BCV has gained more experience, the content of the report has been strengthened, and more data is being provided. Over time, there has been good consistency in covering key stability risks, as well as sectors like the insurance markets, payment systems and the regulatory framework. The use of more sophisticated tools like stress tests (adopted in 2009 after Cabo Verde’s FSAP) has increased over time, and has enhanced the forward-looking orientation of the report.

Drawing on international best practices, the BCV’s FSR could be strengthened further as follows:

  • improving the linkages between assessments over time, to clarify main changes in the assessment;

  • strengthening forward orientation, by using early warning tools and surveys (e.g., Bank Lending Survey);

  • focusing more on the interconnectedness of banks, to avoid missing risks to financial stability;

  • exploring the introduction of a non-core part of the report where issues for follow up, selected articles, collaborative studies or papers on topical issues are discussed; and

  • including the BCV’s definition of financial stability and the aims of the FSR in each report, to improve users’ understanding of the purpose of the report.

1 Martin Čihák (2006) “How Do Central Banks Write on Financial Stability?” IMF Working Paper WP/06/163

Authorities’ views

36. The BCV explained the recent steps they have taken to shore up financial stability. Banks have been required to strengthen their provisions and, in cases of insufficiency, they must register these insufficiencies immediately in their financial statements. The BCV is also monitoring write-offs of fully provisioned NPLs very closely, and explained that a new BCV regulation requires banks to regularly report all impaired loans to the BCV.

37. The BCV noted that the coverage ratio of provisions is actually higher than indicated by headline measures. All banks were asked to harmonize their accounting provisions by end-December 2013. Where relevant, the BCV identified underprovisioning in banks’ financial reports and deducted the estimated underprovisioning from bank capital, reporting this as “adjusted” capital. Based on the harmonization exercise, if the value of the provisions recorded in the financial statements is included, the coverage ratio of provisions improves to 55 percent for credits more than 30 days overdue, and 70 percent for credits more than 90 days overdue.

D. Bolstering Competitiveness to Sustain Inclusive Growth

38. To sustain robust and inclusive growth over the medium term, Cabo Verde needs to make further progress in addressing shortcomings in competitiveness. The country made significant strides in recent years, moving up in the World Economic Forum’s (WEF) Global Competitiveness rankings from 146th in 2010 to 122nd in 2012. And as noted in Box 1, the exchange rate is assessed as broadly in line with long-term fundamentals. However, compared to its peers in the region, Cabo Verde still lags behind in a number of areas that matter for global competitiveness. It has also demonstrated greater macroeconomic vulnerabilities than its peers (Figure 3).

Figure 3.Cabo Verde’s Performance Compared to Small Middle-Income SSA Peers1

Sources: IMF, World Economic Outlook 2013; Cabo Verdean authorities; and IMF staff.

1 Botswana, Cabo Verde, Lesotho, Mauritius, Namibia, Seychelles, and Swaziland.

39. Improving the performance of the labor market is particularly important to increase productivity, raise employment, and reduce inequality. The WEF ranks Cabo Verde 129th out of 148 countries for labor market efficiency. A new Labor Code—which is being finalized through broad-based consultation with stakeholders—should help reduce inflexibility with regards to working hours, disciplinary measures, and redundancy regulations. In addition to making labor regulations more employment-friendly, the authorities should explore providing more funding for vocational training and other skills enhancement. This would help address the skill mismatch, which has been found to be an important factor in explaining the decline in total factor productivity (Appendix I).

40. Cabo Verde has continued to do exceptionally well in the area of social development, putting achievement of all MDGs by 2015 within reach. Staff took note of the ambitious and comprehensive strategy set out in the GPRSP-III to promote economic growth, create jobs, and reduce poverty. Even as the country overall has done well, poverty and unemployment remain troublesome in rural and agricultural areas—and among women overall—where the incidence is higher. This calls for policies that focus in particular on increasing opportunities for groups that are doing less well. Given constraints on financial resources and capacity, further prioritization of the objectives of the GPRSP-III would help achieve goals with the highest social and economic return.

