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Chapter 5. Article IV Consultations

Author(s):
International Monetary Fund
Published Date:
October 1997
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The Fund holds bilateral consultations with all its member countries, in most cases every year, under the provisions of Article IV of the Articles of Agreement. As part of these consultations, a staff team from the Fund visits a country to discuss with officials economic developments and the monetary, fiscal, and structural policies that the authorities are following. The team also gathers relevant economic and financial information on the economic situation facing the country. On its return to Fund headquarters, the team prepares a report analyzing the economic situation and evaluating the stance of policies, which serves as the basis for the Board’s discussion. At the end of the discussion, the Chairman of the Board summarizes the views expressed by Directors during the meeting. This summary is transmitted to the country’s authorities. In April 1997, the Board agreed to issue Press Information Notices, on a voluntary basis, following the conclusion of members’ Article IV consultations (see Chapter 4, the section “Biennial Review of Surveillance,” and Appendix V). During 1996/97, 150 consultations under Article IV were concluded by the Fund (Table 3).

Table 3Article IV Consultations Concluded in Financial Year 1997
AlbaniaFebruary 28, 1997GuatemalaOctober 16, 1996NorwayFebruary 24, 1997
AlgeriaJune 26, 1996GuineaJanuary 13, 1997OmanMarch 21, 1997
Antigua and BarbudaJuly 19, 1996Guinea-BissauMarch 21, 1997PanamaJuly 19, 1996
ArgentinaOctober 30, 1996GuyanaOctober 9, 1996Papua New GuineaDecember 20, 1996
ArmeniaSeptember 23, 1996HaitiOctober 18, 1996ParaguayJuly 19, 1996
AustraliaFebruary 19, 1997HondurasDecember 2, 1996PhilippinesDecember 20, 1996
AustriaMay 24, 1996Hong Kong, ChinaFebruary 21, 1997PolandMarch 7, 1997
AzerbaijanDecember 20, 1996HungaryAugust 28, 1996PortugalOctober 18, 1996
Bahamas, TheOctober 11, 1996IcelandFebruary 10, 1997QatarJune 7, 1996
BangladeshAugust 28, 1996IndiaNovember 4, 1996RomaniaApril 23, 1997
BarbadosNovember 15, 1996IndonesiaJuly 26, 1996Rwanda

San Marino
November 18, 1996
BelarusJuly 31, 1996Iran, Islamic Republic ofJuly 24, 1996
BelgiumFebruary 7, 1997August 23, 1996São Tomé and Príncipe
BeninAugust 28, 1996IrelandJuly 1, 1996June 21, 1996
BhutanDecember 6, 1996IsraelDecember 18, 1996Saudi ArabiaFebruary 24, 1997
ItalyApril 4, 1997SenegalJune 28, 1996
Bosnia and HerzegovinaAugust 26, 1996JamaicaJuly 26, 1996SingaporeFebruary 7, 1997
BotswanaMarch 5, 1997JapanJuly 24, 1996Slovak RepublicMarch 19, 1997
BrazilMarch 3, 1997JordanFebruary 10, 1997SloveniaDecember 16, 1996
Brunei DarussalamMay 1, 1996KenyaMarch 21, 1997Solomon IslandsJune 26, 1996
Burkina FasoFebruary 14, 1997KoreaNovember 15, 1996South AfricaMay 29, 1996
CambodiaFebruary 3, 1997KuwaitAugust 19, 1996SpainMay 3, 1996
CameroonOctober 9, 1996Kyrgvz RepublicJuly 31, 1996SpainMarch 19, 1997
CanadaJanuary 29, 1997Lao People’s Democratic RepublicSri LankaJuly 31, 1996
Cape VerdeAugust 26, 1996May 8, 1996St. LuciaNovember 15, 1996
Central African RepublicFcbruary 21, 1997LatviaNovember 25, 1996St. Vincent and the Grenadines
LebanonJuly 3, 1996November 8, 1996
ChadMay 22, 1996LesothoSeptember 23, 1996SudanFebruary 12, 1997
ChileAugust 30, 1996LibyaAugust 28, 1996SwazilandMarch 7, 1997
ComorosAugust 30, 1996LithuaniaJune 26, 1996SwedenSeptember 9, 1996
Congo, Republic ofJune 28, 1996Macedonia, FYRApril 11, 1997SwitzerlandFebruary 12, 1997
Costa RicaJune 14, 1996MadagascarMay 17, 1996SyriaMarch 24, 1997
Côte d’IvoireNovember 15, 1996MalawiJune 19, 1996TajikistanMay 8, 1996
CroatiaMarch 12, 1997MalaysiaAugust 30, 1996TanzaniaNovember 8, 1996
Czech RepublicNovember 27, 1996MaldivesJuly 10, 1996ThailandJuly 17, 1996
DenmarkFebruary 24, 1997MaliNovember 25, 1996TogoFebruary 3, 1997
DominicaJuly 1, 1996Marshall IslandsAugust 21, 1996TongaJanuary 27, 1997
Dominican RepublicMay 15, 1996MauritiusMarch 10, 1997Trinidad and TobagoMarch 24, 1997
EgyptOctober 11, 1996MexicoAugust 2, 1996TurkeyAugust 26, 1996
Equatorial GuineaNovember 27, 1996MicronesiaAugust 21, 1996UgandaMay 1, 1996
EritreaJune 12, 1996MoldovaSeptember 23, 1996UgandaApril 23, 1997
EstoniaJuly 29, 1996MoroccoDecember 6, 1996United Arab EmiratesOctober 9, 1996
EthiopiaMay 1, 1996MozambiqueNovember 18, 1996United KingdomOctober 23, 1996
FijiAugust 21, 1996MyanmarMarch 5, 1997United StatesJuly 22, 1996
FinlandJuly 29, 1996NamibiaJuly 3, 1996UruguayJuly 26, 1996
FranceOctober 16, 1996NepalMay 29, 1996UzbekistanJune 26, 1996
GeorgiaSeptember 23, 1996NetherlandsJune 3, 1996VanuatuJune 26, 1996
GeorgiaMarch 21, 1997Netherlands AntillesMarch 3, 1997VenezuelaJuly 12, 1996
GermanySeptember 6, 1996New ZealandNovember 25, 1996VietnamNovember 27, 1996
GhanaJune 21, 1996NicaraguaOctober 9, 1996Western SamoaMarch 12, 1997
GreeceAugust 2, 1996NigerJune 12, 1996Yemen, Republic ofJuly 15, 1996
GrenadaMay 29, 1996NigeriaFebruary 3, 1997ZambiaJuly 8, 1996

This chapter describes the main elements of the Board’s discussions of a number of Article IV consultations with member countries. The countries have been selected on the basis of their importance in the global or regional economy, with some smaller countries being included on a rotating basis. Each country description provides a short account of significant macroeconomic and structural developments at the time of the consultation, together with a table of the main economic indicators available to the Board at that time. This is followed by a summary of the conclusions of the Board’s discussion. In a number of cases, where a consultation was held early in the financial year and there were significant subsequent developments, an additional column of updated staff estimates has been added to the table of selected economic indicators. Also, in some cases where there were significant policy developments in a member country since the consultation was concluded, an additional paragraph has been added to the text.

Advanced Economies

Major Industrial Countries

United States

The Board concluded the Article IV consultation with the United States in July 1996. This came after a year of rebounding economic activity (Table 4), with growth accelerating in the third quarter of 1995, stowing in the fourth quarter, and rising again to 2.3 percent (annual rate) in the first quarter of 1996. In the final quarter, growth was largely driven by the strength of consumption and private fixed investment, which more than compensated for the negative effects of inventory investment and net exports. The unemployment rate hovered around lows of 5.6 percent during 1995 and early 1996, as employment grew strongly and the participation rate rose.

Table 4United States: Selected Economic Indicators

(Data as of Board discussion in July 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real GDP2.33.52.02.22.4
Unemployment rate6.96.15.65.65.4
Change in consumer prices
(end of period)2.82.72.52.93.3
In billions of U.S. dollars1
External economy
Exports, f.o.b.456.8502.5575.9615.2611.7
imports, f.o.b.–589.4–668.6–749.4–788.9–799.3
Current account balance–99.9–148.4–148.2–150.9–165.1
Direct investment–35.1–4.7–35.3–4.4
Portfolio investment–41.831.095.6180.9
Capital account balance56.4134.7116.6218.2
Gross official reserves70.845.6100.0129.4
Current account balance
(in percent of GDP)–1.5–2.1–2.0–2.0–2.2
Change in real effective
exchange rate (in percent)2.6–1.1–5.55.9
In percent of GDP1
Financial variables
General government balance–3.6–2.3–2.0–1.5–1.4
Gross national saving14.315.215.916.016.8
Gross national investment316.517.717.717.8
Change in broad money
(M2 year-over-year; in percent)1.11.42.14.9
Three-month treasury bill rate3.04.25.55.25.1
(yearly average; in percent)

Unless otherwise noted.

Updated Fund staff estimates.

Includes net capital grants received by the United States.

Unless otherwise noted.

Updated Fund staff estimates.

Includes net capital grants received by the United States.

Consumer price inflation during 1995 was 2.8 percent, in line with the average over the past four years, while inflation measured by the producer price index and the GDP deflator registered small increases. Inflation at the consumer and producer levels rose during the first five months of 1996 owing to weather-induced increases in food and energy prices.

Steady progress had been made in reducing the fiscal deficit, which fell from 3 percent of GDP in fiscal year 1994 (ending in September) to 2.3 percent in fiscal year 1995, reflecting expenditure cuts, tax increases, and the effects of the economic recovery. Owing to larger-than-anticipated revenue in the first seven months of fiscal year 1996 and to constraints on spending, the federal fiscal deficit for the fiscal year was estimated at the time of the consultation to decline to about 1.6 percent of GDP.

The Federal Reserve Board had begun to ease monetary policy in July 1995 in response to a slowdown in economic growth and evidence that potential inflationary pressures were abating. By January 1996 the target rate for federal funds had been reduced to 5¼ percent and was kept there for the first half of 1996. Long-term rates fell by about 2 percentage points over 1995 but rose by over 100 basis points in the first half of 1996, primarily reflecting evidence that economic growth in the first half of 1996 was picking up faster than expected.

The dollar, which had recovered in late 1995 from historical lows against the yen and the deutsche mark, appreciated somewhat further in early 1996 in response to the rise in U.S. interest rates. The current account deficit narrowed slightly to 2.0 percent of GDP in 1995. The merchandise trade deficit was unchanged at 2.4 percent of GDP, Net private capital inflows fell substantially in 1995, as banking and direct investment shifted to net outflows, which were only partially off-set by a large increase in net foreign purchases of U.S. securities.

In their discussion, Directors praised the U.S. economy’s strong performance, noting in particular the continued growth with impressive employment creation and low unemployment rates while inflation was kept in check. They also commended the expert handling of monetary policy and the achievement in reducing the fiscal deficit.

Directors agreed that the immediate challenge was to maintain the progress in reducing inflation. The pace of economic activity had quickened since the beginning of 1996, with domestic demand increasing rapidly. As a result, the economy was operating at a high level of resource utilization, and the unemployment rate had fallen to low levels. Moreover, it appeared that the economy’s considerable strength would carry over to the second half of the year. Given these conditions, most Directors agreed that an early tightening of monetary conditions would be needed to ensure that inflationary pressures did not emerge and to prevent the buildup of adverse expectations and uncertainty in stock and bond markets.

In view of the low level of U.S. national saving and the imbalance between saving and investment, most Directors believed that the federal budget deficit remained the main economic policy challenge in the medium term. Therefore, it was important to consolidate into legislative action the consensus on achieving a balanced budget by fiscal year 2002. Several Directors considered that the effort needed to balance the budget might have to he greater than envisaged. Questions were raised about the feasibility of substantial further cuts in discretionary spending and whether the saving from the proposed entitlement reforms would be as large as assumed. Furthermore, since much of the deficit reduction envisaged by the authorities would be achieved late in the budget’s time horizon, Directors noted that tax cuts should be delayed until significant progress toward a balanced budget had been made. It would also be important to act expeditiously to address the impending fiscal pressures expected to result from the aging of the U.S. population.

On medium-term monetary policy. Directors agreed price stability should be the primary long-term objective. They endorsed the Federal Reserve’s handling of monetary policy, including its careful attention to signs of emerging pressure. They commended its willingness to act preemptively on the basis of its assessment of where the economy was heading; this had contributed to the enviable anti-inflation record.

Directors were generally satisfied that the strengthening of the U.S. dollar had helped to moderate aggregate demand in the United States and had contributed to economic recovery in other major industrial countries. However, they noted that the U.S. current account deficit remained large and that the net foreign liabilities of the United States continued to increase. They saw further tightening of fiscal policy over the medium term as the best means of raising national saving and contributing to a reduction in U.S. demands on global saving.

Directors commended the U.S. support for trade liberalization in multilateral and regional forums. They urged the authorities to take full advantage of the strengthened dispute settlement procedures of the World Trade Organization (WTO), and they stressed that unilateral trade policy actions by the United States risked undermining the effectiveness of the multilateral trading system. Directors expressed regret over the decline in U.S. official development assistance in terms of GDP and over U.S. arrears to multilateral institutions.

Subsequent to the consultation, the pace of economic activity slowed in the third quarter of 1996, but it rose sharply in the fourth quarter and maintained a very rapid pace in early 1997. The economy moved to a very high level of resource utilization; output growth exceeded estimates of the economy’s potential growth rate, and the unemployment rate fell from 5.8 percent in early 1996 to between 5.2 and 5.4 percent in the second half of 1996 and the first part of 1997. Despite continued high levels of resource utilization, there was little direct evidence of inflationary pressures, with core consumer price inflation (the consumer price index excluding food and energy) declining somewhat during 1996 and into 1997. Nevertheless, citing the need for monetary policy to be forward looking and concerns about the persistent strength of aggregate demand, with its attendant risks for inflation prospects, the Federal Open Market Committee acted to tighten monetary policy by increasing the target range for the federal funds rate by ¼ of 1 percent to 5½ percent in March 1997. The fiscal deficit was brought down to 1.4 percent of GDP in 1996, compared with 3.6 percent in 1993, and an agreement was reached on a fiscal framework that will achieve fiscal balance by 2002.

Japan

The Board concluded the Article IV consultation with Japan in July 1996. The pace of recovery after the bursting of the asset price bubble in 1990–91 had picked up since mid-1995 (Table 5), with real GDP growth reaching 3.0 percent in the first quarter of 1996 and averaging 6½ percent annually in the three quarters since mid-1995. This marked acceleration resulted from a strengthening in all major components of domestic demand. The unemployment rate rose to a historic peak of almost 3½ percent in late 1995, but other indicators suggested the beginning of a turnaround in labor market conditions.

Table 5Japan: Selected Economic Indicators

(Data as of Board discussion in July 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real GDP0.10.50.93.43.6
Unemployment rate2.52.93.13.33.4
Change in consumer prices
(period average)1.30.7–0.10.20.1
In billions of U.S. dollars1
External economy
Exports, f.o.b.352.9386.0429.4420.6400.2
Imports, f.o.b.213.3241.5297.2327.8316.7
Current account balance132.0130.6111.469.566.0
Direct investment–13.7–17.2–22.7–23.323.5
Portfolio investment–70.7–26.7–36.2–43.6–43.6
Capital account balance–1.5–1.9–2.3–0.2–0.2
Gross official reserves398.5125.9183.2216.6216.6
Current account balance
(in percent of GDP)3.12.82.21.51.4
Change in real effective
exchange rate (in percent)22.17.65.7–13.3–14.8
In percent of GDP1
Financial variables
General government balance–1.6–2.1–3.1–4.0–4.6
General government balance
(excluding social security)–4.8–5.0–5.9–6.8–7.3
Gross national saving32.831.530.831.131.2
Gross national investment29.728.728.729.929.8
Change in broad money
(M3; in percent)3.94.03.6
Three-month CD rate
(average; in percent)2.82.12.1

Unless otherwise noted.

Updated Fund staff estimates.

Excluding gold.

Unless otherwise noted.

Updated Fund staff estimates.

Excluding gold.

After mild deflationary pressures in 1995, consumer prices started to rise slightly in the first half of 1996, owing more to the pass-through effects of yen depreciation than to tighter market conditions. Most indicators pointed to continuing large margins of slack in output and labor markets. Consumer spending increased only modestly through 1995 but jumped by 2½ percent in the first quarter of 1996. More recent consumption data suggested that the surge in activity in the first quarter was a temporary phenomenon, as did data on public and residential investment, industrial production, and employment.

From mid-1995, as interest rates dropped and the yen fell back, monetary conditions eased substantially. Growth in broad money (M3) remained stable at about 4 percent, but lower interest rates caused a shift to more liquid deposits and cash, causing growth in M2 plus certificates of deposit (CDs) to increase to about 3 percent, while growth in Ml jumped to over 15 percent. After remaining flat in 1994, growth of both domestic credit and bank lending resumed in 1995. The shift of deposits from banks to the postal savings system continued, with the ratio of postal savings to M2 plus CDs reaching almost 40 percent.

The general government budget position (excluding social security) deteriorated from approximate balance in fiscal year 1990 to a deficit of 6½ percent of GDP in fiscal year 1995, mostly as a result of weak cyclical conditions on revenues and a reversal of the temporary surge in revenues from the asset price bubble. The deterioration in economic conditions in early 1995 led the authorities to introduce an economic stimulus package an September 1995, providing for ¥8 trillion in public investment, and the extension of an income tax cut for another year. Thus, substantial fiscal support was in place for fiscal year 1996.

Nominal and real external balances fell sharply in the face of the drop in the real effective value of the yen after mid-1995 to close to historical trends. Declines in the external balance were explained in part by the strong growth in domestic demand and by structural changes in trade patterns. Real net exports dropped sharply, and manufactured imports grew much more strongly than might have been expected, Both exports and imports were affected by the further outsourcing of domestic production.

In their discussion, Directors welcomed signs that Japan was finally entering a phase of recovery, partly as a result of the decisive stimulus measure taken the previous year and the reversal of the overvaluation of the yen. Most Directors believed that this reversal had returned the exchange rate to a level broadly in line with the fundamentals. Directors considered that the recent surge in GDP growth probably overstated the underlying strength of activity. At the same time, the continued large output gap, higher-than-usual unemployment, and the absence of wage and price pressures suggested that there was little immediate danger of economic overheating, and Directors concluded that the current policy stance should be maintained for the time being and reassessed later in the year. In the longer run, a range of structural reforms would be necessary to increase efficiency and ensure durable growth.

As regards fiscal policy, Directors agreed that past stimulus packages continued to provide desirable support to economic activity. However, the fiscal position had deteriorated sharply since the collapse of the bubble economy, and there had been a substantial increase in public debt. Most Directors emphasized that the exceptional fiscal stimulus through recent measures should be phased out in 1997 if the recovery continued as envisaged. However, some Directors noted that, given the historically high rate of unemployment and downside risks to the economic outlook, there may be a need to continue fiscal support measures—particularly if activity were to weaken later in the year. Directors expressed concern about the deterioration in Japan’s longer-run fiscal situation, noting the significant challenges posed by the country’s aging population. They noted the desirability of taking decisive and forward-looking actions to put the fiscal situation on a sustainable footing, and they welcomed the authorities’ intention to place fiscal consolidation in a medium-term framework.

