1. The Cabo Verdean authorities are thankful to staff for their constructive cooperation and dialogue during the Article IV mission. The process has provided an opportunity for an exchange of views on a broad range of topics that will contribute to a refinement of the authorities’ macroeconomic objectives in the current transition of Cabo Verde from low to middle-income status.
2. Cabo Verde is pursuing a pathway of reforms that, together with the successful conclusion of the public investment program (PIP), are expected to accelerate growth by increasing productivity and competitiveness, as well as to foster economic diversification and develop human capital. The authorities also attribute a high priority to enhancing financial supervision, improving debt management and strengthening tax administration, areas in which Fund’s technical assistance (TA) has been instrumental.
Economic developments and outlook
3. Exposed to a difficult external environment, the Cabo Verdean economy decelerated in the last two years. The country has been particularly affected by a decline in remittances and foreign direct investment (FDI) originating from Europe. In 2013, according to staff, GDP is estimated to have grown by 0.5 percent. If confirmed, this growth rate would be the lowest since 1990. Against this background, support to domestic demand by the PIP seems to have been of crucial importance. An outright recession could have been the outcome in 2013 had the government followed staff’s advice in the last Article IV consultation and pursued fiscal consolidation at a faster pace.
4. The continued decline in the current account deficit (from 16.3 percent of GDP in 2011 to an estimated 4.5 percent of GDP last year) has been linked most of all to the good performance of the services sector, especially tourism, and to the reduction of imports in the context of a carefully-managed re-phasing of the PIP. Thanks to infrastructure investments and consistent policies for the sector, tourism has continued to expand in 2013, albeit at a slower pace, and remained a key driver for growth and exports. The overall balance of payments moved into surplus in 2012 and 2013 and is expected by staff to remain in positive territory until 2017. As a result, at end-2013, gross international reserves held by the central bank (Banco de Cabo Verde – BCV) reached the equivalent of 4.4 months of prospective imports, the midpoint of the Fund’s estimated optimal range for Cabo Verde. We note that, in the last Article IV report, staff projected reserve coverage for 2013 at 3.3 months of prospective imports, below the floor of the optimal range.
5. For 2014 and beyond, GDP growth is expected to accelerate as remittances and FDI gradually recover and the impact of the PIP on productivity and competitiveness starts to be more clearly felt. Cabo Verde is an archipelago with its economic activity concentrated in three of the nine inhabited islands: Santiago, the administrative center, and Sal and Boa Vista, the main tourist destinations. One of the main objectives of the PIP is to overcome infrastructural bottlenecks and enhance integration between the islands. As the infrastructural transformation takes place, synergies are being created between the most dynamic sectors and the rest of the economy, allowing each island to fully develop its potential, according to its comparative advantages.
6. Cabo Verde has a long record of sound macroeconomic management, and the authorities are aware of the need to pursue fiscal consolidation. As highlighted in our last Buff statement, the fiscal deficit has been closely associated with the PIP and the country is a good example of why it may be relevant to separate the capital from the current budget. The ordinary or current budget balance — proxied by the overall balance excluding public investment — was in surplus last year to the amount of 1.3 percent of GDP, as can be seen from Table 3b of the staff report. Public investment (net acquisition of non-financial assets) corresponded to 9.1 percent of GDP while the central government’s overall deficit was 7.8 percent of GDP. Current expenditures (including wages, goods and services, subsidies, transfers, social benefits and interest) have decreased as a share of GDP, from 28.3 percent in 2000 to 22.4 percent in 2012 and 2013. We are surprised to see that staff once again fails to make this fundamental distinction, thus providing a misleading presentation of Cabo Verde’s public finances.
7. Even when including public investment, a trend towards medium-term fiscal consolidation can be observed since the PIP peaked in 2012. The overall deficit of the central government dropped from 9.9 percent of GDP that year to 7.8 percent in 2013. It is expected to fall to 7.4 percent in 2014 and to gradually decline to 4.6 percent in 2017. Moreover, the pace of fiscal consolidation is likely to be more pronounced in the years to come than portrayed under staff’s baseline projections. Staff’s forecasts are based on expenditure plans contained in the original 2014 budget and in the current Medium-Term Fiscal Framework (MTFF). However, given Cabo Verde’s budgetary rules, actual fiscal performance is often less expansionary than originally envisaged.1 This has been the case in recent years, and the authorities are currently reviewing this year’s budget execution in order to reduce expenses according to the weaker revenue performance observed in the first quarter. Expenditures projected in the MTFF for years 2015–17 are also being reduced accordingly.