Authorities’ views

41. Improving the business climate is a key feature of the government’s medium-term growth and development plan (GPRSP-III). Enhancing labor market flexibility, bolstering productivity, and improving the quality and relevance of education and training are central to the authorities’ reform agenda. The authorities also noted that while some indices may rank Cabo Verde low on competitiveness, others rank them much higher—for example, they noted that the country is now ranked 60th out of 160 countries in the Heritage Foundation’s Economic Freedom Index.

42. With regards to social development, the authorities expressed their strong commitment to reducing inequality in income and increasing employment opportunities. The GPRSP-III seeks to reduce these inequalities through policies that promote pro-poor growth, for example by targeting training resources for workers in the farming and informal sectors, investing in infrastructure in less-advantaged areas, and strengthening linkages between tourism and other parts of the economy (especially agriculture).

Staff Appraisal

43. Cabo Verde finds itself at an important juncture in its economic development, with capital investment waning as a driver of growth. For the transition to a productivity-led economy to be successful, an ambitious structural reform agenda is needed to address challenges to competitiveness. Maintaining robust growth over the medium term is certainly achievable, but far from given, with the historical experience of micro and small economies indicating an average long term growth rate of 3–4 percent. At the same time, given Cabo Verde’s high public debt, a strong commitment to fiscal consolidation is critical to support macroeconomic stability.

44. In the near term, the outlook for economic growth is improving, though subject to some downside risks. With demand from major trading partners expected to pick up, tourism should continue to do well, and FDI to recover. And as banks work through the NPL overhang, a modest increase in credit growth could help fuel an incipient recovery in domestic demand.

45. For 2014, the macroeconomic policy stance is now broadly appropriate, though it required a shift in the policy mix and a reduction in the fiscal deficit. In the face of sharply lower investment and depressed private consumption, there has been a need for policies to support economic activity. And with the outlook for growth still moderate and uncertain, staff sees a continued role for accommodative policies. However, given the high level of public debt, staff recommended a more ambitious fiscal consolidation path than envisioned by the authorities. In addition, while the expenditure containment measures agreed after the mission are welcome, it would have been preferable for the original budget to set out a more realistic expenditure path, given likely risks to revenue. With regards to monetary policy, in the absence of pressures on the external position or on prices, staff welcomed the decision to loosen the monetary policy stance in support of the recovery.

46. Looking farther ahead, ambitious fiscal consolidation holds the key to ensuring macroeconomic stability and providing a sound basis for private sector-led growth. The large-scale public investment program has helped close infrastructure gaps and cushion the economy from the impact of the global financial crisis. However, with debt now approaching 100 percent of GDP, a strong commitment to bringing down debt is needed to reinforce Cabo Verde’s reputation of sound macroeconomic management, and also to create room for financing private sector growth. Staff therefore welcomes the authorities’ decision to adopt expenditure containment measures (for 2014 and beyond), though recommends that further containment measures be taken to put Cabo Verde on a faster downward trajectory for public debt.

47. The fixed exchange rate regime has anchored macroeconomic stability in Cabo Verde, and external stability does not appear to be at risk. However, with its high dependence on tourism and remittances, Cabo Verde remains vulnerable to changes in external conditions. This underscores the importance of adopting reforms that enhance competitiveness and support economic diversification. At the same time, cautious macroeconomic management remains essential to safeguard the peg and macroeconomic stability more generally.

48. Cabo Verde’s Third Growth and Poverty Reduction Strategy Paper (GPRSP-III) provides the country with a sound blueprint for achieving these aims. The GPRSP-III presents an ambitious and comprehensive strategy to promote economic growth, create jobs, and reduce poverty. Given constraints on resources—both financial and in terms of capacity—staff recommends further prioritization amongst the goals set out in the strategy, focusing efforts on those where the economic and social returns are expected to be highest.

49. While data are adequate for surveillance purposes, some key shortcomings remain. National accounts data are released with a significant lag and only on an annual basis. This represents a serious obstacle to macroeconomic policy formulation. STA has provided technical assistance in this area, focusing most recently on quarterly national accounts data. The authorities are taking steps to improve the provision of statistics, but still face both financial and human resource constraints.