Monetary conditions were at the easiest levels since the start of the recession, Directors noted. Given that the margins of slack were large and inflationary pressures were negligible. Directors generally concluded that the current accommodative monetary stance was appropriate and should be maintained until there were clear signs that the economy was on an autonomous recovery path. Some Directors mentioned the desirability of strengthening the independence of monetary policymakers, noting that such steps would facilitate setting longer-term objectives for policy.

Directors welcomed the authorities’ changed approach over the past year in dealing with strains in the financial sector. Restoring strength and confidence in the financial sector would take time, and they considered that the passage of legislation to deal with the jusen problem (the insolvency of several housing loan companies) was an important step toward reducing uncertainties. Nevertheless, many Directors expressed concern about the lack of transparency in the approach taken to resolving the jusen problem and emphasized the need for a clearly defined and comprehensive plan to resolve remaining difficulties that did not rely on further ad hoc solutions.

Directors underscored the key role of structural adjustment in medium- and long-term growth prospects. In the view of a number of Directors, this constituted the authorities’ main policy challenge, and they urged the Japanese authorities to accelerate efforts to deregulate the economy, including reforming the labor sector and implementing reforms relating to land use and the telecommunications sector. Aggressively pushing ahead with such policies would enhance Japan’s welfare and would benefit the international community. They commended Japan’s role as the world’s largest provider of financial assistance to developing countries and welcomed Japan’s generous support for the ESAF and the Fund’s technical assistance activities.

Since the consultation, the Japanese authorities have completed the introduction of procedures and other measures to be taken in the case of the failure of financial institutions. Also, the Rank of Japan Law has been revised with a view to strengthening the independence of the central bank.

Germany

The Board concluded the Article IV consultation with Germany in September 1996. Real GDP, after growing during 1994 and the first half of 1995 at almost 3 percent, stalled in the second half of 1995, for an annual increase of only 1.9 percent (Table 6). In the first quarter of 1996, real GDP contracted slightly. Private consumption continued its moderate (0.5 percent quarterly) growth rate. Unemployment had reached its highest postwar level in March 1996, at 10.4 percent, before edging down to 10.3 percent in June.

Table 6Germany: Selected Economic Indicators

(Data as of Board discussion in September 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real GDP–1.22.91.91.01.4
Unemployment rate8.99.69.410.310.3
Change in consumer prices
(period average)4.52.71.31.61.5
In billions of U.S. dollars1
External economy
Exports, f.o.b.445.0493.3588.1594.5604.2
Imports, f.o.b.436.6481.9563.5558.1574.4
Current account balance–16.0–21.8–17.3–10.9–17.1
Direct investment–15.3–16.7–34.9–30.5
Portfolio investment119.4–33.226.750.9
Capital account balance0.30.2–0.711.9
Gross official reserves14.22.0–7.2–1.3
Current account balance
(in percent of GDP)–0.9–1.0–0.7–0.5–0.7
Change in real effective
exchange rate (in percent)8.02.27.9–0.6
In percent of GDP1
Financial variables
General government balance–3.5–2.6–3.5–4.0–3.8
Primary structural balance30.81.70.91.41.2
Gross national saving20.621.721.720.820.7
Gross national investment21.422.722.421.321.5
Change in broad money
(M3; annual average; in percent)8.28.50.16.547.5
Three-month interbank rate
(in percent)7.25.34.53.353.3

Unless otherwise noted.

Updated Fund staff estimates.

General government balances for 1995 and 1996 were affected by the incorporation of previously off-budget (primarily interest) expanditures, so that changes in the primary structural balance—which is the budgetary position, excluding interest transactions, that would be observed if the level of actual output coincided with potential output—are a better measure of the fiscal impulse.

Average January–May 1996 compared with average January–May 1995.

Average January–June 1996.

Unless otherwise noted.

Updated Fund staff estimates.

General government balances for 1995 and 1996 were affected by the incorporation of previously off-budget (primarily interest) expanditures, so that changes in the primary structural balance—which is the budgetary position, excluding interest transactions, that would be observed if the level of actual output coincided with potential output—are a better measure of the fiscal impulse.

Average January–May 1996 compared with average January–May 1995.

Average January–June 1996.

Consumer prices rose by only 1¾ percent in 1995, owing to the strength of the deutsche mark, competitive pressures on traded goods, and weakness of domestic demand. In the first half of 1996 consumer prices rose only 1½ percent over the corresponding period in 1995, while wholesale, producer, and import prices fell.

Government deficits for 1995 and 1996 were substantially greater than expected and exceeded the Maastricht reference values. Efforts to correct the fiscal imbalances induced by unification experienced an unexpected setback in 1995, when the general government deficit increased by nearly I percentage point to 3½ percent of GDP. Despite expenditure restraints, the federal deficit was projected to rise further, by almost ½ of 1 percentage point of GDP, in 1996 because of an unanticipated revenue shortfall, which resulted from unusually large lagged effects on tax receipts from the 1992–93 recession and the extensive use of special tax allowances for investment in eastern Germany and in housing.

Broad money (M3) grew by only 2.7 percent in 1995 compared with the average in the fourth quarter of 1994, tailing short of the target range of 4–6 percent, but the annualized six-month growth rate for M3 reached 6 percent by December; by June 1996, M3 was growing at an annual rate of 9.3 percent over the fourth quarter of 1995, The authorities lowered the discount and Lombard rates by a total of 150 basis points during 1995 to 3 percent and 5 percent, respectively, by end-1995, and short-term market interest rates dropped in concert with the official rates. Despite rapid M3 growth, the Bundesbank lowered the discount and Lombard rates again in April, bringing them to historical lows. This reflected the authorities’ approach of taking a wide array of real, financial, and international indicators into account in gauging the appropriateness of monetary conditions. The lowering of rates by the Bundesbank signaled the Bundesbank’s view that rates could drop in the market; the repurchase rate, however, was kept unchanged at 3.3 percent until August 1996, Long-term rates have been volatile.

Since the end of 1995, the deutsche mark had weakened against the U.S. dollar and many European currencies outside the exchange rate mechanism (ERM) of the European Monetary System (EMS)—in particular, the lira and pound sterling—depreciating by 3½ percent in nominal effective terms by June 1996. However, turbulence in the U.S. stock market meant that the dollar slipped by 2 percent vis-à-vis the deutsche mark in July.

In their discussion, Directors welcomed the projected rebound in economic activity after the significant weakening in 1995 but noted that there was still some way to go before a robust recovery might take hold. They were encouraged by the more moderate wage settlements in the current year, which would help to enhance Germany’s weakened cost competitiveness. However, comprehensive action on both the macroeconomic and the structural fronts was necessary to improve the fundamentals, reduce reliance on regulations and subsidies, enhance confidence, and reduce unemployment.

Directors noted that prudent monetary policy in the past few years had restored low inflation; in the current circumstances, they welcomed the more recent relaxation of monetary conditions. They warmly commended the recent lowering of the repurchase rate, which would lessen the downside risks to growth, particularly in view of the sizable fiscal retrenchment taking place simultaneously in Germany and its major European trading partners. Some Directors emphasized the need for continued close attention to monetary policy given Germany’s anchor function in the ERM.

Directors supported the authorities’ package of fiscal measures and structural reforms and urged that it be fully implemented. They considered the package an appropriate response to the challenges posed by both the domestic economy and the move toward Economic and Monetary Union (EMU) in Europe. However, Directors were of the view that, if growth were lower than projected, fiscal policy should continue to be anchored by medium-term structural goals. Directors supported the authorities’ medium-term fiscal objectives, including further consolidation efforts, a return of expenditures as a share of GDP to the preunification level, and a lowering of the heavy tax-cum-social contribution burden.

Directors observed that the high unemployment rate continued to be Germany’s most pressing economic issue, and they stressed the need for significant structural reforms to realize the labor market flexibility required to achieve lasting reductions in unemployment. Major structural reform was needed in the goods and services markets, the health and pension systems, and the labor market. The authorities were in the early stages of addressing those issues, and Directors encouraged them to persevere in making the economy more flexible and competitive.

Directors noted the significant progress achieved in the past five years in integrating the new Lander into the German market economy, but they stressed that serious challenges remained, including the imbalance between saving and investment in the east, the severe labor cost disadvantage in the new Lander, and the public transfers and subsidies from the west that risked promoting an entitlement culture and distorting resource allocation.

Several Directors commended the authorities on their significant assistance to economies in transition, but it was hoped that the decline in official development assistance observed in the preceding few years would be reversed.

France

The Board concluded the Article IV consultation with France in October 1996. Economic performance in 1995 fell substantially short of expectations, with an overall growth in real GDP of 2½ percent (Table 7). Production recovered in early 1996 following the end of widespread strikes in November and December 1995, with output leveling off in the second quarter of 1996. Unemployment edged down to 11½ percent in 1995 but was back to the record high of 12½ percent by mid-1996, underlying inflation in 1995 was lower than the recorded 2 percent rise in consumer prices—and remained low through June 1996.

Table 7France: Selected Economic Indicators

(Data as of Board discussion in October 1996)2

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real GDP–1.32.22.31.31.5
Unemployment rate11.612.311.612.412.4
Change in consumer prices
(end of period)2.11.62.11.81.7
In billions of U.S. dollars1
External economy
Exports, f.o.b.196.3221.6267.5271.5270.5
Imports, f.o.b.189.4216.2258.0257.5257.3
Current account balance9.27.016.622.321.2
Direct investment0.3–6.35.0–4.4
Portfolio investment3.0–55.8–13.5–60.9
Capital account balance–11.8–11.1–21.3–20.1
Gross official reserves22.626.326.926.8
Current account balance
(in percent of GDP)0.70.61.21.41.4
Change in real effective
exchange rate (in percent)2.10.00.4–1.13–1.9
In percent of GDP1
Financial variables
General government balance–5.8–5.8–5.0–4.0–4.2
Gross national saving18.219.019.819.118.8
Gross national investment417.218.418.317.517.1
Change in broad money
(M3; in percent)–3.21.74.70.63–1.5
Three-month interbank rate
(period average; in percent)8.45.86.64.053.9

Unless otherwise noted.

Updated Fund staff estimates.

Second quarter over same period in 1995.

Stockbuilding included.

Average to September 18, 1996.

Unless otherwise noted.

Updated Fund staff estimates.

Second quarter over same period in 1995.

Stockbuilding included.

Average to September 18, 1996.

In 1995 the government took measures to correct the incipient fiscal slippage and to initiate a far-reaching reform of social security. These were important steps forward in tackling the economy’s structural fiscal problem and improving the prospects for meeting the criteria of EMU on the planned timetable. The fiscal reforms kept the deficit to the targeted 5 percent of GDP, which contrasted positively with the outturn in the previous four years. For 1996, the government announced a ceiling on the fiscal deficit of 4 percent of GDP, which put French fiscal policy on course to meet the Maastricht target of 3 percent for 1997.

As regards monetary policy, the Bank of France had managed since the fall of 1995 to bring the franc back within the former narrow band of the EMS and to narrow interest rate differentials with Germany. Overall, the return of market confidence contributed to a substantial easing in monetary conditions.

Exports weakened markedly during the second half of 1995, but with domestic demand relatively subdued the current account surplus reached about 1¼ percent of GDP in 1995. Total official reserves (excluding gold) increased slightly, to $27 billion. The fiscal reform packages played a critical role in the strengthening of the franc.

In their discussion, Directors commended the authorities for the progress they had made in fiscal consolidation, their maintenance of a prudent monetary policy, and their strong commitment to further fiscal consolidation and first-round participation in EMU—policies that had been rewarded by a striking improvement in financial market conditions. However, economic activity had been weaker than expected, and some uncertainty clouded the outlook for 1997.

As regards fiscal policy, Directors felt it was still possible to hold the deficit in 1996 to the targeted 4 percent of GDP if economic recovery was on track. However, they were concerned about slippages in cutting back the social security deficit and noted the risks of further overruns in health care spending. Directors welcomed the announcement of a budget for 1997 designed to respect the Maastricht reference value of 3 percent of GDP, although they noted that the budget contained little margin for unexpected adverse developments. They also noted that the decline in the 1997 deficit was due in large part to a one-off transfer from a public enterprise. They urged the authorities to implement additional measures beginning in early 1997 to ensure adequate structural adjustment and to avoid an increase in the deficit, in the event of weaker-than-expected activity, that could jeopardize market confidence in the achievement of EMU. France faced serious pressure on the public finances from demographic changes in the long term, and the fiscal deficit should therefore be reduced to close to balance over the next few years. The level of public spending was clearly too high.

Directors welcomed the skillful handling of monetary and exchange rate policy. Inflation remained low, and the reduction of interest rates reflected the credibility of both monetary and fiscal policy. Directors supported the cautious approach of the Bank of France to further monetary easing and the priority attached to sustaining the stable and favorable monetary environment.

Directors were concerned about the record level of unemployment, which was due in large part to structural problems in the labor market. Far-reaching reforms were needed to cut unemployment, which was both a serious social problem and a potential threat to the credibility of fiscal adjustment.

Directors urged the authorities to strengthen their efforts to address the problems in state-owned banks. The authorities should proceed rapidly with privatization, remove distortions and establish a more level playing field, strengthen supervision, and improve corporate governance and internal controls. They also pressed for progress with privatization and reforms in other sectors where the state was involved in commercial activities.

Directors praised France’s traditionally generous commitment to development assistance, and they urged the authorities to maintain aid flows, which had suffered from budgetary stringency, at as high a level as possible.

United Kingdom

The Board concluded the Article IV consultation with the United Kingdom in October 1996. Real GDP growth slowed to about 2 percent a year through the second quarter of 1996 as economic slowdowns in the United Kingdom’s trading partners affected net exports (Table 8). Weak demand meant overhanging stocks, which translated into output cuts that further harmed growth, and the beef crisis adversely affected agricultural output. The unexpected weakness of output and its uncertain duration caused sluggish private fixed investment. Nonetheless, unemployment fall to a five-year low of 7½ percent in July 1996 (2 percent below the European Union average), thanks in part to active policies against long-term unemployment.

Table 8United Kingdom: Selected Economic Indicators

(Data as of Board discussion in October 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real GDP2.13.82.52.22.1
Unemployment rate10.39.38.27.67.5
Change in consumer prices
(period average)33.02.42.82.82.9
In billions of U.S. dollars1
External economy
Exports, c.i.f.182.3206.3240.5251.0259.4
Imports, f.o.b.202.6222.8258.8273.2278.5
Current account balance–16.2–3.7–6.2–1.80.0
Direct investment–10.1–17.7–8.0–10.9
Portfolio investment–59.177.5–37.0–48.0
Capital account balance19.6–4.10.7–4.6
Gross official reserves43.643.050.142.742.7
Current account balance
(in percent of GDP)–1.7–0.4–0.6–0.20.0
Change in real effective
exchange rate (in percent)–8.2–0.8–4.33.83.3
In percent of GDP1
Financial variables
General government balance–7.8–6.8–5.5–4.4
Gross national saving13.715.715.816.1
Gross national investment15.015.415.615.3
Change in broad money
(M4; in percent)4.94.09.99.49.5
Three month interbank, rate
(period average; in percent)5.95.56.76.06.0

Unless otherwise noted.

Updated Fund staff estimates.

Excludes mortgage interest payments.

Unless otherwise noted.

Updated Fund staff estimates.

Excludes mortgage interest payments.

Inflation was contained despite sharp increases in 1995 in input costs associated with sterling’s depreciation and a surge in commodity prices. Factors contributing to subdued inflation included moderate economic expansion with a continuing output gap, increased competition associated with a structural change in retailing, and pricing policies for privatized utilities.

Following initial successes, the fiscal consolidation effort was marred by slippages. The public sector borrowing requirement for 1995/96 was 4.9 percent of GDP, compared with 3.4 percent projected in the November 1994 budget. Revenues were responsible for about four-fifths of the slippage; nominal expenditures were successfully kept within the established targets, although real expenditures were somewhat higher because of lower-than-expected inflation. The November 1995 budget measures were broadly neutral; income tax reductions of about ½ of 1 percent of GDP were roughly offset by cuts in current and capital spending.

In line with the medium-term monetary policy framework, official interest rates were raised in several steps in late 1994 and early 1995, but once growth slowed and inflation prospects improved official rates were lowered between December 1995 and June 1996 by a total of 1 percentage point in four steps. Monetary conditions eased considerably as a result of the depreciation of sterling in early 1995. Monetary aggregates expanded quite rapidly, with growth of sterling M4 rising to nearly 10 percent. Credit expansion was also strong. There was limited progress in strengthening policy credibility, as revealed by yields on indexed government securities and long-term interest rate differentials with Germany.

The external current account remained near balance, with rising surpluses on services and oil trade offsetting a decline in non-oil trade. External competitiveness was favorable by past standards.

In their discussion, Directors welcomed the United Kingdom’s recent economic performance, which was especially noteworthy given the sluggish activity elsewhere in Europe. Directors noted that prospects for 1997 were positive, with growth likely to strengthen, unemployment to decline further, and inflationary pressures to remain subdued. Directors emphasized the importance, in achieving this performance, of sound policy that emphasized medium-term stability, fiscal consolidation, and flexible markets.

Nevertheless, Directors noted the need to enhance the credibility of the authorities” policy commitment, especially in the fiscal area, and therefore considered that the fiscal imbalances were too large and that further consolidation was required. Directors observed that the ratio of current expenditure to GDP had risen in recent years, despite the significant decline in the unemployment rate. They suggested that current outlays bear the brunt of additional fiscal cuts, keeping in mind the potential effect on income distribution. Many Directors considered that there was no scope for further tax cuts in the upcoming budget. Steps should be taken to bolster the revenue-generating capability of the tax system, including by reducing exemptions and preferences.

A number of Directors considered that credibility could be strengthened by increasing central bank independence. Directors observed that the inflation-targeting framework for monetary policy had delivered impressive results. They generally cautioned against further reductions in short-term interest rates.

Board members welcomed the United Kingdom’s continued active involvement in discussions on preparations for EMU in Europe, and the authorities’ view that the economic criteria under the Maastricht Treaty were highly desirable objectives for U.K. policy, whether or not the country eventually decided to join the monetary union.

The United Kingdom’s structural policies—notably privatization, labor market reforms, and deregulation—had contributed in important ways to improving economic performance and prospects, in the Board’s view. Combined with macroeconomic policies geared to medium-term stability, these structural reforms should provide a basis for improving growth performance in the medium term.

Directors noted the likelihood that official development assistance, which was at a level of 0.3 percent of GNP, was set to decline even further, and they encouraged the authorities to raise it.

Italy

Directors met in April 1997 to conclude the 1996 Article IV consultation with Italy, against the background of a sharp decline in inflation but a weak economic recovery (Table 9). GDP growth was estimated at 0.7 percent and unemployment at about 12 percent in 1996. Inflation (year-on-year) was more than halved from 6 percent in November 1995 to slightly over 2 percent in early 1997, with the official target for 1997 (2½ percent) set to be achieved.