8. Raising fiscal revenues is another important component of the middle-term consolidation strategy. In 2013, measures continued to be taken by the Ministry of Finance and Planning (MFP), with the help of Fund TA, to broaden the tax base, enhance tax collection, and strengthen the institutional and administrative capacities of the General Directorate for Contributions and Taxes (Direção Geral de Contribuições e Impostos – DGCI). The authorities believe that the full impact of these measures will materialize in the course of the current year. The same can be said of the harmonization of the value-added tax (VAT) rates, approved in 2012. In this case, a loophole in the original law was seized by the biggest tourism operators allowing them to pay old rates on tourist packages during 2013, provided that contracts had been signed in 2012.2
9. The performance of state-owned enterprises (SOEs) is improving, as noted by staff. Of the six largest SOEs, only two remain under distress — the energy company Electra and the airline company TACV (Transportes Aéreos de Cabo Verde) — but reforms on both companies are starting to show positive results. Preliminary data for 2013 indicate that Electra’s operational losses decreased by half when compared to 2012. Insofar as TACV is concerned, with the sale of its baggage handling branch, streamlining of routes and fleet, as well as ongoing managerial improvements, losses have been similarly contained and the company is expected to break even in 2015.
10. While maintaining Cabo Verde’s commitment to sound public finances, the authorities intend to finalize in the next few years their strategy of harnessing the concessional financing still available to the country for ramping up public investment in infrastructure and social projects. This has resulted in a rapid increase in public external debt, but under very favorable conditions.3 Interest rates are very low (averaging 1.1 percent), mostly fixed (over 92 percent of the total), and the amortization and grace periods are very long. As can be seen in Text Table 2 of the Debt Sustainability Analysis (DSA), multilateral debt, which represents over 50 percent of total external debt, has an average grace period of 9 years and an average amortization period of 34 years. As a result, external public debt does not breach any indicative threshold under the DSA baseline.
11. Financing infrastructure projects through concessional rather than non-concessional resources has entirely different implications. Staff continues to ignore or downplay this elementary point, and focuses excessively on the debt to GDP ratio. Had Cabo Verde not stepped up its investment during the current window of opportunity after graduation to middle-income status, it would have been required to pay much more to finance the same infrastructure. The completion of the PIP will lay the ground for higher future growth and enhance the country’s capacity to pay its debt.
12. Staff continues to consider Cabo Verde’s public and publicly guaranteed debt to be sustainable but seems unwilling to say so. The important conclusion that Cabo Verde’s debt is sustainable is only stated in the DSA, and not in the main report, let alone in the staff appraisal. The report concentrates on emphasizing debt-related risks to such an extent that a different impression is conveyed to the reader. While references to high or very high overall debt levels abound (for example, three times in the seven paragraphs of the staff appraisal), there are very few reminders of the overwhelmingly concessional nature of Cabo Verde’s debt.
Monetary policy and financial sector
13. Monetary policy in 2013 was successful in keeping inflation low and supporting the exchange rate peg with the euro. With the increase in international reserves to a comfortable level and inflation under control, the BCV was able to ease monetary policy to support the economic recovery, in line with staff’s advice. It cut the policy rate by 150 basis points — to 4.25 percent — last March, and reduced the rates of rediscount and of the lending facility by the same amount, to 8.25 and 7.25 percent, respectively.
14. Staff had also recommended the BCV to lower the 18 percent minimum reserve requirement (MRR), stating that it is high compared to peers and that a decrease would free up liquidity and support credit creation. The BCV, however, considers the current level of the MRR as adequate, given its dual role as a monetary and prudential tool, and also argued that reserve requirements should not be changed frequently. Staff’s arguments for lowering the MRR are indeed unconvincing. It is doubtful that a central bank would make a decision on reserve requirements based on a simple comparison with its peers. Moreover, with already high excess liquidity, freeing up more bank reserves would hardly have any effect on credit, and would make liquidity management an even greater challenge.
15. BCV’s measures to address non-performing loans (NPLs) in the banking system, on the other hand, could bring about an increase in credit to the private sector. As indicated in Box 2 of the staff report, among other initiatives, the BCV conducted a detailed review of banks’ practices for NPL provisioning and disclosure, and requested banks to follow strictly International Financial Reporting Standards (IFRS) definitions. The level of NPLs has started to fall, but, at 16 percent, is still high.
16. Cabo Verde’s banking sector remains well capitalized and liquid. Foreign banks do not depend on parent institutions as they are fully funded by domestic deposits. The BCV is committed to completing the implementation of the 2009 FSAP recommendations. Future priorities of the BCV include refining its operational framework so as to raise the efficiency of the transmission mechanism and promote the development of the interbank market.
The approved budget includes a provision stipulating that as much as 30 percent of several classes of expenditures can only be executed if revenues perform as expected.
This was possible because the VAT law used the date contracts were signed as the basis for determining the rate to be applied. Taking advantage of that, tourism operators anticipated to 2012 the signature of contracts for a sizeable number of tourist packages sold for 2013.
External public debt accounts for 76 percent of Cabo Verde’s total public debt.