50. Staff urges the authorities to consent to the 2010 IMF Quota and Voice reforms. Staff recommends that the next Article IV consultation take place on the standard 12 month cycle.

Table 8.Cabo Verde: Millennium Development Goals
Cabo VerdeSSA
2000200520102010
Goal 1: Eradicate extreme poverty and hunger
Employment to population ratio, 15+, total (%)59606164
Employment to population ratio, ages 15–24, total (%)53525246
GDP per person employed (constant 1990 PPP $)3,549
Income share held by lowest 20%5
Malnutrition prevalence, weight for age (% of children under 5)22
Poverty gap at $1.25 a day (PPP) (%)621
Poverty headcount ratio at $1.25 a day (PPP) (% of population)2148
Vulnerable employment, total (% of total employment)40
Goal 2: Achieve universal primary education
Literacy rate, youth female (% of females ages 15–24)989969
Literacy rate, youth male (% of males ages 15–24)969777
Persistence to last grade of primary, total (% of cohort)888860
Primary completion rate, total (% of relevant age group)107879970
Total enrollment, primary (% net)99979376
Goal 3: Promote gender equality and empower women
Proportion of seats held by women in national parliaments (%)11111820
Ratio of female to male primary enrollment (%)96959293
Ratio of female to male secondary enrollment (%)10410912082
Ratio of female to male tertiary enrollment (%)10310812963
Share of women employed in the nonagricultural sector (% of total nonagricultural employment)38.9
Goal 4: Reduce child mortality
Immunization, measles (% of children ages 12–23 months)86929675
Mortality rate, infant (per 1,000 live births)32251971
Mortality rate, under 5 (per 1,000 live births)392923113
Goal 5: Improve maternal health
Adolescent fertility rate (births per 1,000 women ages 15–19)998774108
Births attended by skilled health staff (% of total)897846
Contraceptive prevalence (% of women ages 15–49)536122
Maternal mortality ratio (modeled estimate, per 100,000 live births)17011079500
Pregnant women receiving prenatal care (%)999873
Unmet need for contraception (% of married women ages 15–49)25
Goal 6: Combat HIV/AIDS, malaria, and other diseases
Children with fever receiving antimalarial drugs (% of children under age 5 with fever)38
Condom use, population ages 15–24, female (% of females ages 15–24)
Condom use, population ages 15–24, male (% of males ages 15…24)
Incidence of tuberculosis (per 100,000 people)160153147271
Prevalence of HIV, female (% ages 15–24)3.9
Prevalence of HIV, male (% ages 15–24)1.6
Prevalence of HIV, total (% of population ages 15–49)5.5
Tuberculosis case detection rate (%, all forms)41404960
Goal 7: Ensure environmental sustainability
CO2 emissions (kg per PPP $ of GDP)0000
CO2 emissions (metric tons per capita)0111
Forest area (% of land area)20.320.821.128.0
Improved sanitation facilities (% of population with access)44536131
Improved water source (% of population with access)83858861
Marine protected areas (% of territorial waters)0006
Net ODA received per capita (current US$)21434366152
Goal 8: Develop a global partnership for development
Debt service (PPG and IMF only, % of exports, excluding workers’ remittances)11953
Internet users (per 100 people)1.86.130.010.0
Mobile cellular subscriptions (per 100 people)5177545
Telephone lines (per 100 people)1215151
Fertility rate, total (births per woman)4325
Other
GNI per capita, Atlas method (current US$)1,3302,0803,2801,178
GNI, Atlas method (current US$) (billions)0.61.01.61,005.5
Gross capital formation (% of GDP)30.736.037.820.5
Life expectancy at birth, total (years)69727454
Literacy rate, adult total (% of people ages 15 and above)818563
Population, total (billions)0.00.00.00.9
Trade (% of GDP)87.5104.3105.765.2
Source: World Development Indicators, World Bank.Figures in italics refer to periods other than those specified.
Source: World Development Indicators, World Bank.Figures in italics refer to periods other than those specified.
Appendix I. Raising Potential Growth in Cabo Verde1

Over the last two decades, Cabo Verde’s rapid economic growth has allowed it to graduate to middle-income country status. In recent years, growth has been driven primarily by factor inputs, with productivity playing a fairly small (and declining) role. For Cabo Verde to remain on the path towards upper-middle income status, reforms that boost productivity will be essential. These include easing the regulatory burden in the labor market, reducing the skills mismatch, improving the business environment for local entrepreneurs and SMEs, and enhancing the efficiency of key public services.