Table 9Italy: Selected Economic Indicators(Data as of Board discussion in April 1997)
19931994199519961
In percent
Domestic economy
Change in real GDP–1.22.13.00.7
Unemployment rate210.211.312.012.1
Change in consumer prices (end of period)4.34.05.62.6
In billions of U.S. dollars3
External economy
Exports, f.o.b.226.8250.3298.9329.9
Imports, f.o.b.192.7212.9253.5266.3
Current account balance11.415.127.242.3
Direct investment–3.5–2.9–0.9–3.4
Portfolio investment72.6–5.130.341.6
Capital account balance9.5–13.8–4.0–5.1
Gross official reserves53.756.755.869.4
Current account balance (in percent of GDP)1.11.52.53.5
Change in real effective exchange rate (in percent)–16.2–6.3–8.010.4
In percent of GDP3
Financial variables
General government balance–10.0–9.6–7.0–6.7
Gross national saving18.118.920.621.1
Gross national investment16.917.118.117.8
Change in M2 (in percent)47.81.72.12.7
Three-month rate on treasury bills
(period average; in percent)10.58.810.78.6

Fund staff estimates.

Excluding workers in the Wage Supplementation Fund.

Unless otherwise noted.

End of period, moving average of last three months; growth rate used for target monitoring.

Fund staff estimates.

Excluding workers in the Wage Supplementation Fund.

Unless otherwise noted.

End of period, moving average of last three months; growth rate used for target monitoring.

The current account balance improved strongly in 1996: although export growth decelerated sharply as from late 1995, the slowdown in domestic demand also made for a marked fall in imports. Aided also by an improvement in the terms of trade, the trade surplus widened to close to 5 percent of GDP.

The notable progress in reducing the fiscal imbalance in 1992–95 stalled in 1996, with the general government deficit amounting to an estimated 6.7 percent of GDP, above official objectives. The overrun from the original deficit target was primarily due to considerably weaker growth, as well as the underlying dynamics of primary current spending.

For 1997, the government set the objective of joining EMU from the start, and it presented a budget aimed at achieving a general government deficit of 3 percent of GDP, In early 1997, the authorities estimated that, in the absence of additional measures, the general government deficit target would be missed. Against this background, on March 27 the government introduced a corrective fiscal package (in an amount of 0.8 percent of GDP), with a view to achieving the Maastricht deficit criterion, and announced the start of negotiations with the social partners on a reform of the welfare system.

The authorities continued to pursue a tight monetary policy, geared to reducing inflation. With progress on the latter front, official rates were gradually reduced, bringing the discount rate to 6¾ percent after the latest reduction in January 1997. Long-term interest rates declined sharply over the past year, to a level consistent with the Maastricht interest rate criterion. By January 1997, long-term differentials with Germany had reached a low of under 150 basis points, although they widened somewhat thereafter in the face of market uncertainties regarding the EMU process. The improved inflation performance and relatively high money market rates helped to foster the appreciation of the exchange rate. By the fall of 1996, the authorities judged the lira to have strengthened sufficiently and on a durable basis to justify ERM reentry, and the lira rejoined the ERM in November.

In their discussion, Directors commended the significant progress that Italy had made since 1992 toward price stability, fiscal consolidation, and strengthened external accounts. That progress had placed the country in a position to aspire to participate in EMU from the start, and had been rewarded by increased market confidence. Directors particularly welcomed the remarkable decline in inflation, aided by wage moderation and the authorities’ firm conduct of monetary policy.

At the same time, Directors emphasized that Italy faced several key challenges, including a slow economic recovery, relatively inflexible labor markets, high unemployment concentrated in the south, and the need to achieve sustained structural strengthening of public finances. On the labor market. Directors welcomed the positive aspects of the recent Pact for Employment but stressed the need for bolder initiatives toward labor market flexibility, in particular through greater regional and sectoral wage differentiation and a wider use of nontraditional work contracts.

Given its high public debt and interest rate premiums, Italy had much to gain from participation in EMU. However, it faced the difficult task of having to effect the largest fiscal correction among early EMU contenders in the context of a weak economic outlook. Directors commended the authorities’ decision to step up the pace of fiscal adjustment in 1997. However, while the corrective fiscal package of March 1997 would bring the deficit within reach of the Maastricht reference value in 1997, Directors noted that the reliance on revenue and one-off measures raised questions about the sustainability of fiscal adjustment beyond 1997. Permanent savings in such key spending areas as pensions, health, and public employment were critical. Directors welcomed the government’s intention to rely on structural measures in the 1998 budget and the announcement of the imminent start of discussions on the reform of social spending.

Directors noted that monetary union, with the intensified competitive pressures that it would bring, would increase the challenges faced by the Italian banking system. Directors recognized that current problems had both important cyclical and regional components, but they stressed the importance of continuing to address the problems of nonperforming loans, overstaffing, and high operating costs. Accelerated privatization of the major banks was seen as crucial to addressing the banking sector’s structural problems.

Canada

The Board concluded the Article IV consultation with Canada in January 1997. Canada has had considerable success in the implementation of its economic strategy. In fiscal year 1996/97 (ending March 1997) the federal budget deficit was expected to be below the target of 3 percent of GDP. This was being accomplished by measures introduced in the 1994, 1995, and 1996 budgets, which cut business and farm subsidies, commercialized public spending programs, imposed user charges, and lowered government consumption by scaling back most spending programs, cutting defense spending, and eliminating some 55,000 government jobs.

Real GDP growth picked up in 1996, from 0.7 percent during 1995 (fourth quartet to fourth quarter) to an annual rate of 1.3 percent during the first half of 1996 and 3.3 percent in the third quarter, led by increases in residential construction and investment in machinery and equipment. Personal consumption increased sharply in the first quarter of 1996 but rose moderately during the second and third quarters. The unemployment rate remained at about 9½ percent during the first half of 1996, but then rose slightly to 9.7 percent in December (Table 10).

Table 10Canada: Selected Economic Indicators(Data as of Board discussion in January 1997)
19931994199519961
In percent
Domestic economy
Change in real GDP2.24.12.31.4
Unemployment rate11.210.49.59.7
Change in consumer prices (end of period)1.70.11.81.6
In billions of U.S. dollars2
External economy
Exports, f.o.b.161.9183.1212.3226.5
Imports, f.o.b.164.4179.9198.3206.4
Current account balance–22.3–16.2–8.20.3
Direct investment–0.8–0.25.0
Portfolio investment21.09.014.7
Capital account balance29.414.34.4
Gross official reserves12.113.115.3
Current account balance (in percent of GDP)–4.0–3.0–1.40.0
Change in real effective exchange rate
(in percent)–3.3–6.7–3.9
In percent of GDP2
Financial variables
General government balance–7.3–5.3–4.1–2.1
Gross national saving13.615.317.017.5
Gross national investment18.219.018.217.5
Change in broad money (in percent)3.12.74.02.3
Three-month treasury bill rate (in percent)4.85.57.04.2

Fund staff projections.

Unless otherwise noted.

Fund staff projections.

Unless otherwise noted.

Core consumer price inflation fell from 4.6 percent in 1989 to less than 2 percent at the beginning of 1996. It dropped further to 1.7 percent during the first 11 months of 1996, reflecting the slack in the economy.

Monetary conditions eased significantly in 1995 and 1996. The Bank of Canada’s operating band for the overnight interest rate was reduced in steps from 5½–6 percent in early January to 2¾–3¼ percent in November. Canadian short-term interest rates have been below their U.S. counterparts since March 1996—unprecedented in recent decades—while differentials between Canadian and U.S. long-term interest rates narrowed sharply to levels well below the historical average. This reflects Canada’s sustained low inflation and the steady progress in reducing the federal budget deficit.

The external current account deficit was 1.4 percent of GDP in 1995 and continued to improve during 1996, shifting into small surpluses in the second and third quarters. This improvement was largely due to the strength of the U.S. economy, and to the lagged effects of the real effective depreciation of the Canadian dollar in the early 1990s.

Canada experienced large net inflows of direct investment and portfolio capital in 1995 and the first three quarters of 1996, while at the same time large short-term outflows by Canadian banks and sales of money market instruments were recorded.

In their discussion, Directors commended the authorities for the impressive progress in implementing their economic strategy during the past year. They noted that inflation had been contained at a low level, federal fiscal deficit targets were being more than met, and substantial measures had been taken by provincial governments to balance their budgets. Sound macroeconomic policies had improved confidence in financial markets, as reflected in the negative short-term Canada–U.S. interest rate spreads. This considerable progress in the economic fundamentals had improved Canada’s prospects for sustainable growth.

Directors agreed that the easing in monetary conditions during 1996 had been appropriate in light of the sustained low inflation, strong fiscal adjustment at all levels of government, and considerable slack in the economy. Caution would have to be exercised in easing monetary conditions further, however, given the considerable stimulus from past policy actions and the lags between monetary policy actions and their effects on the economy. Directors noted that strong output growth in the third quarter of 1996 and the economic indicators for the fourth quarter seemed to signal the long-awaited strengthening of economic activity in Canada.

Directors were encouraged by the plans to eliminate fiscal imbalances at the federal and provincial levels during the next few years. They noted the quality of the fiscal adjustment, which relied mainly on expenditure cuts rather than revenue increases. It was important that the government hold to its planned fiscal policy course set out in the 1995 and 1996 federal budgets to achieve the deficit-reduction targets for the coming years. Those measures might balance the budget by 1999/2000.

Directors remained concerned by the persistence of high unemployment rates. They also observed that the public old-age support system faced important challenges, given the aging population in Canada and the large unfunded liability of the system. They commended the authorities’ initiatives in facing those challenges and urged the federal and provincial authorities to reach agreement quickly on an appropriately balanced package of contribution rate increases and benefit cuts to shore up the finances of the Canada Pension Plan. Subsequent to the Board discussion, agreement was reached between the federal and provincial governments on measures to deal with the long-term needs of the Plan.

Directors commended Canada’s consistent support for free trade, including multilateral trade liberalization and regional and bilateral market opening on terms supportive of the multilateral trading system. They supported the further reduction of tariffs on a range of goods and the simplification of Canada’s tariff system.

Directors were encouraged by Canada’s commitment to raise its official development assistance, as circumstances allowed, toward the target of 0.7 percent of GNP.

Other Advanced Economies

Greece

The Board concluded the Article IV consultation with Greece in August 1996. Greece’s economic performance had improved during 1995 as output growth accelerated to 2 percent, although unemployment rose slightly to 10 percent during the year (Table 11). Inflation dropped below two digits in 1995 for the first time in two decades.

Table 11Greece: Selected Economic Indicators(Data as of Board discussion in August 1996)
19931994199519961
In percent
Domestic economy
Change in real GDP–1.01.52.02.5
Unemployment rate9.79.610.09.8
Change in consumer prices (end of period)12.110.88.15.0
In billions of U.S. dollars2
External economy
Exports, f.o.b.5.05.25.8
Imports, c.i.f.17.618.722.9
Current account balance–0.7–0.1–2.9
Capital account balance4.46.93.1
Gross official reserves8.615.315.7
Current account balance (in percent of GDP)–0.40.2–1.5–1.8
Change in real effective exchange rate
(in percent–3.61.33.7
In percent of GDP2
Financial variables
General government balance–14.2–12.1–9.2–7.0
Gross national saving21.121.020.321.0
Gross national investment21.520.821.822.8
Change in broad money (in percent)15.313.98.39–12
Three-month treasury bill rate (in percent)18.218.214.5

Fund staff estimates.

Unless otherwise noted.

Fund staff estimates.

Unless otherwise noted.

There was further progress in fiscal consolidation, with the central government deficit declining from 12.7 percent of GDP in 1994 to 11.2 percent in 1995, against a budget target of 10 percent. The overrun was due mainly to revenue shortfalls, particularly in indirect taxes, and to delays in transfers from the European Union. However, the authorities met the convergence plan target for the general government deficit. Monetary policy continued to be guided by the preannounced exchange rate target. The target for the rate of crawl of the drachma vis-à-vis the European currency unit (ECU) of 3 percent during 1995 was achieved. This policy and the successful handling of a speculative attack against the drachma in May 1994 had spurred a surge in capital inflows. The Bank of Greece adopted a cautious stance in dealing with the inflows—lowering intervention rates only slowly, sterilizing most of the inflows, raising reserve requirements from 9 percent to 11 percent, and extending reserve requirements to short-term foreign currency liabilities of the banking sector.

After two years at near balance, the current account deficit widened in 1995 to 1.5 percent of GDP because of a sharp increase in imports of investment goods. The capital account remained in surplus, although the surplus was smaller than in 1994. Foreign exchange reserves rose slightly.

Against the positive short-term outlook, the macroeconomic framework was showing signs of strain in 1996. Inflation picked up early in the year before resuming a downward trend, the pace of fiscal consolidation slowed, the Bank of Greece was finding it increasingly difficult to use interest rates to contain credit and reduce inflationary pressures, and there were escalating expenditure pressures.

In their discussion, Directors commended the authorities for their continued efforts at fiscal consolidation and inflation reduction. Nevertheless. Directors saw an urgent need to strengthen the adjustment effort.

Directors noted that the budget deficit target for 1996 risked being overshot by about 1 percentage point of GDP and cautioned that such an outcome would represent an unfortunate setback. They welcomed the policy package announced in July 1996, which envisioned reductions in public employment, a review of extra budgetary accounts, and a strengthening of financial control of public entities. Directors urged the authorities to enact further corrective measures promptly, especially on the expenditure side. They praised the authorities’ efforts to expand the tax base but stressed that achievement of lasting fiscal consolidation would require expenditure reduction. Directors expressed concern that the pace of fiscal consolidation had slowed down despite faster-than-projected growth.

Directors noted that the “hard drachma” policy had contributed to reducing inflation in recent years and viewed the authorities’ cautious interest policy as appropriate. They pointed out, however, that capital inflows had illustrated the inability of right monetary policy alone to secure further disinflation in the current policy environment. Directors urged the government to pursue a strict wage and employment policy in the public sector that would serve as a signal to the private sector.

Directors stressed the need to accelerate structural reform to improve Greece’s long-term growth performance and to ensure real convergence with Europe. They welcomed the authorities’ agenda for structural reform, which included rationalization of public spending, strengthened management of public entities, increased accountability in the public sector, and reform of the unemployment benefits system. They urged the authorities to expand the scope and to accelerate the pace of privatization. Directors also pointed to the need to reduce the state’s presence in the banking sector.

Hong Kong, China

Directors met in February 1997 to consider the staff report for the 1996 Article IV consultation discussions with Hong Kong, China4 against the backdrop of average annual growth of real GDP of almost 7 percent over the past 15 years. That performance had been achieved in the context of a dramatic change in economic structure, under which the importance of the manufacturing sector and domestic merchandise exports had declined sharply and Hong Kong had emerged as a mature, services-based economy.

Although growth has been slowing since 1994, there were signs in the second half of 1996 of moderate recovery. Retail sales and property prices began to rise, and private construction rebounded. However, merchandise export growth—which usually accompanies the upturn—remained subdued, as export volume rose by only 5 percent in the first nine months of 1996. For the year as a whole, real GDP was projected at the time of the Board discussion to grow by 4½ percent (Table 12). Subsequently, the estimate was revised upward to almost 4¾ percent, the same as the 1995 growth fate. Inflation fell from percent in 1995 to about 6 percent in 1996, owing largely to a slowdown in domestic demand, combined with falling import prices resulting from an appreciating exchange rate and some labor market slack. Unemployment, which had risen sharply in 1995 with an expansion of the labor supply, gradually eased to about 2½ percent in 1996.

Table 12Hong Kong, China: Selected Economic Indicators(Data as of Board discussion in February 1997)
19931994199519961
In percent
Domestic economy
Change in real GDP6.15.44.74.5
Unemployment rate2.02.03.32.6
Change in consumer prices (period average)8.58.18.76.0
In billions of U.S. dollars2
External economy
Exports, f.o.b.163.1182.5209.2222.5
Imports, c.i.f.155.0181.0214.8221.0
Current account balance38.21.5–4.91.6
Gross official reserves43.049.355463.8
Current account balance (in percent of GDP)37.01.6–2.31.0
Change in real effective exchange rate
(in percent)10.51.5–1.24.1
In percent of GDP2
Financial variables
General government balance42.52.31.3–0.3
Gross national saving535.833.831.033.0
Gross domestic investment27.631.934.532.0
Change in broad money (in percent)15.613.613.613.1
Best lending rate (in percent)6.58.58.88.5

Fund staff estimates.

Unless otherwise noted.

Balance on goods and nonfactor services.

Data are for fiscal years ending March.

Foreign component of saving included for 1993 and 1994 only.

Fund staff estimates.

Unless otherwise noted.

Balance on goods and nonfactor services.

Data are for fiscal years ending March.

Foreign component of saving included for 1993 and 1994 only.

The Board commended the authorities for successful management of the economy. Directors observed that the key challenge in the near term was to maintain confidence and ensure a smooth transition to Chinese sovereignty. They considered that this could best be achieved by continued adherence to the broadly rules-based policy framework—consisting primarily of the link of the exchange rate to the U.S. dollar, a prudent fiscal policy stance, and firm financial regulation.

Directors fully endorsed continuation of the linked exchange rate system as an important anchor for stability and confidence. They welcomed the Chinese authorities’ reaffirmation of their commitment to monetary independence for Hong Kong following the transfer of sovereignty. In fight of the different levels of financial development in Hong Kong and the mainland of China, Directors supported the continuation of two separate monetary systems and currencies, as well as two independent monetary authorities. The Board also emphasized the need to continue with a broadly neutral and noninterventionist approach to fiscal policy. Directors considered that continued moderate government surpluses would be appropriate, given the fiscal implications of an aging population. Directors also commended the authorities for giving priority to maintaining a strong system of banking supervision. They stressed that, given banks’ dependence on property lending and the increasing linkages with China’s economy, continued close monitoring of asset quality and maintenance of high prudential standards were needed. Directors also welcomed the Hong Kong Monetary Authority’s participation in the New Arrangements to Borrow (NAB).

The Board viewed Hong Kong as having strong potential for further high growth over the medium term. They noted that its future lay in developing its services-based export industries and maintaining its status as an international financial center. In this context, they encouraged the authorities to proceed with plans to deregulate the non traded goods and services markets. Directors also noted that safeguarding Hong Kong’s institutions and values, particularly the rule of law, impartiality of the judiciary, neutrality of the civil service, and freedom of information, was important for its medium-term prospects. Directors looked forward to the success of the “one country-two systems” framework and the continued prosperity of the Hong Kong economy.

Israel

The Board concluded the Article IV consultation with Israel in December 1996. The rapid, but fairly balanced, expansion of the Israeli economy since 1989—with GDP rising at more than 6 percent a year—turned into generalized overheating in 1995–96 (Table 13). Underlying inflation accelerated to a rate of 12 percent in mid-1996, from 9 percent in 1994—95, as real wages rose by 2.5 percent in the first half of the year. According to preliminary estimates, domestic demand grew by 5.5 percent, and unemployment rose slightly to some 6½ percent in 1996.