Cabo Verde’s Economic Development and Recent Challenges

1. Cabo Verde has achieved impressive gains in social and economic development over the past two decades. Good governance, sound macroeconomic policies, and structural reforms have attracted foreign direct investment and significant donor financing. Annual real GDP growth average over 6 percent during 2000–07, faster than most small island economies and the average for sub-Saharan Africa. As a result, Cabo Verde reached middle income country (MIC) status in December 2007.

2. To continue along its transition towards upper middle income level, Cabo Verde must now address new challenges. First, the crucial growth engines of the Cabo Verdean economy have been tourism, tourism-related foreign investment, and construction, all of which are greatly dependent upon the global economy. Second, the large-scale public investment program launched in 2008—which has contributed significantly to growth—is expected to wind down soon, as Cabo Verde’s access to grants and concessional financing ends. Third, Cabo Verde faces considerable structural limits to sustaining high growth over the medium term. The growth experience of micro and small middle income countries shows that long-term growth has averaged around 3 to 4 percent (Table 1).

Table 1.Average Real GDP Growth Rates of Small and Micro Countries(Percent)
1980–20131980s1990s2000–122000–072008–122008–13
All small and micro countries3.143.662.963.003.552.112.18
Upper middle income countries3.274.743.442.593.680.861.03
Lower middle income countries3.062.352.593.523.493.523.48
Small and micro countries in SSA3.353.773.083.473.673.133.12
Cabo Verde5.685.746.155.286.912.672.47
Source: IMF World Economic Outlook.Note: Small states refer to small developing countries with populations of under 1.5 million.
Source: IMF World Economic Outlook.Note: Small states refer to small developing countries with populations of under 1.5 million.

3. A growth accounting framework can help explain the dynamics of economic growth in Cabo Verde. The framework decomposes output growth into (i) the contributions from increases in the amount of factor inputs—namely physical capital, and human capital-augmented labor—and (ii) the growth residual which cannot be accounted for by observed increases in factor inputs (Solow, 1957).2 The contribution of capital input is calculated from the estimated capital stock—using the standard perpetual inventory model with geometric depreciation—weighted by the income share of capital. Meanwhile, the contribution of human capital-augmented labor input is derived from the estimated human capital stock—using the average educational attainment of the employed labor and the estimated returns to education—weighted by the income share of labor. With this growth decomposition, the growth residual indicates a change in technological progress and is known as total factor productivity (TFP). TFP affects economic growth through improvement in resource allocation, innovation, and productivity of each of the factor inputs. Therefore, rising TFP provides an economy with the opportunity to grow more efficiently, and thus, more sustainably in the long run.

4. A decomposition of Cabo Verde’s growth since the mid-1980s indicates that TFP’s contribution to economic growth has been relatively small and declining in recent years. TFP has fluctuated in line with economic growth, and its decline in the late 2000s coincided with the economic downturn. While the contribution of capital accumulation to output growth has increased, the contribution of human capital has been small and steady over time. However, one should analyze the growth decomposition results with caution. As being a residual, TFP could also reflect the quality of data and estimates on the other components.

Cabo Verde’s Growth Accounting with Human Capital

sources: Penn World Tables and IMF staff calculations.

Raising Potential Growth in Small Middle Income Countries of Sub-Saharan Africa

5. The growth experience of Cabo Verde—with a period of rapid growth and high resource accumulation followed by a period of slow growth and falling TFP—is also found in other small middle income countries in sub-Saharan Africa (SSA SMICs). The growth slowdown prevents countries from reaching upper middle income and high income status—a phenomenon known as the “middle income trap”.3 To overcome this challenge, SSA SMICS—including Cabo Verde—need to revisit their growth model and identify new, higher-productivity drivers of growth.

Real GDP Growth (%) in SSA SMICs

Source: IMF World Economic Outlook.

TFP Contribution to Growth (%) in SSA SMICs

Sources: Penn World Tables and IMF staff calculations.

6. The experience of SSA SMICs suggests a two-stage trend in TFP and thus economic growth: capital deepening during the high growth period, and economic concentration and regulatory constraints in the slower growth period (Table 2). In the earlier decades, when global economic conditions where relatively supportive, SSA SMICs undertook capital deepening in the form of infrastructure investment and higher FDI to bolster productivity and growth. However, in the last few years, as the external environment deteriorated, the growth momentum in SSA SMICs weakened. The structural reforms that would have sustained the growth of TFP—such as those that encouraged economic diversification, and helped create a business friendly environment—were not fully implemented. In addition, their highly restrictive regulatory systems, albeit in different markets, and large public sector hinder productivity gains by raising production costs, and thus, reducing investment efficiency.

Table 2:Structural Impediments to Productivity Enhancement in Selected SMICs
Macroeconomic EnvironmentLabor MarkretFinancial SectorPublic SectorEnvironment
Resource Rich SMICs
BotswanaLack of economic diversificationHigh reservation wage and skill mismatchHigh concentration of bank loans to householdsEffectiveness of tax system; quality of public spending
NamibiaLack of economic diversificationLack of competitiveness; large and persistent structural unemploymentHigh concentration of bank loans to households, in particular mortgagesQuality of public spending (not getting value for money) and large public sector
Non Resource Rich and Non Island SMICs
LesothoLack of economic diversificationHigh and persistent structural unemployment; HIV prevalence among labor forceSmall and inefficient; high lending rates; large risk premiumLarge and ineffective public sector distorts labor market incentives and creates unfavorable business environmentDrought; soil degradation
SwazilandLack of economic diversification; depress capital accumulation; uncompetitive business environmentHigh and persistent structural unemployment; HIV prevalence among labor forceLarge expansion with no clear evidence of high fiscal multiplier
Non Resource Rich and Island SMICs
Cabo VerdeLack of economic diversification; reliance on imports for food, fuel, manufacturing items and capital goodsLow labor market efficiency owing to restrictive labor market regulations and shortage of technical skillsPredominantly bank-based; high concentration (four systematic banks account for more than 80 percent); sizeable exposure to the real sectorLarge public investment in infrastructure financed by borrowing, leading to deteriorating fiscal balance and high public debt
MauritiusAlthough economy is relatively diversified, there is still reliance on European markets for trade and tourismStructural labor market problems, including youth unemploymentEnvironmental degration and weather-related disasters
SeychellesLack of economic diversification; reliance on imports for food, fuel, manufacturing items and capital goodsStructural problems including shortage of adequate skills and expertise; complex procedures for hiring qualified foreign workersLack of financial deepeningInefficient public investment; presence of large parastatals operating in quasi-monopoly environmentEnvironmental degration and weather-related disasters
Sources IMF staff.
Sources IMF staff.

7. Cross-country empirical analysis can help shed light on the role of macroeconomic, structural, and institutional factors in TFP growth. Three econometric methodologies are applied to an (unbalanced) panel dataset of 33 middle-income countries (MICs) during the 1981–2010 period. First, the dynamic panel regressions are estimated to control for time-invariant country fixed effects, using the generalized method of moments.4 Second, the co-integration analysis is used to identify and estimate the long-run relationship between TFP and its determinants. And third, a panel Probit analysis is conducted to identify the factors that contribute to TFP growth. The cross-country panel dataset is obtained from five primary sources: the Penn World Tables, the IMF’s World Economic Outlook (WEO), the World Bank’s World Development indicators (WDI), the Economic of Freedom of the World (EFW) project, and the Barro-Lee database.