Table 13Israel: Selected Economic Indicators

(Data as of Board discussion in December 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real GDP3.56.87.14.34.4
Unemployment rate10.07.86.36.36.7
Change in consumer prices
(end of period)11.214.58.112.010.6
In billions of U.S. dollars1
External economy
Exports, f.o.b.14.816.719.019.920.2
Imports, c.i.f.20.422.626.728.928.3
Current account balance–1.1–2.3–3.9–5.2–4.9
Direct investment–0.21.21.6
Capital account balance2.41.63.96.1
Gross official reserves6.46.88.211.4
Current account balance
(in percent of GDP)–1.7–3.2–4.5–5.6–5.2
Change in real effective exchange rate (in percent)–0.62.43.53.3
In percent of GDP1
Financial variables
General government balance–3.5–2.2–3.4–4.2
Gross national saving
(in percent of national income)20.218.718.1
Gross national investment
(in percent of national income)21.822.022.6
Change in broad money
(in percent)22.024.621.72.4
Interest rate at discount window
(in percent)11.313.415.516.1

Unless otherwise noted.

Updated Fund staff estimates.

Unless otherwise noted.

Updated Fund staff estimates.

A shift to an expansionary fiscal stance abetted the evolution from growth to overheating. In late 1994, in the wake of what proved to be a transitory rise in revenues, the authorities instituted large increases in public sector wages and simultaneously cut taxes at a cost to the budget of 2.5 percent of GDP. Since then, tax revenues had consistently fallen short of expectations, and the targets for the domestic deficit had been missed by wide margins. For 1996, the general government budget deficit was estimated at 4.2 percent of GDP.

With fiscal policy easing and the economy overheating, monetary policy turned restrictive after 1994, leading to controversial side effects. The exchange rate strengthened within its crawling band, appreciating about 5 percent in terms of the consumer price index and unit labor costs since 1993, Capital inflows surged, averaging some 2.5 percent of GDP annually during 1995 and 1996. Moreover, domestic financial markets were unsettled by the restrictive monetary policy.

The economy’s overheating was particularly evident in the external accounts. The current account deficit increased to more than 5 percent of GDP in 1996, a level not experienced since the early 1980s.

In their discussion, Directors praised authorities for their effective management of the economy over the past six years, marked by a near halving of inflation and unemployment rates and by the successful absorption of immigrants. They expressed concern, however, about the persistence of inflation and the high current account deficit. The main policy requirement was for the authorities to strengthen domestic saving with a more ambitious fiscal consolidation effort. Directors viewed the authorities’ medium-term strategy of fiscal consolidation, disinflation, and structural reform as charting the appropriate direction for the needed adjustment.

Noting that fiscal policy had been at the root of the overhearing experienced in 1995/96, Directors stressed that improving public sector saving was essential and called for strict adherence to the deficit target for 1997. They viewed as important recently announced plans for additional spending cuts and the establishment of a contingency reserve. They considered the authorities’ emphasis on containing expenditures helpful and suggested the adoption of more realistic revenue estimates. Directors generally regarded the existing medium-term fiscal targets as insufficient to generate the domestic saving required to sustain a high rate of investment and to achieve low single-digit inflation in five years. They therefore urged the adoption of more ambitious medium-term objectives. They also recommended improved transparency and accountability of fiscal policy, in particular by also providing deficit estimates inclusive of the accrued liabilities associated with indexation that are excluded from the present measures and by explaining the government’s accounting methodology to the public.

Directors observed that monetary policy had to bear the brunt of the fight against inflation over the past two years, but they considered that a shift to a less restrictive monetary stance should await credible progress with fiscal consolidation. They generally thought that the increased emphasis on inflation targeting within the crawling exchange rate band had provided a clarity of purpose and objectives that could facilitate the pursuit of disinflation. They urged the adoption of a forward-looking inflation strategy that could usefully integrate structural aspects—policies for releasing public lands, the privatization and regulation of utilities, and enhanced competition policies.

Directors considered that Israel’s record on structural policies was mixed. Although progress had been made in liberalizing trade, strengthening antitrust and competition policy, and downsizing banks’ holdings in nonfinancial companies, there was need to accelerate privatization and to decrease other forms of government intervention in the economy. Directors welcomed plans to rationalize the tax and regulatory treatment of financial instruments, but they felt that much more needed to be done if Israel were to establish a resilient and efficient capital market.

Korea

The Board concluded the Article IV consultation with Korea in November 1996. Following two years of rapid expansion led by buoyant investment and exports, economic growth moderated in late 1995 and early 1996 in response to an earlier tightening of monetary conditions and less favorable short-run export prospects. Domestic demand decelerated sharply as growth of investment in equipment slowed because of a large capacity buildup in recent years as well as the less favorable export outlook. In late 1995 and the first half of 1996, the labor market was tight, with the unemployment rate at about 2 percent. Influenced by unfavorable agricultural price developments, consumer price inflation edged up in the first half of 1996 to 5.0 percent from 4.5 percent in 1995 (Table 14).

Table 14Korea: Selected Economic Indicators

(Data as of Board discussion in November 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real GDP5.88.69.07.17.1
Unemployment rate2.8242.02.02.0
Change in consumer prices
(end of period)5.85.64.74.94.5
In billions of U.S. dollars1
External economy
Exports, f.o.b.80.993.7123.2129.4128.3
Imports, f.o.b.79.196.8128.0139.8143.5
Current account balance0.4–4.5–8.9–17.7–23.7
Direct investment–0.5–1.3–1.9–1.7
Portfolio investment10.76.88.511.3
Capital account balance2.69.116.024.6
Gross official reserves20.225.632.733.2
Current account balance0.1–1.2–2.0–3.6–4.8
(in percent of GDP)
External debt (in percent of GDP)13.314.717.222.9
Debt service (in percent of exports of goods and services)9.16.25.4
Change in real effective exchange
rate (in percent)–1.80.71.13.6
In percent of GDP1
Financial variables
General government balance0.30.50.4
Gross national saving35.234.935.134.5
Gross national investment35.136.137.138.0
Change in broad money
(end of period; in percent)17.317.613.717.8
Three-month CDs (in percent)12.314.811.713.5

Unless otherwise noted.

Updated Fund staff estimates.

Unless otherwise noted.

Updated Fund staff estimates.

The fiscal situation in Korea remained sound as the result of a long tradition of fiscal conservatism. Over the years, fiscal expenditure, relatively low by international standards, had been broadly in line with revenue, resulting in moderate levels of government debt and high government saving. Monetary developments in 1995–96 were broadly consistent with the government’s objectives to lower underlying inflation and achieve a soft landing. Growth of the broad monetary aggregate in 1995, although rapid at the beginning of the year, slowed to 13.7 percent by the end of December, well within the target range of 12 percent to 16 percent. Other monetary aggregates showed a similar behavior.

Since 1994, the current account deficit had widened sharply, initially in tandem with the rapidly growing economy, but subsequently mainly as a result of adverse developments in the terms of trade. Nevertheless, capital inflows, growing in response to continued relaxation of controls on foreign equity investment and on access to trade financing, had comfortably financed this deficit. In 1995 the surplus on the capital account rose to S16 billion, and net inflows of S14 billion were recorded during the first half of 1996. Since 1994, the authorities have progressively dismantled import barriers and cut tariffs in accordance with the Uruguay Round; except for a small number of products with potentially adverse health or security effects, import licensing is now automatic. The nominal effective exchange rate had been broadly unchanged in the period since late 1994, notwithstanding large fluctuations over the same period in key currency exchange rates.

Over the past ten years, the authorities had partially implemented two public enterprise privatization programs; the program introduced in December 1993 envisaged privatization of 58 of 133 public enterprises during 1994–98. As of mid-1996, 16 enterprises had been privatized.

In their discussion, Directors welcomed Korea’s continued impressive macroeconomic performance: growth had decelerated from the unsustainably rapid pace of the previous two years, inflation had remained subdued notwithstanding some modest pickup in the months prior to the consultation, and the widening of the current account deficit largely resulted from a temporary weakening in the terms of trade. They welcomed Korea’s prospective membership in the OECD and the BIS and noted the challenge of ensuring that the speed of structural reforms in the financial sector and the capital account was commensurate with the needs of Korea’s transformation into an industrial economy.

Board members stressed that monetary policy should focus firmly on the ultimate goal of price stability and agreed that monetary policy should be supported by more flexibility in the exchange rate, particularly if capital inflows were to accelerate following further capital account liberalization. Greater exchange rate flexibility would be facilitated by, and would itself contribute to, the deepening of the forward market for the Korean won.

Directors praised the authorities for their enviable fiscal record and suggested that fiscal policy could best contribute to strengthening medium-term macroeconomic performance by maintaining a strong budgetary position as much-needed spending on social overhead capital was undertaken. They also welcomed the recent acceleration of capital account liberalization; although some Directors agreed with the authorities’ gradual approach to capital account liberalization, a number of Directors considered that rapid and complete liberalization offered many benefits at Korea’s stage of economic development. Directors agreed with the authorirties’ intention of not rigidly linking capital account liberalization to the narrowing of interest differentials with partner countries and noted that liberalization itself would be important in reducing Korean interest rates from the current high levels.

Directors suggested that the recent speeding up of capital account liberalization intensified the need for further reforms of the domestic financial sector. Despite considerable progress in financial sector reform, bank interest rates appeared to remain sticky, and secondary markets for many financial assets were either shallow or absent. In addition, monetary policy had not yet completed the transition to indirect instruments. Directors observed that faster progress in these areas would help to strengthen the efficiency of the financial sector and increase the effectiveness of monetary policy.

The Board welcomed the broadening of structural reforms, including labor market reforms and privatization, that should contribute to productivity gains and ensure the continued competitiveness of the Korean economy.

New Zealand

The Board concluded the Article IV consultation with New Zealand in November 1996. At the time of the meeting, economic developments in New Zealand continued to be satisfactory. Real GDP growth had slowed to a sustainable 3 percent, consistent with a soft landing rather than the recession that had been a typical feature of earlier business cycles. Employment growth remained rapid, and the underlying rate of inflation was held close to 2 percent, although the upper limit of the target range was breached slightly, partly because of a sharp rise in housing prices. The tight stance of financial policies continued: the budget surplus had risen to nearly 4 percent of GDP in 1995/96, interest rates were kept at relatively high levels in real terms, and the exchange rate had appreciated in both nominal and real effective terms by 5 percent (Table 15). Although the external account deficit had widened to 4 percent of GDP in 1995/96, market confidence remained strong.

Table 15New Zealand: Selected Economic Indicators1

(Data as of Board discussion in November 1996)2

1996/97
1993/941994/951995/96Projections at

time of Board

discussion
Outturn3
In percent
Domestic economy
Change in real GDP6.25.22.82.52.0
Unemployment rate9.56.96.56.56.4
Change in consumer prices
(period average)1.42.43.32.42.2
In billions of U.S. dollars2
External economy
Exports, f.o.b.10.812.613.414.515.2
Imports, c.i.f.9.111.312.814.414.7
Current account balance–0.6–2.0–2.4–2.8–2.8
Direct investment0.51.24.54.24.4
Portfolio investment1.30.41.21.41.2
Capital account balance1.01.82.92.82.9
Gross official reserves3.83.94.54.74.4
Current account balance
(in percent of GDP)–1.3–3.9–4.1–4.5–4.3
Change in real effective exchange rate (in percent)6.45.35.7
In percent of GDP2
Financial variables
General government balance0.93.13.83.12.0
Gross national saving18.917.918.417.918.2
Gross national investment20.221.822.622.422.5
Change in broad money
(in percent)6.66.712.015.010.0
Interest rate on 90-day bank bills
(in percent)5.49.48.99.9

Data are for fiscal years ending March.

Unless otherwise noted.

Updated Fund staff estimates.

Data are for fiscal years ending March.

Unless otherwise noted.

Updated Fund staff estimates.

The economic expansion was expected to continue in 1997, propelled by the tax cuts contained in the 1996/97 budget. Under the budget, the tax burden was to be reduced by more than 1 percent of GDP in 1996/97 and in 1997/98, personal income taxes were to be lowered, and allowances were to be increased. Nevertheless, a budget surplus of 3 percent of GDP was projected for 1996/97, enabling net public debt to decline further, to 28 percent of GDP.

Directors commended the authorities for their steadfast implementation over the past decade of rigorous financial policies and comprehensive structural reform in a context of transparency and accountability. They welcomed the authorities’ commitment to maintain their policy orientation over the medium term. They considered the policy stance of tight monetary conditions and public expenditure control to be appropriate because that stance helped to contain inflation, ensured sustainability of the external position, and laid the foundation for resumption of more rapid growth over the medium term.

Directors believed that the monetary framework, including the inflation-targeting regime, had been instrumental in containing inflationary expectations and securing market credibility for the overall economic strategy. While a few Directors thought that a widening of the 0–2 percent target band for inflation would allow greater flexibility for monetary policy, most Directors cautioned against such a move, at least until inflation was brought back into the band, so as not to affect adversely the credibility of inflation policy.

Directors strongly endorsed the medium-term budgetary strategy, which provided for continuing surpluses and implied a steady decline in the ratio of public debt to GDP, They urged continued progress with civil service and welfare reforms in order to free up funds for higher spending on health and education, as well as accelerated privatization of the remaining public sector trading interests. A number of Directors thought it advisable to postpone the second round of tax cuts until expenditure reductions could be clearly identified.

A number of Directors thought the size of the external current account deficit posed risks, given New Zealand’s vulnerability to external shocks and to changes in market sentiment. Directors believed it would be advisable for the authorities to tighten fiscal policies, if necessary, to prevent a widening of the current account deficit. Financial stability and continued structural reforms would help to keep the traded-goods sector competitive and to maintain private capital inflows.

Directors underscored the importance of continuing with structural reforms to enhance potential growth. In particular, they proposed perseverance in efforts to raise private investment and saving in relation to GDP and to improve education and training facilities to raise labor productivity. They welcomed the authorities’ commitment to promote further multilateral and regional initiatives to liberalize trade.

Subsequent to the consultation, in December 1996 a new coalition government took office. While the economic policy stance has not been fundamentally modified, two changes are of note. First, the inflation band was widened from 0–2 percent to 0–3 percent, and the Reserve Bank signaled its intention to keep inflation in the middle part of the new band. Meanwhile, inflation pressures continued to ease; underlying inflation for the March 1997 quarter was 0.2 percent, and for the 12-month period ending March 1997 it was 2 percent on average. Second, budgeted spending on health, education, and law and order was increased for the next several years by 1½ percent of GDP a year, and the announced July 1997 tax cut was delayed by one year. However, sizable budget surpluses continue to be targeted.

Spain

The Board concluded the Article IV consultation with Spain in March 1997. Recent economic developments in the country were then generally favorable. Growth in private consumption had strengthened to about 2.5 percent (quarter-on-quarter, annualized) in mid-1996 as booming stock and bond markets added to household wealth. For 1996 as a whole, GDP grew by an estimated 2.2 percent (Table 16). Consumer inflation fell to 3.2 percent (year-on-year) in December 1996, the lowest rate in three decades. With output still below potential, unemployment remained a serious economic and social problem. After peaking at over 24 percent in early 1994, the unemployment rate was reduced by the subsequent recovery to 22 percent of the labor force in the third quarter of 1996, still well above that of any other industrial country.

Table 16Spain: Selected Economic Indicators(Data as of Board discussion in March 1997)
1993199419951996
In percent
Domestic economy
Change in real GDP–1.22.12.82.2
Unemployment rate (period average)22.724.222.922.2
Change in consumer prices14.94.34.33.2
In billions of U.S. dollars2
External economy
Exports, f.o.b.62.174.092.7103.1
Imports, c.i.f.77.088.8110.4116.9
Current account balance–5.8–6.81.22.9
Net investment354.2–15.823.41.0
Net other portfolio investment4–54.521.2–31.018.7
Capital account balance2.92.66.05.9
Gross official reserves (end of period)45.344.538.261.8
Current account balance (in percent of GDP)–1.1–1.40.20.6
Change in real effective exchange rate
(in percent)–10.5–4.81.42.3
In percent of GDP2
Financial variables
General government balance (Maastricht basis)–7.4–6.2–6.6–4.4
Gross national saving18.718.621.321.0
Gross national investment19.920.021.120.6
Change in broad money (end of period; in percent)10.17.09.26.3
Three-month interbank interest rate (period average; in percent)11.78.09.47.5

End of period, year-on-year percentage change (December on previous December).

Unless otherwise noted.

Including foreign direct investment and marketable securities.

Including loans, deposits, and repurchase operations.

End of period, year-on-year percentage change (December on previous December).

Unless otherwise noted.

Including foreign direct investment and marketable securities.

Including loans, deposits, and repurchase operations.

Since late 1994, monetary policy had been centered squarely on the task of lowering inflation. Inflation and monetary growth both declined during 1996, allowing the Bank of Spain to reduce the reference ten-day repurchase rate to 6 percent in January 1997 from 9.25 percent in December 1995. Fiscal policy focused on qualifying Spain for entry into EMU in 1999. The convergence plan submitted to the European Council in July 1994 called for the general government deficit to fall from 7.4 percent of GDP in 1993 to 3.0 percent in 1997, primarily through expenditure reductions. During 1994–96, multiyear limits were imposed on public sector wage increases, agreements were struck with local and regional governments to limit their deficits, controls were placed on the rise in health care spending, and unemployment benefits were reduced. Although progress on fiscal consolidation in 1995 was disappointing, the situation improved during 1996. Preliminary data suggested that the general government deficit target of 4.4 percent of GDP on a national accounts basis was attained.

Spain’s external position remained strong. The external current account moved to a surplus of 0.6 percent of GDP in 1996 from 0.2 percent in the previous year, owing to an improvement in the trade balance and tourism. Official foreign reserves rose from $36 billion in March 1995 to $65.3 billion at the end of January 1997, against the background of considerable net capital inflows. Over the same period, the peseta was maintained close to the middle of the ERM band.

In their discussion Directors commended the authorities for their sound macroeconomic policies and particularly for progress in fiscal consolidation and structural reforms. They observed that Spain seemed poised in 1997 for a strengthening of the economic recovery and sustainable growth over the medium term. They also welcomed Spain’s firm commitment to meeting the Maastricht convergence criteria in 1997 and considered that this achievement was within the authorities’ reach. They agreed that the authorities should be prepared to introduce additional fiscal measures, if needed to ensure compliance with the Maastricht criteria.

Directors urged the authorities to take early steps to place the fiscal consolidation process on a sustainable footing. They noted that it would be necessary to go beyond the temporary expenditure cuts and to undertake a comprehensive restructuring of government expenditure. On the revenue side, some Directors encouraged the authorities to improve the tax code by a reduction in the marginal tax rates.

Directors complimented the Bank of Spain for its success in reducing inflation, noting that the increased independence of the bank and its inflation-targeting framework had worked well. They agreed with the authorities that the recent low inflation data might allow prudent interest rate cuts, although subsequent reductions in interest rates should be linked to clear progress on the fiscal front.

Because of the strong performance of the external sector in recent years. Directors generally agreed that competitiveness was not an immediate problem. Nevertheless, they stressed the need for structural reforms and continued wage moderation to ensure the maintenance of external competitiveness over the medium term. As regards internal competition, they encouraged the authorities to move ahead in improving the markets for urban real estate, professional services, and retail trade and in implementing a more market-oriented autonomous regulatory framework for monopolies.