8. The empirical results suggest that macroeconomic stability and trade openness are necessary but not sufficient conditions for productivity growth (Table 3). MICs need to improve the quality of human capital to minimize the skills mismatch, reduce the regulatory burden on firms, and be aware of limits up to which infrastructure gap could be closed by public borrowing. First, the panel estimation results point to a negative impact of skill-mismatches on the contribution of TFP to growth.5 They also suggest a concave impact of government debt on TFP contribution. Although public investment could enhance overall productivity and play an important counter-cyclical role, it carries risks of inefficient crowding-out similar private sector initiatives.6 Second, turning to the co-integration analysis, most findings are consistent with those of the dynamic panel regressions, with foreign direct investment (FDI), trade openness, and market capitalization as additional positive factors for TFP. High inflation is found to reduce TFP growth. In addition to these results, the panel Probit analysis shows that restrictive labor and credit market regulations have a negative impact on TFP growth, while the impact of access to credit for small and medium enterprises (SMEs) is positive.

Table 3:Summary of the Empirical Results
Short-runLong-run
Dynamic PanelCointegrationPanel Probit
Government debt to GDP(-) or Concave *(-) or Concave *(-)/(+) or Concave *
Trade to GDP(+)(+)*(-)
FDI to GDP(+)(+)/(-)*
Credit to GDP(+)/(-)2*(+)
Share of agricultural sector in GDP(-)*
Share of manufacturing sector in GDP(+)*
Female labor force participation(+)/(-)(+)/(-)3*
Inflation(+)/(-)(-) *(-) *
Years of education(+)(+)*
Skill mismatch(-) *(-) *(-) *
Credit market regulation index1(+)(+)*
Labor market regulation index1(+)*
Goods market efficiency index1(+)/(-)
SMEs with credit line(+)*
(+)/(-) indicates ambiguous results; * indicates statistical significance at least at the 10 percent level.

A high value of the index implies a less restrictive regulatory system and/or a more competitive market.

This probably reflects the high number of countries in our sample that have experienced financial crisis.

The impact of female participation becomes positive after controlling for the share of agriculture in GDP.

(+)/(-) indicates ambiguous results; * indicates statistical significance at least at the 10 percent level.

A high value of the index implies a less restrictive regulatory system and/or a more competitive market.

This probably reflects the high number of countries in our sample that have experienced financial crisis.

The impact of female participation becomes positive after controlling for the share of agriculture in GDP.

Relevance of the SSA SMICs’ Productivity Analysis for Cabo Verde

9. The results of the cross-country analysis could help identify factors that are inhibiting TFP in Cabo Verde. The following factors may be of particular relevance: skill mismatch, labor market regulations, access to finance by SMEs, and the size of public debt.

10. Improving the quality and relevance of education and training is crucial to reduce skill mismatch and generate employment. Skill mismatch has been relatively high in Cabo Verde and contributed to high unemployment, especially among young people. The unemployment rate was over 16 percent at end-2013, with youth unemployment more than double that rate. While the country has significantly improved access to higher education and professional training, it is still not able to create enough jobs for all new graduates. In 2012, there were around 9,300 formal job offers for graduates, compared to around 23,000 young people looking for jobs. Cabo Verde’s medium-term development plan for 2012–16—the Growth and Poverty Reduction Strategy Paper-III (GPRSP-III)—seeks to address skill mismatch and unemployment by focusing resources on technical and vocational training, especially in tourism, agri-business and the creative economy. As funding is one of the challenges for expanding the education and training development plan, the government should also encourage more private sector participation in human capital development.

Skill-Mismatch Index

Sources: Penn World Tables, WDI, INE, and IMF staff calculations.

Unemployment Rates in Cabo Verde

(Percent)

Source: INE.