Directors observed that the high unemployment rate and severe labor market rigidities remained the most pressing policy challenge. Spain’s prospective entry into the EMU made it imperative for the authorities to undertake labor market reforms without delay.

Sweden

The Board concluded the Article IV consultation with Sweden in September 1996. During 1990–93 Sweden had experienced its worst postwar economic crisis, but, propelled by strong export performance, the economy had been making a strong recovery since the second quarter of 1993. Real GDP growth reached 3.6 percent in 1995, the highest rate since 1987 (Table 17). Consumer price inflation dropped to below 2 percent beginning in January 1996, partly as a result of the appreciation of the krona and declining mortgage interest rates. Wage increases, however, continued to be uncomfortably high; although total unemployment edged down slightly, it remained above 12 percent in the first quarter of 1996.

Table 17Sweden: Selected Economic Indicators

(Data as of Board discussion in September 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real GDP–2.23.33.61.11.1
Unemployment rate8.28.07.78.08.0
Change in consumer prices
(period average)4.62.22.50.50.5
In billions of U.S. dollars1
External economy
Exports, f.o.b.49.460.079.784.5
Imports, c.i.f.42.551.364.966.6
Current account balance–4.00.84.96.26.1
Direct investment2.4–0.43.10.6
Portfolio investment4.14.8–5.2–3.5
Capital account balance3.8–0.8–5.0–6.0
Gross official reserves2.53.13.42.92.9
Current account balance
(in percent of GDP)–2.20.42.12.52.4
Change in real effective exchange rate (in percent)–23.7–2.2–1.211.69.9
In percent of GDP1
Financial variables
General government balance–12.3–10.8–8.0–4.0–2.5
Gross national saving11.314.517.517.717.2
Gross national investment13.314.115.515.114.7
Change in broad money
(M3; in percent)4.00.32.711.711.7
Three-month interbank interest rate (period average; in percent)8.57.68.86.06.0

Unless otherwise noted.

Updated Fund staff estimates.

Unless otherwise noted.

Updated Fund staff estimates.

After the general government deficit reached 12.3 percent of GDP in 1993, Sweden had set its public finances firmly on a path of fiscal consolidation. The EMU Convergence Program adopted by the government in June 1995 specified measures expected to reduce the deficit by 7.5 percent of GDP by 1998—with the reduction split evenly between spending decreases and tax increases. With rapid output growth, it was expected that the fiscal deficit would narrow to 2.5 percent of GDP in 1997 (meeting the Maastricht criterion), but weakened economic activity since late 1995 had altered this outlook. In April 1996 a Supplementary Budget Bill accordingly proposed additional expenditure measures of SKr 12 billion to bring the deficit below 3 percent of GDP in 1997. The positive reception of this bill in the markets also eased pressure on the krona and on interest rates. By mid-July 1996 the krona had appreciated by 18 percent from its low point in 1995, and the differential in long-term interest rates with Germany had narrowed to 160–170 basis points, or about one-third of its highest level in early 1995.

In their discussion, Directors noted that the Swedish economy was well on its way to recovery from the crisis of 1990–93. The Swedish inflation rate was among the lowest in Europe. Directors commended the authorities for their steadfast pursuit of a strong program of fiscal consolidation and the successful resolution of the banking crisis. These successes had enhanced government credibility in financial markets. Directors emphasized, however, the need for structural reforms in the labor market to help moderate wage inflation and reduce the high unemployment rate, as well as full implementation of the fiscal consolidation program. Noting the sensitivity of fiscal consolidation to growth. Directors welcomed the adoption of additional fiscal measures in the April 1996 Supplementary Budget Bill to keep the fiscal consolidation program on track, as well as the greater weight put on expenditure reduction in these measures.

With evidence of the growing credibility of policies, and in view of the high level of unemployment, Directors concurred that casing monetary policy had been an appropriate initiative. Most Directors considered that the Riksbank’s monetary policy framework, including inflation targeting, had contributed to reducing inflation. Some Directors thought a strong commitment to EMU membership would help to safeguard the favorable market sentiment that had been gained.

Directors welcomed the appreciation of the krona during the preceding year and generally concurred with the authorities’ view that the krona appeared to be at or close to equilibrium. They were concerned, however, with the high rates of wage increases, which could increase inflation, decrease competitiveness and the momentum of growth, and slow the reduction of unemployment.

Directors welcomed the initiatives of the Employment Hill, although a number of Directors considered them insufficient to meet the authorities’ employment objectives. They urged reforms to increase the flexibility of the labor market and supported the formulation of a new wage-setting mechanism. Several Directors stressed the importance of greater wage differentiation and of measures to facilitate the employment of new entrants into the labor market.

Developing Countries

Algeria

The Board concluded the Article IV consultation with Algeria in June 1996 and conducted the second review under the extended arrangement for Algeria. In 1995, real GDP was estimated to have increased by 4.3 percent—after two years of decline—driven by a strong export-led expansion in the hydrocarbon sector, a rebound of agriculture, and an upturn in the construction and services sectors (Table 18). Inflation fell from 39 percent in the 12 months to the end of 1994, to 22 percent by the end of 1995. Unemployment remained high.

Table 18Algeria: Selected Economic Indicators

(Data as of Board discussion in June 1996)1

199219931994199519962
In percent
Domestic economy
Change in real GDP1.6–2.2–1.14.34.0
Unemployment rate21.323.224.424.828.0
Change in consumer prices
(end of period)28.016.138.621.915.1
In billions of U.S. dollars1
External economy
Exports, f.o.b.11.510.48.910.312.6
Imports, f.o.b.8.38.09.210.29.6
Current account balance1.30.8–1.8–2.30.2
Direct investment0.00.00.00.00.2
Capital account balance–1.2–0.8–2.5–3.9–2.8
Gross official reserves (end of period)1.51.52.62.13.7
Current account balance (in percent of GDP)2.81.6–4.3–5.60.3
External debt (in percent of GDP)52.053.070.378.472.4
Debt service (in percent of exports of goods and services)78.382.248.743.832.7
Change in real effective exchange rate
(in percent)27.014.2–28.7–6.05.0
In percent of GDP1
Financial variables
Central government balance–1.2–8.7–4.4–1.42.6
Gross national saving31.230.827.426.528.3
Gross national investment28.429.231.832.028.0
Change in broad money (in percent)23.921.515.410.515.0
Repurchase rate (in percent)17.017.021.023.020.0

Unless otherwise noted.

Fund staff estimates.

Unless otherwise noted.

Fund staff estimates.

The fiscal deficit narrowed to 1.4 percent of GDP in 1995 from 4.4 percent in 1994. The ratio of revenue to GDP increased, mainly owing to higher hydrocarbon receipts. On the expenditure side, interest payments exceeded targets, but the fiscal program was kept on track as the authorities cut current outlays and contained salary increases. As a result, civil service wages fell substantially in real terms.

Fiscal adjustment provided the underpinning for a tight monetary policy, as demand for broad money continued to grow less than nominal GDP. Credit to the economy rose by 85 percent in 1995; an expansion in credit to food-importing agencies and the railway company was partly offset by a sharp contraction of credit to the government and by increased bank provisioning and recapitalization. Real interest rates became positive in late 1995.

Notwithstanding demand restraint and a substantial real depreciation of the Algerian dinar in 1994, the external current account deficit increased by 1.3 percentage points to 5.6 percent of GDP in 1995, Imports rose in response to trade liberalization and higher cereal prices. However, the balance of payments strengthened significantly in the first half of 1996, as the trade balance responded strongly to the dinar depreciation, more than offsetting a drying up of short-term inflows in the form of suppliers’ credit pending an expected debt-rescheduling agreement, and official reserves rose.

In financial sector reform, the introduction of regular repurchase auctions on the money market in May 1995 was later followed by the institution of a formal auction system to sell negotiable treasury bonds on the money market, with a view to establishing open market operations by the central bank. In the public enterprise sector, enterprises were put under hard budget constraints and relieved of their quasi-fiscal functions in preparation for privatization. In addition, 84 local public enterprises were liquidated, and a number of public enterprises in the construction sector were merged or dissolved. The authorities also took decisions to address the financial difficulties of the public housing program and to maintain the pace of housing construction.

In their discussion, Directors commended the authorities for courageously and steadfastly implementing the strong adjustment and reform program despite difficult political and external circumstances. Substantial progress had been made in stabilizing the economy, resulting in a significant deceleration of inflation and a recovery of growth and per capita income, as well as in establishing market mechanisms, restructuring the public sector, and substantially liberalizing the trade regime.

Directors thus considered that Algeria was now better positioned to realize the fundamental objectives of the program: macroeconomic stabilization, an outward-oriented economy, and private-sector-led growth. In view of the high unemployment level and the acute housing problem. Directors called for intensified efforts by the authorities to marshal public support for the program and supported continuation of ongoing political reforms. Establishing security and political stability would be essential to elicit the foreign investment and technology transfers needed for private sector development, which, in turn, was crucial to sustaining growth at a sufficently high level to absorb the increase in the active population and reduce unemployment.

Directors emphasized the importance of consolidating macroeconomic stabilization by bringing inflation down to single-digit levels in 1997. It was therefore essential to continue implementing the tight incomes policy. Most Directors considered that a small budget surplus was needed in 1996 and called for deploying oil revenue both to reduce public debt and to meet infrastructure and social safety needs. Directors commended the authorities for their decision to eliminate quasi-fiscal deficits and fully budget all public expenditure on housing beginning in 1996. They also underscored the importance of strengthening the monitoring and control of expenditure, restraining wages, reducing subsidies, and improving tax administration. Many Directors cautioned against a premature relaxation of monetary and interest rate policy, emphasizing that interest rates should be kept positive in real terms. Directors welcomed that the exchange rate was being determined in an active interbank market and recommended that it continue to be set flexibly.

Directors considered that the proposed housing reform would put that critical sector on a firmer footing. They called for the accelerated development of a private housing market, noting that expanded housing construction would help to absorb excess labor. Directors also urged the authorities to move decisively on privatization to signal the government’s commitment to a market economy. In that connection, some Directors expressed concern about the government’s decision to assume temporarily wage payments of some insolvent enterprises. Directors also called for the establishment of a more effective legal framework.

Although Algeria’s medium-term balance of payments prospects were encouraging. Directors observed that in view of the vulnerability of the external position to external shocks, rapid movement on structural reform and diversification was needed. The large medium-term debt-service burden also called for prudent external debt management. Algeria’s exemplary adjustment and reform efforts, it was agreed, merited the continued support of the international financial community.

Bangladesh

The Board concluded the Article IV consultation with Bangladesh in August 1996 following the assumption of office by a new government elected in June 1996. The erosion of macroeconomic stability during the preceding period of political uncertainty had served to demonstrate the weakness of institutions of economic management in Bangladesh.

Real GDP was estimated to have increased by about 5½ percent in 1995/96, with growth triggered principally by recovery in agricultural output. The performance of the mining and quarrying sectors was satisfactory, as was that of the transport, trade, and housing sectors. Growth in the industry, power, and construction sectors, however, fell short of performance in 1994/95. Inflation decelerated somewhat in 1995/96, although it remained above 6 percent based on a new national index with updated (1985–86) weights. The import of food grains increased substantially, and the current account deficit rose from 3.3 percent of GDP in 1994/95 to 4.8 percent of GDP in 1995/96 (Table 19).

Table 19Bangladesh: Selected Economic Indicators1

(Data as of Board discussion in August 1996)2

1996
199319941995Projections at

time of Board

discussion
Outturn3
In percent
Domestic economy
Change in real GDP45.04.54.94.95.6
Change in consumer prices
(period averages)52.53.78.96.7
In billions of U.S. dollars2
External economy
Exports, f.o.b.2.42.53.53.93.9
Imports, c.i.f.4.14.25.86.86.9
Current account balance–0.6–0.4–1.0–1.6–1.6
Capital account balance1.31.31.20.60.6
Gross official reserves2.12.83.12.02.0
Current account balance
(in percent of GDP)–2.6–1.5–3.3–4.8–4.7
External debt (in percent of GDP)47.955.351.549.744.0
Debt service (in percent of exports of goods and services)12.011.49.710.79.4
Change in real effective exchange rate (in percent)–3.3–2.0–4.61.91.9
In percent of GDP2
Financial variables
Central government balance–5.4–5.5–6.4–5.7–5.3
Gross national saving10.612.912.310.311.0
Gross fixed investment13.214.315.615.115.7
Change in broad money
(in percent)11.414.516.08.28.2
Bangladesh Bank rate (in percent; end of period)6.55.55.56.56.5

Data are for fiscal years ending June.

Unless otherwise noted.

Updated Fund staff estimates.

Fund staff estimates based on rebenchmarking the national accounts to 1989/90; official data based on 1984/85 weights show slightly lower estimates of GDP.

Based on the updated 1985/86 national index.

Data are for fiscal years ending June.

Unless otherwise noted.

Updated Fund staff estimates.

Fund staff estimates based on rebenchmarking the national accounts to 1989/90; official data based on 1984/85 weights show slightly lower estimates of GDP.

Based on the updated 1985/86 national index.

Pressures on the budget increased in 1995/96, and budget policy weakened in important respects. Although reduced development spending helped to lower the budget deficit below the original projection, the domestic financing burden on the banking system was twice the original budget target. Locally financed projects formed a much higher proportion of development spending, and the composition of current expenditures also shifted owing to election-related spending, flood relief, and unbudgeted higher interest payments. To avoid an increase in official interest rates, the higher domestic financing need was met by the central bank’s absorption of unsold treasury bills.

With the sharp increase in net domestic credit by 22.8 percent, as against 16.5 percent in the previous year, monetary policy remained relaxed. However, as net foreign assets declined sharply, broad money growth decelerated to 8.2 percent as against 16 percent in the preceding year. The real effective exchange rate appreciated slightly during 1995/96. To slow the appreciation, the exchange rate of the taka vis-à-vis the U.S. dollar was depreciated several times during 1995/96.

In their discussion, Directors welcomed the opportunity that the new government now had to adopt bolder polices. They urged the authorities to undertake a fundamental overhaul of the role of government and to reform the financial sector.

Directors viewed the strengthening of fiscal policy as the central element of the adjustment effort. They emphasized the need for the government to resist pressures for higher public sector wages, to make timely cuts in low-priority domestically financed expenditure, and to be ready to implement additional measures. In view of the country’s low ratio of revenue to GDP, Directors suggested that the authorities should vigorously pursue tax administration reform, a broadening of the tax base, and elimination of tax exemptions.

Directors stressed the importance of reducing domestic credit growth by limiting the expansion of bank borrowing by the government and curbing central bank lending to banks and to specialized institutions. They pointed to the need for a more independent and effective role for the central bank. They noted the need to increase further the flexibility of interest rates and for the authorities to be prepared to tighten their monetary targets for 1996/97 to bring about a desired reduction in inflation and to strengthen the international reserve position.

Directors generally encouraged the authorities, in conjunction with tightening financial policies, to adopt a more market-based exchange rate regime. This would help to prevent a further decline in reserves and help the conduct of monetary policy while avoiding recourse to administrative controls on imports.

Directors observed that prolonged delays in implementing structural reforms were an important reason for the economy’s lackluster performance over the past few years. They considered that top priority should be given to the early reform of the closely related problems in the financial sector and public enterprises. While welcoming ongoing improvements in bank supervision, they urged the authorities to expedite implementation of plans to restructure the banking system. Noting the large losses in public enterprises. Directors urged the authorities to proceed quickly to develop a comprehensive program of reform and privatization. Establishing a strong record of fundamental and sustained reforms would help Bangladesh to mobilize needed external assistance.

Benin

The Board concluded the Article IV consultation with Benin in August 1996 and approved a request for a new arrangement under the ESAF (see Chapter 6). The discussions were held against a background of continued satisfactory performance by Benin, attributable to adjustment undertaken in the 1980s, the devaluation of the CFA franc in January 1994, and improved terms of trade.

Real GDP growth is estimated to have reached almost 5 percent in 1995, while the rate of inflation declined and public finances continued to improve (Table 20). Benin observed all the performance criteria under the ESAF for the end of September 1995, but at the end of December it missed the benchmarks for net credit to the government and net domestic assets of the central bank.

Table 20Benin: Selected Economic Indicators(Data as of Board discussion in August 1996)
1993199411995119961
In percent
Domestic economy
Change in real GDP3.24.34.85.5
Change in consumer prices (end of period)4.154.33.16.7
In millions of U.S. dollars2
External economy
Exports111.7174.5234.9289.3
Imports369.2277.1435.8458.8
Current account balance3–158.6–76.5–177.7–163.6
Capital account balance–33.7–20.710.348.1
Gross official reserves174.6173.7128.5164.8
Current account balance (in percent of GDP)3–7.5–5.0–8.6–7.3
External debt (in percent of GDP)72.486.482.079.6
Debt service (in percent of exports of goods and nonfactor services)418.619.717.515.1
Change in real effective exchange rate (in percent)–0.2–35.87.5
In percent of GDP2
Financial variables
General government balance–4.7–6.9–7.0–6.6
Gross national saving49.612.811.712.6
Gross national investment14.915.819.017.8
Change in broad money (in percent)5.941.216.114.0
Interest rate (in percent)57.55.56.05.5

Fund staff estimates.

Unless otherwise noted.

Excluding official grants.

Including current official grants, but excluding project grants.

Average monthly money market rate; end of period.

Fund staff estimates.

Unless otherwise noted.

Excluding official grants.

Including current official grants, but excluding project grants.

Average monthly money market rate; end of period.

Investment rose to about 19 percent of GDP in 1995 from 15.8 percent in 1994, in part because of strong construction activity and rising private investment in the cotton sector, and in part because of public infrastructure projects undertaken in connection with the summit of francophone countries. Benin’s improved terms of trade raised incomes and boosted private consumption by about 10 percent. The investment boom was not matched by an equivalent increase in savings, and the external current account deficit rose to 8.6 percent in 1995, Imports rose by 38 percent because of the robust growth in domestic demand, whereas exports of goods were virtually flat because of a disappointing cotton crop.

Fiscal developments were generally favorable in 1995, with Benin meeting key targets, including the narrowly defined primary surplus and the ratio of revenue to GDP, with some margin. The overall budget deficit was held to about 7 percent of GDP, somewhat lower than envisaged. In contrast, primary expenditure exceeded the target, in part because of unanticipated outlays for infrastructure. These were partly offset by lower expenditures for health and education. Net credit to the government also exceeded the program target but was expected to be reversed in the second half of 1996. Although the net domestic assets of the banking system expanded, its net foreign assets grew less than envisaged.

The authorities continued to address the task of strengthening the private sector through privatization, restructuring, and price liberalization. Price controls were fitted on seven products in early 1995, leaving those on only five subject to government approval.

In their discussion, Directors noted the considerable improvement in Benin’s macroeconomic performance in recent years, with robust growth and lower inflation, following the implementation of successive adjustment programs. However, they observed that the economy was not sufficiently diversified and that policies needed to be strengthened to increase national saving, attract foreign direct investment, and support private sector activities.