11. Enhancing labor market efficiency would also bolster competitiveness. Available business surveys reflect investors’ concerns with heavy labor market regulations. The World Economic Forum (WEF) ranked Cabo Verde 129th out of 148 countries on labor market efficiency in its 2013/14 Competitiveness Report. In addition, the labor regulation indicators from the Economic Freedom of the World indices suggest that Cabo Verde’s labor market is more restrictive than other SSA SMICs, particularly in hiring and wage-setting regulations, hour regulations and dismissal costs. Cabo Verde is already taking steps to address these inefficiencies. A new labor code is expected to enable a business climate and job creation by providing more flexibility in terms of working hours, disciplinary measures and redundancy costs.

Economic Freedom of the World’s Labor Market Regulation Indicators

Source: Economic Freedom of the World (2011).

Note: Increases in the indices indicate a less restrictive labor market.

12. Creating a business climate that better supports local entrepreneurs and SMEs would also play an important role in boosting growth. Given the large informal sector, another effective way to promote sustainable employment and increase productivity is to support entrepreneurship and self-employment. As set out in the GPRSP-III, the government aims to develop entrepreneurship by both expanding training programs in entrepreneurial skills and innovation, and fostering an enabling business environment. The WEF had also identified access to financing as one of the most serious obstacles to doing business in Cabo Verde. The GPRSP-III addresses this issue, by setting out plans to strengthen access to financing by local entrepreneurs and SMEs, encouraging cooperative behavior, and providing business support infrastructure.

13. It is also worth considering whether the size of public debt could potentially slow productivity growth. Since 2008, Cabo Verde’s public debt has increased by nearly 40 percentage points of GDP, reaching an estimated at 95 percent of GDP at end-2013. The significant increase in public debt reflects in good part a large-scale public investment program, which focuses in particular on reducing bottlenecks in energy and transportation, which are expected to play a positive role in boosting productivity. With many of Cabo Verde’s infrastructure gaps now having been addressed (and access to concessional financing likely to end), it is possible that the public sector could make greater contributions to productivity by focusing more on the efficiency of public investments rather than by further increasing it. In addition, as the government reduces its draw on domestic financing, it will create more financing room for the private sector to investment in innovation and growth.

Conclusion

14. The cross-country analysis has shown the importance of boosting productivity to achieve sustainable economic growth in Cabo Verde. Reforms in the following areas look particularly relevant: reducing skill mismatch and the regulatory burden in the labor market, creating an enabling business environment for local entrepreneurs and SMEs, and enhancing the efficiency of public investment. The GPRSP-III sets out many important initiatives in these areas. Steady progress in implementing these reforms would play a key role in raising TFP in Cabo Verde, and moving towards upper MIC status.

References

    BarroR. J. (1991) “Government Spending in a Simple Model of Endogenous GrowthNBER Working Papers 2588 National Bureau of Economic Research Inc.

    EstevaoM. and E.Tsounta (2013) “Has the Great Recession Raised U.S. Structural Unemployment?IMF Working Paper (WP/11/105).

    FelipeJ. (2012) “Tracking the Middle-Income Trap: What Is It? Who Is In It? And Why?: Part 1&2Asian Development Bank Economics Working Paper Series No. 306–307.

    GhaliK. (1999) “Government Size and Economic Growth: Evidence from a Multivariate Cointegration AnalysisApplied Economics31(8) 975987.

    International Monetary Fund (2014) “Policies that Can Raise Potential Growth in Small Middle Income Countries of Sub-Saharan AfricaIMF Selected Issue Paper (Country Report No. 14/41).

    LeighL. and I.Flores (2013) “Closing the Jobs Gap in the Southern Africa Customs Union (SACU)”, Chapter 6 of a book entitled “Building a Common Future in Southern AfricaInternational Monetary Fund.

    RanisG. (1989) “The Role of Institutions in Transition Growth: The East Asian Newly Industrializing CountriesWorld Development17(9) 14431453.

    Sala-I-MartinX.G.Doppelhofer and R. I.Miller (2004) “Determinants of Long-Term Growth: A Bayesian Averaging of Classical Estimates (BACE) ApproachAmerican Economic Review94(4) 813835.

    World Bank (2013) “Cape Verde: Addressing the Challenges of a Middle-Income Small State—Country Economic MemorandumThe World Bank Report No. 83115-CV.