In the fiscal arena, Directors called for stronger efforts to reduce reliance on foreign resources and to help raise domestic saving. They also stressed the need to increase budgetary allocations for education, health, and other social sectors. While they welcomed the decision to reduce the burden of taxation on the cotton sector by raising producer prices, they called for offsetting revenue measures. Directors welcomed a number of developments in Benin that would promote a more efficient allocation of financial resources in the region; the broadening of financial instruments, the creation of a regional financial market, and the deepening of the regional interbank market.

Directors emphasized the need for a larger private sector role and encouraged the authorities to persevere with privatization to help foster private-sector-led growth. While noting the recent substantial increase in cotton production, they recommended reducing the government’s role in that sector.

Directors took the view that Benin’s adjustment efforts deserved continued support by the international financial community. The external debt was high, but the operations to reduce the debt stock requested by the authorities should improve debt indicators in the coming years. Nevertheless, the economy would remain vulnerable to external shock. To achieve broadly based growth and external debt sustainability over time, Benin therefore needed to implement sound macroeconomic policies and structural reforms combined with a prudent debt-management policy and adequate financing on concessional terms.

Cambodia

The Board concluded the Article TV consultation with Cambodia in February 1997. Real growth had rebounded to 7½ percent in 1995 (Table 21), boosted by a record rice harvest and buoyant activity in construction, tourism, and the garment industry, and was projected at about 6 percent for 1996, the modest slowdown arising from the negative impact of recent floods on rice output. Inflation dropped to single digits during 1995 and the first nine months of 1996 (from over 100 percent in 1993).

Table 21Cambodia: Selected Economic Indicators(Data as of Board discussion in February 1997)
199319941995119962
In percent
Domestic economy
Change in real GDP4.14.07.66.0
Change in consumer prices (end of period)31.026.10.110.0
In millions of U.S. dollars3
External economy
Exports, f.o.b.4102234269305
Imports, f.o.b.–305–509–650–700
Current account balance5–189–329–469–430
Direct investment080151171
Capital account balance75136206195
Gross official reserves71100182217
Current account balance (in percent of GDP)–9.4–13.7–16.0–13.9
External debt (in percent of GDP)620201921
Debt service (in percent of exports of
goods and services)0.43.21.33.7
Change in real effective exchange rate
(annual percent change; end of period)–10.18.7–0.2–10.67
In percent of GDP3
Financial variables
General government balance (cash basis)–5.6–6.8–7.7–7.0
Gross national saving4.74.85.65.8
Gross national investment14.118.521.619.7
Change in broad money
(end of period; in percent)840.029.444.333.0

Fund staff estimates.

Fund staff projections.

Unless otherwise noted.

Excludes reexports.

Excluding official transfers.

Excludes debt to countries of the former Council for Mutual Economic Assistance amounting to an estimated Rub 840 million, for which dollar valuation is not available.

October.

Including foreign currency deposits.

Fund staff estimates.

Fund staff projections.

Unless otherwise noted.

Excludes reexports.

Excluding official transfers.

Excludes debt to countries of the former Council for Mutual Economic Assistance amounting to an estimated Rub 840 million, for which dollar valuation is not available.

October.

Including foreign currency deposits.

Fiscal policy continued to play the central role in sustaining macroeconomic stability. Fiscal discipline was maintained in 1996 despite revenue shortfalls (because of tax exemptions and persistent difficulties in bringing extra budgetary revenue into the budget) and higher-than-budgeted operational outlays on security and defense. Civilian non-wage expenditures, particularly for health and education, however, were compressed below budgeted levels. The overall deficit for 1996 was projected at about 7 percent of GDP, to be fully financed through official aid flows.

Monetary developments were marked by a pronounced shift away from foreign currency in circulation toward domestic currency and foreign currency deposits. This portfolio shift resulted in an acceleration in the growth of measured broad money (including foreign currency deposits) to 44 percent in 1995. With a slowdown in the growth of riel in circulation, monetary expansion moderated in the second half of 1996 and was projected to fall to 30 percent by the end of the year.

In 1996, the balance of payments benefited from large official financing flows and increased foreign direct investment, and the current account deficit was expected to narrow to 14 percent of GDP, with the overall balance in a small surplus. International reserves strengthened to slightly over two months of imports, and the exchange rate remained broadly stable, in contrast with earlier years.

Progress was made in key areas of structural reform, though the pace of implementation was slower than anticipated. Steps taken included the adoption of a new institutional framework for the few enterprises slated to stay in the public sector and for privatization of the remaining state enterprises, enactment of a new central bank law, and some progress in military reform. But only limited progress was made in developing a monitoring system for foreign direct investment and associated tax exemptions, and civil service reform was set back by large-scale new hiring for political integration.

In their discussion, Directors welcomed Cambodia’s solid progress in economic rehabilitation over the past three years, including favorable macroeconomic performance with robust growth, low inflation, and a significant improvement in the external position. However, sustained progress in the transition to a market economy would require attention to key fundamental weaknesses in the economy. Directors called for accelerated structural reforms, especially in the fiscal and financial areas, and for the implementation of transparent resource management policies, particularly in the forestry sector.

Directors stressed the key importance of continued fiscal discipline if macroeconomic stability were to be consolidated. Revenues were currently a very low percentage of GDP and had to be increased decisively by strengthening tax administration, eliminating ad hoc tax exemptions, implementing the planned tax reform measures to broaden the domestic tax base, and rigorously applying legislative provisions to enhance budgetary transparency and strengthen financial controls over the use and transfer of state assets. Directors also urged the authorities to implement civil service reform and rein in military spending to accommodate increased social spending and human capital development.

Directors encouraged the authorities to continue avoiding bank financing of the budget deficit; this was critical to keeping inflation low in Cambodia’s highly dollarized and largely cash-based financial system. Continued financial stability was the key to reversing currency substitution and establishing a viable system of financial intermediation in the domestic currency. Directors stressed the urgent need for the National Bank to reinforce its supervision capacity through on-site inspections of commercial banks. On exchange rate policy, the market-based system had served Cambodia well.

Directors considered the reform of public institutions and improved governance in the management of public resources as the most urgent structural tasks at hand. They called on the authorities to implement transparent and effective procedures in the management of forestry resources. This was an area in which the authorities had to demonstrate that they could deliver on their policy commitments and reestablish the credibility of their economic reform program. This was vital if private sector confidence and the support of the international community were to be sustained.

Directors noted that Cambodia’s balance of payments outlook would continue to depend on substantial external financing from official and private sources, which was essential to meet Cambodia’s massive infrastructure needs and rebuild its productive base.

Cameroon

The Board concluded the Article IV consultation with Cameroon in October 1996. At that time, the country was recovering from a prolonged economic decline, which had begun to turn around in 1994 following the devaluation of the CFA franc in January. In 1995/96, real GDP grew by 5 percent, largely because of a strong expansion in agriculture and manufacturing. Production of coffee, cocoa, and cotton rose despite a drop in world prices. Non-oil real GDP is estimated to have risen by about 6 percent owing to buoyant export activity and a recovery in domestic demand. Public finances also strengthened considerably. Between 1993/94 and 1995/96, total revenue relative to GDP increased by 4 percentage points, total expenditure was reduced by 2 percentage points, and the primary fiscal balance moved from a deficit of 1½ percent of GDP to a surplus of more than 5 percent of GDP. Consumer price inflation slowed to 4½ percent in the year ended June 1996 from 13½ percent the year before (Table 22).

Table 22Cameroon: Selected Economic Indicators1(Data as of Board discussion in October 1996)
1992/931993/9421994/9521995/963
In percent
Domestic economy
Change in real GDP–2.3–2.53.35.0
Change in consumer prices
(end of period)–4.133.813.44.4
In millions of U.S. dollars4
External economy
Exports1,651.71,433.31,662.21,755.2
Imports1,020.71,016.71,074.61,192.0
Current account balance–620.1–337.0–170.0–226.7
Direct investment134.0102.288.691.9
Capital account balance–286.1–266.4–661.7–167.2
Gross official reserves45.113.512.713.7
Current account balance
(in percent of GDP)–5.2–4.3–2.1–2.5
External debt (in percent of GDP)70.8122.7116.2104.3
Debt service (in percent of exports of goods and services)42.555.060.954.5
Change in real effective exchange rate
(in percent)–2.6–24.7–13.66.6
In percent of GDP4
Financial variables
General government balance–6.8–9.2–4.9–2.8
Gross national saving11.311.012.413.5
Gross national investment16.615.314.516.0
Change in broad money (in percent)–10.317.76.1–5.1
Interest rate (in percent)11.512.58.88.0

Data are for fiscal years (July 1–June 30).

Estimated.

Updated Fund staff estimates.

Unless otherwise noted.

Data are for fiscal years (July 1–June 30).

Estimated.

Updated Fund staff estimates.

Unless otherwise noted.

Following the devaluation of the CFA franc, external competitiveness improved in early 1994, leading to a strong recovery in the tradable goods sector. With the recovery, imports of intermediate and investment goods rebounded strongly in 1995/96, giving rise to a slight deterioration in the trade surplus. The current account deficit widened to 2½ percent of GDP from 2 percent in 1994/95, while the capital account deficit narrowed because of lower official amortization payments and a resumption of private capital inflows. The overall balance of payments deficit fell by 7 percent of GDP in 1995/96.

Despite relatively favorable economic conditions and a good start, the government’s 1995/96 economic adjustment program, which had received support under a Fund Stand-By Arrangement approved in 1995, went off track toward the end of that year. Fiscal performance improved in 1995/96, with the overall deficit declining and the primary surplus rising, but not to the extent envisaged in the program.

Moreover, revenue collection was lower and outlays higher than anticipated. A number of structural reforms in 1995/96 were delayed or incompletely implemented, including civil service and administrative reforms, public enterprise divestiture, banking sector restructuring, and the securitization of domestic arrears. Although the authorities reduced external arrears to official creditors by CFAF 309 billion, arrears to these creditors were not eliminated because of a shortfall in the primary balance, an unanticipated buildup of government deposits in the banking system, and a shortfall in external program assistance.

Monetary developments in 1995/96 included an apparent weakening of money demand, a slight deterioration in the net foreign asset position of the banking system, and a pickup in private sector credit. Recorded broad money contracted by 5 percent, implying an increase in income velocity, attributable to problems in the domestic banking system.

At their meeting, Directors noted the strengthening of Cameroon’s economic recovery in 1995/96, accompanied by a sharp drop in inflation and an improved balance of payments. They regretted, however, that slippages in implementing fiscal policy and delays in key structural reforms had led to a continued buildup of external arrears, which affected the credibility of the economic program. Directors urged the authorities to strengthen the implementation of fiscal and structural policies expeditiously to facilitate discussions of a program that could be supported by an arrangement under the ESAF. Prompt action would also help solidify the gains from the CFA franc devaluation and allow Cameroon to achieve its full growth potential.

While recognizing that Cameroon had made progress in improving public finances. Directors expressed concern about revenue shortfalls and expenditure overruns and exhorted the authorities to strengthen the country’s fiscal performance and to implement promptly the measures outlined in the government’s 1996/97 budget. In particular, they urged the authorities to improve tax administration, reduce tax fraud, close tax loopholes, step up expenditure controls, and strictly monitor and prioritize expenditures. Directors also noted that Cameroon had progressed in liberalizing the trade regime and labor markets. But they expressed concern over the persistent delays in implementing other structural reforms, notably in the areas of the financial system and public enterprises.

With respect to Cameroon’s debt burden, Directors were disappointed with the recent further increase in external arrears and urged the authorities to clear them, in line with the terms of the last Paris Club agreement. They emphasized that normalization of relations with external creditors was crucial for mobilizing new external resources to support the country’s adjustment efforts. Directors concluded by underscoring the importance of achieving all fiscal and structural program targets for the second half of 1996, which would allow Cameroon to regain donor confidence and establish a credible track record for consideration of an ESAF arrangement.

Chile

The Board concluded the Article IV consultation with Chile in August 1996. Chile’s economy had continued to perform strongly in 1995. Output grew at a rate of 8.5 percent, and inflation declined to 8.2 percent, from 8.9 percent in 1994. Unemployment tell to 4.7 percent at the end of 1995, from 5.9 percent at the end of 1994 (Table 23). Domestic demand pressures intensified during the year, and aggregate domestic expenditure grew by 13 percent. The growth of private sector credit increased to 23 percent in 1995, from 20 percent in 1994, Exceptionally high copper prices and lower-than-expected budget expenditures increased the public sector surplus to 2.8 percent of GDP in 1995, from 1.2 percent in 1994.

Table 23Chile: Selected Economic Indicators

(Data as of Board discussion in August 1996)1

1996
1993199419952Projections at

time of Board

discussion
Outturn3
In percent
Domestic economy
Change in real GDP6.34.28.57.47.2
Unemployment rate4.76.05.4
Change in consumer prices
(end of period)12.28.98.27.06.6
In billions of U.S. dollars1
External economy
Exports, f.o.b.9.211.616.015.115.4
Imports, c.i.f.–10.2–10.9–14.7–16.416.5
Current account balance–2.1–0.60.2–2.7–2.9
Direct investment0.91.91.92.14.2
Portfolio investment0.81.30.01.31.2
Capital account balance2.74.61.23.75.0
Gross official reserves9.713.214.214.814.9
Current account balance
(in percent of GDP)–4.5–1.20.2–3.8–4.1
External debt (in percent of GDP)42.041.232.434.536.3
Debt service (in percent of exports of goods and services)24.619.226.025.431.8
Change in real effective exchange rate (in percent)4–1.94.92.23.9
In percent of GDP1
Financial variables
General government balance1.92.73.72.93.0
Gross national saving24.225.627.623.923.6
Gross domestic investment28.826.827.427.727.7
Change in broad money
(in percent)27.019.327.419.323.5
Interest rate (in percent)56.56.46.17.3

Unless otherwise noted.

Preliminary.

Updated Fund staff estimates.

Twelve months ended December. Decline indicates depreciation of the Chilean peso.

Average annual rate on 90-day central bank indexed promissory notes.

Unless otherwise noted.

Preliminary.

Updated Fund staff estimates.

Twelve months ended December. Decline indicates depreciation of the Chilean peso.

Average annual rate on 90-day central bank indexed promissory notes.

The external current account shifted to a virtual balance in 1995, from a deficit of 1.2 percent of GDP in 1994, as a result of a sharp improvement in Chile’s main export prices. Partly because of prepayment of external public debt and a shift in portfolio investment to net outflows, total capital inflows dropped to less than $1 billion in 1995, from $3,8 billion in 1994. Official reserves at the end of 1995 were $14.2 billion, an increase of $1.4 billion. The Chilean peso, in real effective terms, appreciated by 2.2 percent in 1995.

Performance in the first quarter of 1996 was strong. Aggregate domestic demand grew by 13 percent and output by 9 percent, compared with the same period in 1995. The trade surplus dwindled because of lower export prices, and capital inflows rebounded sharply in the first half of 1996.

In their discussion, Directors commended the authorities for their skillful management of the economy and had much praise for its impressive performance in recent years: declining unemployment, lower inflation, high saving and investment, a strong external position, and encouraging improvements in social conditions.

Although the medium-term outlook remained favorable. Directors felt that Chile’s most important challenge was to bring inflation down to industrial country levels. In that context. Directors emphasized that more decisive action to reduce the scope of indexation would help in achieving the inflation target. The current tight monetary policy was generally considered appropriate by Directors, in view of the need to curb private demand to a sustainable level. They recommended keeping that stance until signs were clear that inflation was declining in line with the authorities’ target for 1996.

Directors endorsed the authorities’ fiscal stance for 1996, which was stronger than envisaged in the budget. Such a stance would help to reduce the burden of monetary policy and the upward pressure on the currency. Directors noted that achieving the budgeted outcome would require containment of wages and keeping nonpriority spending under close review.

The substantial progress in freeing capital outflows was welcomed by the Board. With respect to regulations to discourage capital inflows, several Directors endorsed the authorities’ view that measures to discourage capital inflows had helped to increase the share of longer-term, non-debt-creating inflows and thus protected the economy from undesirable volatility. Those Directors thought there were risks in liberalizing controls at present. Several other Directors observed that, even though those regulations had been in place for a number of years and had progressively been broadened, inflows had remained strong. They noted that such regulations tended to lose effectiveness over time while their cost for the economy increased, and they advised the authorities to liberalize them over time. Those Directors argued that a more flexible exchange rate system would be more fitting, both to deal with capital inflows and to reduce indexation.

Directors commended the authorities’ emphasis on targeted social policies and their efforts to address income inequalities without compromising fiscal stability. In that connection, the planned ambitious education reform was welcomed. Directors stressed that, although the authorities were aware of environmental problems, environmental protection should be given greater importance.

Data available subsequent to the Board discussion show that output growth slowed to 7.2 percent and inflation declined to 6.6 percent in 1996. Reflecting lower export prices, the fiscal position (including central bank losses) weakened but still registered a surplus of about 1.2 percent of GDP, while the external current account balance shifted to a deficit of about 4 percent of GDP, Private capital inflows (mostly direct investment) surged to a record $4.1 billion (5.7 percent of GDP). Official foreign reserves increased by $0.7 billion to $15 billion by year-end (equivalent to about 11 months of imports of goods and nonfactor services). In real effective terms, the Chilean peso appreciated by 3.8 percent during 1996.

China

The Board concluded the Article IV consultation with China in June 1997, Although the consultation took place after the end of the 1997 financial year, the period covered by this Annual Report, as an exception the consultation with China has been included in consideration of the fact that the Fund’s 1997 Annual Meetings are being held in Hong Kong, China.

Directors met against the background of continued robust growth and steadily declining inflation in China. Real GDP growth was 9¾ percent in 1996 (Table 24) and 9½ percent in the first quarter of 1997, with a strong pickup in net exports offsetting some weakening of domestic demand. Owing to the moderation of demand pressures and favorable agricultural supply conditions, retail price inflation decelerated to 4½ percent at the end of 1996 and averaged 2.6 percent in the first quarter of 1997.

Table 24China: Selected Economic Indicators(Data as of Board discussion in June 1997)
19931994199519961
In percent
Domestic economy
Change in real GDP13.512.610.59.7
Change in retail prices (period average)13.021.714.86.1
In billions of U.S. dollars2
External economy
Exports, f.o.b.75.9102.6128.1128.5
Imports, c.i.f.–86.3–95.3–110.1–114.6
Current account balance3–11.97.71.63.9
Direct investment23.131.833.838.8
Portfolio investment3.03.50.82.4
State gross official reserves423.053.576.0107.7
Current account balance
(in percent of GDP)–2.71.40.20.5
External debt84.495.0106.6116.2
Debt service (in percent of exports of goods and nonfactor services)12.611.610.610.9
Change in real effective exchange rate
(in percent)5–1.909.015.344.95
In percent of GDP2
Financial variables
Overall budgetary balance6–2.0–1.6–1.7–1.5
Gross national saving40.642.641.142.9
Gross domestic investment43.341.240.842.4
Change in broad money (in percent)724.034.529.525.3
Interest rate (in percent; one-year time deposits, year-end)10.9810.9810.987.478

Fund staff estimates.

Unless otherwise noted.

Series has breaks in 1995 and 1996 owing to changes in the coverage of services items.

Includes gold, SDR holdings, and reserve position in the Fund.

December averages.

Central and local governments.

End of period; banking survey. Owing to break in the series in 1993, growth rates for that year are not available and monetary survey data (broadly similar) are reported instead.

End-March 1997.

Fund staff estimates.

Unless otherwise noted.

Series has breaks in 1995 and 1996 owing to changes in the coverage of services items.

Includes gold, SDR holdings, and reserve position in the Fund.

December averages.

Central and local governments.

End of period; banking survey. Owing to break in the series in 1993, growth rates for that year are not available and monetary survey data (broadly similar) are reported instead.

End-March 1997.

Both fiscal and monetary policy remained moderately restrictive in 1996 and early 1997. The deficit of the general government narrowed, because of continued expenditure restraint and an apparent stabilization of the revenue ratio.

The authorities had aimed to slow M2 growth to 25 percent by the end of 1996. This goal was achieved, and there was a further easing in early 1997. Reserve money growth picked up late in 1996, as the People’s Bank of China accommodated an increase in required reserves resulting from stricter enforcement of reserve requirements, but the underlying growth rate was broadly unchanged, with tight control over central bank credit to the banking system offsetting further large increases in net foreign assets. Administered interest rates were cut twice in view of the significant decline in inflation in 1996.

The growth of both exports and imports slowed temporarily in 1996, with a slight net reduction in the trade surplus. In the first quarter of 1997, the trade balance showed a surplus of nearly $7 billion. Foreign direct investment inflows were strong in 1996, and official reserves reached $108 billion (nine months worth of imports) by year-end. The renminbi remained stable against the U.S. dollar but appreciated in real effective terms owing to higher inflation in China than in its trading partners.

The strong macroeconomic picture masked considerable disparities across sectors and regions, largely owing to differences in the performances of the state-owned enterprises and the nonstate sector, which continued to outpace the state sector by a considerable margin. Structural reform was concentrated on the external and financial sectors. A trade package, including cuts in import tariffs, a phasing out of duty exemptions, and selected measures to ease nontariff restrictions, was introduced in April 1996. Effective December 1, 1996, China accepted the obligations of the Fund’s Article VIII. In the financial sector, steps were taken to strengthen the infrastructure and instruments for indirect monetary control.

Directors congratulated the authorities for their skillful and sustained implementation of prudent macroeconomic policies and structural reforms that had made possible the achievement of a soft landing while continuing China’s opening to, and growing integration with, the global economy. They agreed that the key challenge was to take advantage of this favorable situation to undertake bold and comprehensive structural reforms, particularly to address deep-seated weaknesses in the state enterprises and the financial system in order to accelerate China’s transition to a more fully market-based economy.

Directors stressed the importance of maintaining cautious macroeconomic policies to sustain low inflation. Noting the rapid growth of broad money, they generally cautioned that more restrained broad money growth than envisaged in the authorities’ monetary policy framework for 1997 would be prudent.

Directors also stressed that the development of a medium-term framework for fiscal policy would help in prioritizing public expenditures, identifying the associated sources of financing, and assessing the overall fiscal policy stance. They also emphasized the need to improve the transparency of the budget. Also, a marked improvement in budgetary revenue would be required to ensure a strong overall fiscal position. In that connection, they suggested a broadening of income taxes and the value-added tax, the strengthening of tax administration, and the phasing out of tax concessions for foreign-funded enterprises. More generally, they emphasized the importance for a market economy of a broad-based, simple, and nondistortionary tax system.

In view of the continuing weakness in the state-owned enterprise sector. Directors considered that an acceleration of enterprise reform should be a priority to ensure a stable macroeconomic framework and to improve competitiveness and efficiency. They welcomed the authorities’ decision to allow greater management authority and diverse forms of ownership.

Directors emphasized the need to improve the commercial orientation and soundness of the financial system.

Directors commended the authorities for their acceptance of Article VIII. Noting the rapid accumulation of international reserves in recent years and the prospect for further increases in the future. Directors suggested the acceleration of trade liberalization would assist in the adjustment process. Improve efficiency, and ease the pressures on monetary policy emanating from the very strong external position.

Much remained to be done to improve economic statistics, Directors stressed, including in the national, fiscal, and external accounts.

Directors congratulated China on the historic occasion of the reunification of Hong Kong with China, which promised new opportunities for further enhancing the prosperity of China, Hong Kong, and the global economy.

Egypt

The Board concluded the Article IV consultation with Egypt in October 1996 and approved Egypt’s request for a two-year precautionary Stand-By Arrangement. Since 1991, Egypt had been implementing wide-ranging stabilization and structural reforms with the support of two successive Stand-By Arrangements. Real GDP growth, stagnant in 1991/92, at the time of the consultation was estimated to have increased to more than 4 percent in 1995/96, while the annual rate of inflation was reduced from more than 21 percent to slightly over 7 percent (Table 25).

Table 25Egypt: Selected Economic Indicators1(Data as of Board discussion in October 1996)
1992/931993/941994/951995/96
In percent
Domestic economy
Change in real GDP0.52.93.24.2
Change in consumer prices
(period average)11.19.09.47.1
In billions of U.S. dollars2
External economy
Exports, f.o.b.3.43.35.04.6
Imports, c.i.f.10.710.611.913.7
Current account balance2.20.21.60.2
Direct investment0.51.30.70.5
Portfolio investment0.00.00.1
Capital account balance0.82.1–0.40.8
Gross official reserves15.517.018.418.9
Current account balance
(in percent of GDP)35.60.42.70.2
External debt (in percent of GDP)65.858.055.747.1
Debt service (in percent of current account receipts, including all transfers)13.612.110.310.7
Change in real effective exchange rate
(in percent)47.910.4–0.42.4
In percent of GDP2
Financial variables
General government balance–3.5–2.1–1.3–1.3
Gross national saving17.017.219.417.2
Gross national investment16.216.816.717.0
Change in broad money (in percent)16.412.411.110.5
Average interest rate on three-month treasury-bill (in percent)16.313.911.010.5

Data are for fiscal years ending June.

Unless otherwise noted.

Including official transfers.

For 1995/96, the change relates to the 12-month period ended May 1996.

Data are for fiscal years ending June.

Unless otherwise noted.

Including official transfers.

For 1995/96, the change relates to the 12-month period ended May 1996.

Significant progress had been made toward fiscal consolidation. The overall fiscal deficit, which exceeded 15 percent of GDP in the late 1980s, stood at about 1.3 percent of GDP in 1995/96, in line with the budget target and about the same level as in the preceding year. While total revenues declined relative to GDP, current outlays fell commensurately, although priority social sectors such as health and education were shielded.

There had been a further casing of interest rates, and excess reserves of commercial banks had decreased. The rate on three-month treasury bills dropped to 10½ percent, from about 14 percent two years earlier. The nominal exchange rate of the pound vis-à-vis the U.S. dollar remained virtually constant; in real effective terms, the pound appreciated 9 percent, reflecting the stronger U.S. dollar. Overall, the rate of appreciation of the pound in real effective terms slowed significantly from 1993 as the inflation differential between Egypt and its trading partners declined and capital inflows subsided.

The overall balance of payments remained in surplus, leading to a substantial accumulation of net international reserves, which stood at the equivalent of about 15 months of imports in October 1996. With limited external borrowing and further debt relief from the Paris Club, the ratio of external debt to GDP fell to about 47 percent in mid-1996, and the debt-service ratio declined to about 11 percent of current account receipts (including all transfers).

The current account remained in surplus in 1995/96, albeit at a lower level than in 1994/95 (0.2 percent and 2.7 percent of GDP, respectively), despite a substantial widening of the trade deficit, a decline in private remittances, and little change in official transfers. The widening of the trade deficit, which reached 14 percent of GDP in 1995/96, was attributable to a decline in exports from exceptional levels in 1994/95; the impact on imports of more robust economic growth—intermediate and capital goods accounted for a large share of import growth; and rising world prices for imports of wheat and maize. Higher tourism receipts mitigated the deterioration in the trade account. In the capital account, sizable net inflows (largely associated with commercial banks’ drawdowns of deposits abroad) helped to sustain the overall external surplus at about $800 million.

Since 1991, progress had been made in strengthening the revenue system through the introduction of a general sales tax and a global income tax; liberalizing the trade and exchange system; decontrolling interest rates; and initiating a reform of the public enterprise sector, including privatization. The pace of structural reform, particularly privatization, accelerated following the formation of the new government in January 1996.

Directors commended the authorities for the improvement in Egypt’s economic performance over the past few years and welcomed their intention to consolidate and build on recent gains by embarking on a reinvigorated economic reform program.

Directors considered fiscal discipline as crucial to Egypt’s program and stressed the need to maintain the prudent stance of demand management policy as a basis for further reducing inflation and ensuring continued external viability. They noted that Egypt’s exchange system was now virtually free of restrictions and urged the authorities to accept the obligations of Article VIII of the Fund’s Articles of Agreement.

In the area of structural reform, Board members welcomed the wide-ranging measures incorporated in the program. They regarded those related to fiscal restructuring—particularly tax reform and the reorganization of the civil service—as potentially far-reaching and noted that implementation of the plans in the money and foreign exchange markets, in conjunction with the restructuring of the financial sector, would enhance the authorities’ macroeconomic management capacity while broadening and deepening the financial sector. Directors stressed the need to continue to strengthen prudential standards and banking regulations.

In the Board’s view, the privatization program sent a clear signal of the government’s intention of disengaging from the productive sector. On trade liberalization, Directors welcomed the recent round of tariff reductions. Directors supported steps to liberalize rents and investment procedures and emphasized the importance of early passage of a unified investment law. They encouraged the authorities to promote greater flexibility in the labor market to alleviate unemployment. Directors also attached considerable importance to the authorities’ efforts to improve the collection and compilation of data.

Ghana

The Board concluded the Article IV consultation with Ghana in June 1996 and reviewed the country’s progress under the first annual ESAF arrangement. This arrangement had been approved on June 30, 1995 in an environment of intensifying inflationary pressures resulting from slippages in fiscal policy and large credit expansion caused by the difficulties of the Ghana National Petroleum Corporation (GNPC). As part of the program, the authorities took steps to reduce the GNPC’s large overdraft at the central bank, cut off its access to new credits, and placed its oil-trading transactions under the control of the Ministry of Finance. These measures helped reduce inflation, at seasonally adjusted annual rates, from 120 percent in July 1995 to 70 percent in September 1995.

Monetary growth in 1994 was also boosted by the central bank’s inability to absorb the liquidity impact of larger-than-expected foreign exchange inflows from gold and timber exports. Such pressures reemerged in the fourth quarter of 1995 in connection with capital inflows from the cocoa sector. These inflows, combined with a strong current account performance, increased Ghana’s foreign exchange reserves. The central bank’s net foreign asset position exceeded the end-1995 target by the equivalent of 30 percent of reserve money. Broad money consequently grew by 37 percent in 1995 (Table 26). Nonetheless, inflation fell further, to 54 percent at an annualized seasonally adjusted rate at the end of the year.

Table 26Ghana: Selected Economic Indicators

(Data as of Board discussion in June 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real GDP5.03.84.55.05.2
Change in consumer prices
(end of period)27.734.270.825.032.7
In millions of U.S. dollars1
External economy
Exports, f.o.b.1,063.61,226.81,431.21,597.41,510.1
Imports, f.o.b.–1,728.0–1,579.9–1,687.2–1,947.2–1,835.1
Current account balance3–559.1–264.9–141.8–210.6–273.0
Direct investment25.030.035.020.020.0
Overall balance41.2163.8284.0115.3–18.9
Gross official reserves420.4592.9779.7832.5598.9
Current account balance
(in percent of GDP)4–9.2–4.9–2.2–3.4–4.3
External debt (in percent of GDP)82.594.580.884.878.8
Debt service (in percent of exports of goods and services)35.727.435.824.027.9
Change in real effective exchange rate (annual average; in percent)–13.2–17.614.112.2
In percent of GDP1
Financial variables
General government balance5–7.7–3.5–4.5–2.0–8.8
Gross national saving5.610.816.414.614.4
Gross national investment14.815.918.617.918.7
Change in broad money
(in percent)27.446.237.45.034.2
Discount rate on 91-day treasury bills (in percent; end of period)32.029.540.542.8

Unless otherwise noted.

Updated Fund staff estimates.

Excluding divestiture receipts.

Including official grants.

Including divestiture proceeds.

Unless otherwise noted.

Updated Fund staff estimates.

Excluding divestiture receipts.

Including official grants.

Including divestiture proceeds.

Real GDP growth reached 3.8 percent in 1994 and 4.5 percent in 1995. Mining grew strongly in 1995, and agriculture expanded by 4.5 percent, but manufacturing output was sluggish. The revenue picture was also mixed; public dividends and royalties from the banking and mining sectors performed favorably, but collections from petroleum and import taxes fell short of expectations. In 1995, Ghana contained recurrent expenditures, holding the government wage bill at 5.7 percent of GDP and making lower domestic interest payments than expected. The budget recorded an overall deficit on a commitment basis of 4.5 percent of GDP in 1995, exceeding the program target by 1.3 percentage points, partly because of overspending on roads and highways.

In their discussion, Directors noted that, through its prolonged adjustment and reform efforts, Ghana had made significant progress, although performance under the ESAF-supported program had been disappointingly uneven. In 1995, inflation had risen to an unacceptably high level, private saving and investment had remained weak, economic growth had fallen short of target, and deregulation of the petroleum and cocoa sectors had been delayed.

Directors observed that high inflation and policy slippages through mid-1995 had undermined confidence, precluding a private saving and investment response, which was essential for sustained growth. Although external sector performance in 1995 had been stronger than anticipated, stop-and-go policies had prevented Ghana from fully reaping the benefits of its earlier efforts.

Directors welcomed the steps that Ghana had taken since late 1995 to reverse slippages in policy implementation and noted the satisfactory performance during the first quarter of 1996, They saw the economic program for 1996 as constituting a serious effort to comply with the original program targets and as providing a disciplined framework for economic policy during the run-up to the elections in late 1996. Directors exhorted the government to resist spending pressures and stressed the importance of strictly implementing all elements of the program. They also stressed that a substantial and durable reduction in inflation was the priority of the program and should be the key objective of monetary policy. Directors welcomed indications that the growth of reserve money had declined to within program ceilings and that inflation was also declining. They emphasized that the credibility, strength, and sustained implementation of financial policies were critical in achieving low inflation.

As regards fiscal policy, Directors were encouraged by the measures implemented to regularize outstanding arrears to local contractors and to bring road spending under control. They noted, additionally, that the favorable outcome of civil service pay negotiations would help to maintain fiscal restraint and stressed the importance of adopting effective instruments to monitor and control government expenditures. Over the medium term. Directors observed that Ghana needed to rely less on trade taxes and to widen the tax base.

Directors saw structural reforms as essential for accelerating growth and alleviating poverty. These should focus on enhancing private sector activity and on relieving the financial burden public enterprises imposed on the state. While welcoming the progress in deregulating the marketing and pricing of oil and in curtailing the access of the GNPC to central bank credit, Directors expressed concern about the practice of providing the GNPC with official guarantees and urged the authorities to continue with the restructuring of the oil sector. They also encouraged the authorities to move forward with liberalizing cocoa exports by reducing, if not eliminating, export taxes in a framework that would balance competition and regulation to secure a free market while ensuring quality control. Directors welcomed the authorities’ intention to divest the government’s share in the banking sectors.

Directors agreed that, with sustained strong policies, Ghana’s external debt burden appeared manageable in the medium term and that the balance of payments position looked sufficiently robust to sustain modest adverse shocks. They suggested, nonetheless, close monitoring of Ghana’s debt situation.

Guatemala

The Board concluded the Article IV consultation with Guatemala in October 1996. The Guatemalan authorities had succeeded in 1995 in reducing the combined public sector deficit by increasing government revenue and restraining expenditure. In 1995, real GDP grew by 5 percent, spurred by high coffee prices, and inflation dropped to 8½ percent (Table 27). The foreign reserve position deteriorated, owing to lax credit policies and shortfalls in official financing.

Table 27Guatemala: Selected Economic Indicators

(Data as of Board discussion in October 1996)1

1996
1993199419952Projections at

time of Board

discussion
Outturn3
In percent
Domestic economy
Change in real GDP3.94.04.93.83.1
Unemployment rate5.55.24.2
Change in consumer prices
(end of period)11.611.68.610.010.9
In millions of U.S. dollars1
External economy
Exports, f.o.b.1,4621,6872,1562,2462,213
Imports, c.i.f.–2,599–2,781–3,292–3,424–3,146
Current account balance–746–697–589–616–418
Direct investment, net228657010381
Portfolio investment, net155359–1020.088
Capital account balance4955533369607560
Gross official reserves53.53.22.32.22.9
Current account balance
(in percent of GDP)–6.6–5.4–4.0–3.9–2.7
External debt (in percent of GDP)19.818.615.914.715.0
Debt service (in percent of exports of goods and services)14.313.09.29.39.9
Change in real effective exchange rate (in percent)1.57.5–0.25.4
In percent of GDP1
Financial variables
General government balance–1.4–1.1–0.7
Gross national saving10.710.311.410.911.8
Gross domestic investment17.215.715.414.814.8
Change in broad money
(in percent)18.517.914.714.014.0
Interest rate (in percent; end of period)
Lending25.720.222.222.4
Time deposits18.012.514.213.3

Unless otherwise noted.

Estimated.

Updated Fund staff estimates.

Includes errors and omissions.

In months of imports of goods and services.

Unless otherwise noted.

Estimated.

Updated Fund staff estimates.

Includes errors and omissions.

In months of imports of goods and services.

In 1996, under a new administration, the fiscal position continued to improve as a result of additional revenue measures, on the one hand, including an increase in the value-added tax rate to 10 percent from 7 percent and the introduction of an extraordinary and temporary solidarity tax, and, on the other hand, tight expenditure control. Despite the improvement in the two preceding years, Guatemala’s tax ratio at 8½ percent of GDP remained relatively low by regional standards, and the resources devoted to basic social needs and infrastructure continued to be insufficient. Credit to the private sector continued to expand rapidly in the first half of the year, but it slowed subsequently as the central bank tightened credit policy.

Growth of economic activity slowed in 1996, to an estimated 3 percent, because of the effects of lower coffee prices on domestic demand, while inflation rose. The external current account deficit was projected at the time of the consultation to decline marginally, and the overall balance of payments to be in approximate equilibrium (in the event, the current account deficit fell to less than 3 percent of GDP, and the overall balance moved into surplus). Following downward pressure on the quetzal in the first quarter of 1996, which prompted the central bank to sell foreign exchange, the currency appreciated a little in nominal terms in the second quarter, with the central bank intervening on the buying side; in real effective terms the quetzal appreciated by 2 percent during January–June 1996.

Soon after assuming office in January 1996, the new administration, under the auspices of the United Nations, resumed peace negotiations with insurgent groups, and in December 1996 peace accords were signed. The government is committed to implementing an ambitious Peace Program over the next several years to achieve durable progress in the political, social, and economic areas. The program includes (1) the strengthening of democratic institutions, the judicial system, and public security; (2) higher spending on basic infrastructure, low-income housing, primary health care and education, and land reform; and (3) a reduction in military expenditures and higher tax revenue to finance the peace-related outlays within a sound fiscal framework.