Cabo Verde was part of a recent IMF study of total factor productivity in small Middle Income Countries in Sub-Saharan Africa (Country Report No. 14/41). Results from this analytical work were presented during the mission.

Concessional financing is typically available to a country for an additional five years after graduating to Middle-Income Country (MIC) status. However, due to the global downturn and to Cabo Verde’s status as a small island country, donors decided to extend access to concessional financing for a few additional years.

In recent years, the procedure for approving the operating budget has included “freezing” 30 percent of expenditure on goods and services (except for medication, food, security, and a few other items), which can only be spent if revenue performs as budgeted. The “freezing” also affects nonfinancial assets, namely the purchase of administrative equipment and cargo transport equipment (except purchases of sovereign entities). For the investment budget, a minimum of 30 percent (and in some cases up to 50 percent) of expenditure is similarly frozen.

The BCV noted that based on their NPL definitions (Circular 150, rather than IAS/IFRS), Cabo Verde’s financial stability indicators are stronger. Their NPL ratio (which includes only installments that are 90 days or more past due, except where the cumulative past due installments exceed 25 percent of the loan balance) was only 13 percent in December 2013, and the ratio of provisions to NPLs was 60 percent (rather than 48 percent).

The other members of the Budget Support Group are the African Development Bank, the EU, the Luxembourg Agency for Development Cooperation, Portugal, and the Spanish Agency for International Development Cooperation.

The authorities’ fiscal plans are set out in the Medium-Term Fiscal Framework (MTFF), which covers 2014–17.

Staff’s projection for 2014 is based on the MTFF’s expenditure plans, with the exception of debt service, for which staff use the projections agreed by the World Bank and the Ministry of Finance’s Debt Directorate, in the context of the Medium-Term Debt Strategy exercise (MTDS). The latter exclude an “exchange rate buffer”, included in the budget to cover unexpected exchange rate swings, which averages about 0.4 percent of GDP for 2014–16.

The budget deficit target is 8 percent of GDP. However, staff sees downside revenue risks of over 1 percent of GDP.

To encourage payment of tax arrears, the Ministry of Finance has offered to waive overdue interest on amounts due. With regard to claims for tax refunds, the 2014 budget allocates 0.6 percent of GDP towards settling such claims and other refunds. The authorities are also preparing a full database of tax refunds due.

The program entails building affordable housing units financed by external funds, which will be sold by the government to private individuals. The program is subject to financial risks, given that purchasers will need to be able to obtain a mortgage to purchase a property.

Following parliamentary approval of the budget, the government can cut expenditure without obtaining additional parliamentary approval, since the original budget already entailed freezing certain amounts of expenditure pending satisfactory revenue performance.

Remittances have been found to be positively correlated with Cabo Verde’s GDP growth (A. Shanghavi, Country Report No. 08/243). The impact of interest rate differentials was weaker.

An MCM TA mission on liquidity management took place in April 2014.

LEG had provided extensive TA to the BCV when the financial laws were drafted, and stands ready to provide further support as implementing regulations are drawn up.

This annex draws on the Selected Issues Paper “Policies that can raise potential growth in small Middle Income Countries of SSA” (Country Report No. 14/41).

That is, Yt=At · (Kt)α · (HLt)1-α, where Yt represents domestic output in period t, Kt is the physical capital stock, HLt is human capital augmented labor, At is the total factor productivity (TFP), and α is the partial elasticity of output with respect to capital (which is often proxied by the income share of capital).

For more detail see Felipe (2012), “Tracking the Middle-Income Trap: What Is It? Who Is In It? And Why? Part 1&2” Asian Development Bank.

The dynamic panel estimates do not represent long-run effects.

In the empirical analysis, skill mismatch is measured (as set out by Estevao and Tsounta, 2011) by the Skill Mismatch Indexit = Σj (SijtMijt)2 where j denotes skill level; Sijt denotes percent of labor force with skill level j at time t in country i; and Mijt denotes percent of employment with skill level j at time t in country i. For more information, see Leigh and Flores (2011).

Other Resources Citing This Publication