Directors, at their meeting, welcomed the progress made in the peace negotiations. They were of the view that this important achievement provided a clear opportunity to address the economy’s fiscal and external fragility and to improve basic social conditions.

Directors considered that the fiscal position needed to be strengthened substantially. They were of the view that the tax effort, low by regional standards, hindered efforts to address the country’s deep-rooted social problems, develop a more modern infrastructure, and give due attention to human capital formation. To that end, Directors called on the authorities to move quickly with measures to raise the tax effort and strengthen public finances. The additional revenue was needed to ease pressure on interest rates, reduce inflation, and improve the external position. Given the substantial income inequality, Directors felt that attention should be paid to the progressivity of the tax system. They noted that it was important to maintain strict control over government expenditures, particularly the wage bill.

Directors welcomed the steps to curb the rapid growth of credit to the private sector and emphasized the importance of pursuing a conservative credit stance. They recommended that the exchange rate continue to be allowed to respond to market forces in the context of financial policies aimed at lowering inflation and strengthening the reserve position. Directors agreed with the authorities’ position that large-scale intervention in the interbank foreign exchange market should be avoided.

The slow implementation of structural reforms was noted by Directors. They urged the authorities to press on with privatization in the electricity, telecommunications, and railroad sectors, as well as with their plans to modernize the public sector and move to a pension system based on private capitalization. They also encouraged moving ahead with financial modernization, including giving more autonomy to the central bank and strengthening prudential regulations. Directors welcomed the progress made in settling external arrears and urged the authorities to ensure the timely payment of all official financial external obligations. They emphasized that strong macroeconomic and structural reforms were needed to ensure donor support for Guatemala’s adjustment efforts.

India

The Board concluded the Article IV consultation with India in November 1996. The new government that took office in June 1996 had inherited a strong economy, with GDP rising by 7 percent in 1995/96 (Table 28), fueled by a vigorous supply response to reforms, although there were signs of a slowdown in industrial production in early 1996/97. Tight monetary policy combined with a delay in administered price adjustments brought wholesale price inflation down to 5 percent in 1995/96, while consumer price inflation was also on a downward trend. In mid-1996, however, inflation had begun to pick up, mainly reflecting a 20 percent increase in petroleum prices in July.

Table 28India: Selected Economic Indicators1

(Data as of Board discussion in November 1996)2

1996/97
1993/941994/951995/963Projections

at time

of Board

discussion
Outturn4
In percent
Domestic economy
Change in real GDP
(at factor cost)4.36.37.06.86.8
Change in consumer prices
(end of period)9.99.78.99.59.5
In billions of U.S. dollars2
External economy
Exports, f.o.b.22.726.932.534.934.3
Imports, c.i.f.25.131.741.143.145.3
Current account balance–1.2–2.6–5.2–6.2–5.1
Direct investment, net0.61.32.02.32.4
Portfolio investment, net3.63.62.14.23.3
Capital account balance9.88.74.09.111.4
Gross official reserves15.720.817.020.022.3
Current account balance–0.5–0.9–1.6–1.7–1.5
(in percent of GDP)
External debt (in percent of GDP; end of period)36.332.929.226.827.2
Debt service (in percent of exports of goods and services)26.526.426.228.427.8
Change in real effective exchange rate (in percent; end of period)6.9–5.1–0.66.08.0
In percent of GDP2
Financial variables
General government balance–8.8–7.4–7.6–7.4–7.4
Gross national saving21.424.424.626.225.5
Gross domestic investment21.625.226.227.527.5
Change in broad money
(in percent; end of period)18.422.313.216.115.6
Interest rate (in percent)512.512.713.913.713.7

Data are for fiscal years ending March.

Unless otherwise noted.

Fund staff estimates.

Updated Fund staff estimates.

Ten-year government bonds.

Data are for fiscal years ending March.

Unless otherwise noted.

Fund staff estimates.

Updated Fund staff estimates.

Ten-year government bonds.

The fiscal deficit had been on a gradually declining path since 1993/94 but remained large. The central government deficit fell to 5.7 percent of GDP in 1995/96. The combined public sector deficit was estimated to have remained at about 9¼ percent of GDP. The budget for 1996/97 aimed to reduce the central government deficit further to 5 percent of GDP, largely on the basis of higher divestment receipts and cyclical gains to tax revenues.

With the fiscal deficit remaining high, monetary policy had carried the main burden of stabilization. Broad money growth was lowered to 13.2 percent in 1995/96, and corporate liquidity was further constrained by weakness in the stock market and a slowdown in capital inflows. The prime tending rate reached 16–18 percent. However, the monetary policy stance was eased significantly during the early months of 1996/97, reflecting official concerns for the effects of a credit squeeze on investment.

On the external front, the current account deficit widened to 1.6 percent of GDP in 1995/96, mainly because of rapid import growth. At the same time, the capital account weakened as portfolio equity inflows slowed because of preelection uncertainties. The authorities responded to several episodes of sharp downward pressure on the exchange rate by intervening in the foreign exchange market and tightening money market conditions, while taking administrative measures to discourage the use of trade financing for speculative purposes. After February 1996, the foreign exchange market was more stable.

In their discussion, Directors commended India’s impressive economic performance—strong output growth, controlled inflation, and a satisfactory external position—but were concerned over the strains that were beginning to emerge. The high fiscal deficit continued to put upward pressure on interest rates; infrastructure constraints were taking their toll; and inflation was beginning to pick up. Directors were encouraged by the new government’s commitment to adjustment and reform but emphasized that continued economic success would depend on bolder steps.

The too large fiscal deficit still needed to be tackled decisively, Directors stressed. They urged that an ambitious front-loaded adjustment be launched at the time of the next budget, aimed at a more accelerated pace of deficit reduction than presently envisaged by the authorities. Delaying the fiscal adjustment, Directors cautioned, would leave the economy more vulnerable to adverse external developments.

In view of the low revenue-to-GDP ratio, Directors considered that deficit reduction should focus on improving revenue mobilization—including at the state level—through broadening the tax base, eliminating exemptions, and enhancing cost recovery. Considerable scope was also seen for curbing expenditures by improving the targeting of food and fertilizer subsidies and proceeding quickly with civil service reform to reduce the wage bill.

Directors stressed that monetary policy should be firmly focused on inflation and cautioned against undue easing of monetary conditions. They underlined the need to stick to the target for broad money in light of the recent pickup in inflation. Directors also urged the authorities to phase out ad hoc financing from the Reserve Bank of India to the government at the end of the fiscal year as an important step in building the framework for greater central bank independence.

Directors emphasized the need for flexible exchange rate management in close coordination with other macroeconomic policy instruments. They stressed that the exchange rate should be allowed to respond to market signals and that, in managing intervention policy, the authorities should avoid a too mechanical reliance on indicators of the real exchange rate. They also pointed to the considerable efficiency gains from freer capital flows. A number of Directors considered that more could be done to open up the Indian economy to foreign investment and urged that priority be given to removing the remaining obstacles to foreign direct and portfolio investment.

While welcoming the new government’s reform program, Directors emphasized that early elaboration of a comprehensive framework of structural reforms and bold initial action would help to foster an efficient and dynamic private sector response. They pressed for accelerated trade liberalization, including the early phasing out of quantitative restrictions on imports of consumer goods. Directors also called for further efforts to strengthen public sector banks and to ensure effective supervision; more ambitious public enterprise reform, including privatization and implementation of an effective exit policy; and actions to establish a framework for private participation in infrastructure.

Subsequent to the Board meeting, revised national accounts data indicated significantly higher real GDP growth over 1993/94–1995/96 than previously estimated: GDP growth in these years is now estimated at 6.0 percent in 1993/94, 7.2 percent in 1994/95, and 7.1 percent in 1995/96, For 1996/97, by contrast, despite slowing industrial activity, strong agricultural performance helped to maintain GDP growth close to 7 percent. A good harvest also helped to ease pressures on food prices, and wholesale price inflation receded to 6½ percent by early April 1997. While exports slowed markedly, import growth also came down sharply, and the current account deficit remained about 1½ percent of GDP in 1996/97. The overall balance of payments registered a $6¼ billion surplus, boosted by strong private capital inflows, and international reserves rose to about six months of imports by April 1997, The central government’s budget for 1997/98 provided sharp reductions in tax rates, while aiming to lower the deficit to 4½ percent of GDP from 5 percent in 1996/97. Monetary policy aimed at containing inflation to 6 percent in 1997/98, while steps were taken to ease cumbersome regulation of bank lending and to foster development of the government securities and foreign exchange markets. Other recent reform initiatives included further liberalization of the foreign direct and portfolio investment regimes and elimination of quantitative restrictions on a range of consumer goods imports.

Indonesia

The Board concluded the Article IV consultation with Indonesia in July 1996. Over the past few years, Indonesia had been able to sustain the impressive record of economic development established in the 1970s and 1980s through market-oriented reform. In 1995/96, domestic demand grew faster than GDP for a third year, based on strong growth of consumption and investment. Real GDP growth rose to 8 percent (Table 29), although a tightening of the fiscal position helped to mitigate demand pressures. The overall rate of inflation remained at 9 percent, underpinned by food price inflation, which averaged 14 percent in 1995, owing to shortfalls in rice supply and high import prices.

Table 29Indonesia: Selected Economic Indicators1

(Data as of Board discussion in July 1996)2

1995/96
1992/931993/941994/95Projections

at time

of Board

discussion
Outturn3
In percent
Domestic economy
Change in real GDP7.27.37.58.18.2
Change in consumer prices
(end of period)5.010.29.69.09.0
In billions of U.S. dollars2
External economy
Exports, f.o.b.35.336.542.147.847.8
Imports, c.i.f.30.332.337.946.146.1
Current account balance–2.6–3.0–3.3–6.9–6.8
Direct investment1.72.02.65.45.4
Portfolio investment1.22.00.81.71.8
Capital account balance6.64.57.214.712.3
Gross official reserves12.012.713.316.016.0
Current account balance
(in percent of GDP)–1.8–1.9–1.8–3.4–3.3
External debt
(in percent of GDP)58.955.956.854.852.9
Debt service (in percent of exports of goods and services)32.233.433.734.833.2
Change in real effective exchange rate (in percent)–2.41.6–2.5–0.6–0.6
In percent of GDP2
Financial variables
General government balance–1.3–0.50.21.01.0
Gross national saving30.231.432.434.8
Gross national investment32.433.234.337.8
Change in broad money
(in percent)22.220.822.128.028.0
Three-month time deposit rate
(in percent)15.711.515.917.317.3

Data are for fiscal years ending March.

Unless otherwise noted.

Updated Fund staff estimates.

Data are for fiscal years ending March.

Unless otherwise noted.

Updated Fund staff estimates.

A rapid expansion of credit to the private sector in 1995/96 contributed to the substantial rise in domestic demand, and also to pressures on prices and the external current account. The rupiah/U.S. dollar exchange rate continued to depreciate steadily, reflecting the inflation differential with partner countries, while at the same time Bank Indonesia increased the short-run flexibility of the exchange rate by widening the intervention band.

The external current account deficit widened from 1.8 percent of GDP in 1994/95 to 3.4 percent of GDP in 1995/96, owing to a sharp deterioration in the trade balance as imports increased rapidly. Strong capital inflows financed the current account deficit and financed an increase in reserves. Although debt levels remained high relative to levels in some other Asian countries, the external debt burden declined relative to GDP and exports.

In May 1995, the government introduced a substantial package of across-the-board tariff reforms, scheduled to be implemented in stages to 2003. The package lowered tariffs on 6,000 items and resulted in a significant and immediate reduction in the average tariff rate from 19½ percent to 15 percent. Further reductions in tariffs were also scheduled over the period to 2003, in line with the Association of South-East Asian Nations (ASEAN) Free Trade Area’s accelerated Common Effective Preferential Tariff scheme, which would reduce the average tariff to 7 percent.

Directors commended the authorities for Indonesia’s economic achievements of recent years, especially the sizable reduction in poverty and the improvement in many social indicators, as well as the reduced reliance on the oil and gas sectors and the liberalization of important sectors of the economy. They noted that continued excess demand pressures and large capital inflows had raised important policy challenges. The authorities’ flexibility in adapting the policy mix to meet changing circumstances had been an important aspect of their success over the years and would remain essential in addressing those challenges.

Most Directors viewed a stronger fiscal effort as key to restraining demand. While recognizing that the balanced budget rule had served the country well, they generally agreed with further tightening of fiscal policy, with surpluses being used to prepay external debt. Directors emphasized the strengthening of non-oil revenues through tighter tax administration, as well as through revenue measures and broadening the base of existing taxes. At the same time, many Directors supported increased government spending in the medium term on education, health services, and infrastructure.

The Board strongly endorsed the authorities’ aim to reduce broad money growth in 1996. Directors agreed with the authorities’ emphasis on maintaining an open capital account and welcomed the steps already taken to widen the exchange rate band and give greater flexibility to exchange rate policy. That process should be continued as an important component of policies to discourage short-term capital inflows and enhance the effectiveness of monetary policy. Of particular importance in reducing inflation inertia would be the setting of administered wage increases on the basis of forward-looking inflation targets. Moreover, with the impact of the policy mix helping to reduce inflation and with faster structural reform to maintain competitiveness, it should be feasible to move to a more market-determined exchange rate with greater emphasis on achieving the inflation objective.

In the Board’s view, further substantial reforms, including financial sector reforms and the development of a strong capital market, were essential for maintaining rapid, sustained growth. Directors urged the authorities to address weaknesses in the banking sector, and in particular to act decisively to resolve the problem of insolvent banks and recover nonperforming loans. They considered these actions as critical to reduce the vulnerability of the economy to shocks and to lessen moral hazard. Further deregulation and opening of the economy to world markets were the key to maintaining competitiveness, and they welcomed the recent reduction in tariffs. Directors supported accelerated liberalization of internal and external trade of the main commodities in order to enhance equity as well as encourage non-oil exports. More generally, they strongly urged greater transparency in policy implementation, especially a regulatory framework and tax system that provided a level playing field.

Islamic Republic of Iran

The Board concluded the Article IV consultation with the Islamic Republic of Iran in August 1996, Having addressed the 1992/93 foreign exchange difficulties in the First Five-Year Development Plan (ended 1994/95), the authorities had shifted the emphasis of the Second Five-Year Development Plan (1995/96–1999/2000) to boosting growth and lowering inflation in the context of increasing openness and liberalizing the economy. Under this plan, the real GDP growth rate rose from 1.6 percent in 1994/95 to 3.1 percent in 1995/96 (Table 30), Year-on-year inflation soared to 49 percent from 35 percent during that period, but the 12-month rate fell from a peak of 59 percent in May 1995 to 26 percent by May 1996, Despite doubling at the start of the year, domestic energy prices remained far below international prices in 1995/96.

Table 30Islamic Republic of Iran: Selected Economic Indicators1(Data as of Board discussion in August 1996)
1992/931993/941994/951995/96
In percent
Domestic economy
Change in real GDP5.94.91.63.1
Change in consumer prices
(period average)24.422.935.249.4
In billions of U.S. dollars2
External economy
Exports, f.o.b.19.918.119.418.3
Imports, f.o.b.23.319.312.612.8
Current account balance–7.3–4.55.13.5
Capital account balance3.7–4.5–2.9–2.9
Gross official reserves2.92.93.96.7
Current account balance
(in percent of GDP)–5.6–5.67.73.9
External debt (in percent of GDP)12.228.734.524.4
Debt service (in percent of exports of goods and services)13.927.1
In percent of GDP2
Financial variables
General government balance–1.2–7.2–4.5–3.8
Gross national saving29.823.632.033.2
Gross national investment35.429.224.229.3
Change in broad money
(in percent of stock)24.734.829.437.0
Short-term deposit rate (in percent)7.58.08.08.0

Data are for fiscal years ending on March 20.

Unless otherwise noted.

Data are for fiscal years ending on March 20.

Unless otherwise noted.

The fiscal deficit narrowed further to 3.8 percent of GDP in 1995/96, following a decline in 1994/95 to 4.5 percent from the peak of 7.2 percent in 1993/94. Although the ratio of total budgetary revenue to GDP fell from the previous year, the authorities contained budgetary expenditure within the scope of revenue collection. As in the two preceding years, the deficit resulted mainly from extra budgetary foreign exchange losses.

Broad money grew by 37 percent in 1995/96, compared with 29 percent in the previous year. Both net domestic asset expansion (caused partly by bank support for the servicing of external debts incurred before March 1994 by public enterprises and the private sector) and net foreign asset expansion fueled the growth. Deposit rates, already negative in real terms over the past several years, became more strongly misaligned as inflation rose. The subsequent deceleration of inflation reduced this misalignment, but the disintermediation associated with negative real rates of return contributed to the growth, albeit incipient, of alternative channels for financial intermediation, including the Teheran stock exchange.

In the external sector, the authorities continued to strengthen their reserve position in 1994/95–1995/96, reducing the stock of external arrears to $315 million in March 1996 from over $11 billion in March 1994, This improvement was driven by a sharp turnaround in the external current account, which, in turn, was caused by the almost 50 percent drop in imports achieved over that time through intensified import controls and exchange restrictions instituted in May 1995, Total exports, meanwhile, fell by 5.6 percent in 1995/96, as non-oil exports, affected by the imposition of exchange controls and a misalignment of the export exchange rate, declined by 33 percent. The overall capital account deficit was roughly unchanged from 1994/95, and the overall balance of payments shifted to a surplus, the first in several years. The exchange controls gave rise to a parallel market, in which the exchange rate depreciated gradually from May 1995 to June 1996.

In their discussion, Directors commended the authorities for the considerable progress made over the past two years in regularizing the external debt situation, lessening the vulnerability of the foreign exchange reserve position, and reducing inflation despite an unfavorable external environment. Those positive developments put the authorities in a position to design and implement in a timely fashion a comprehensive reform effort, which should give priority to unifying the exchange rate at a realistic level, abolishing exchange restrictions, and liberalizing imports while substantially strengthening public finances and pursuing a prudent monetary policy.

Directors encouraged the authorities to strengthen further the fiscal stance by cutting the deficit, including by reducing the extra-budgetary foreign exchange losses, and by significantly lessening the dependence on oil revenue. They noted in that connection that the fiscal position would benefit by broadening the domestic tax base through the introduction of a value-added tax and improvement in tax administration, by reducing the gap between domestic and international energy prices, and by containing public expenditure. Directors underscored the need for prudent credit and monetary policies based on greater use of market-based instruments of control, including positive real interest rates, to lower inflation. They encouraged the authorities to promote sound money and securities markets by liberalizing credit allocation and control and by strengthening the regulatory and prudential policy framework.

Directors noted that the existing exchange rate system was severely hampering investment and growth of the non-oil sector. They encouraged the authorities to develop a firm timetable leading to the early unification of exchange rates under the Second Five-Year Development Plan and called for the liberalization of the remaining exchange restrictions and trade controls. They also emphasized the importance of addressing long-standing distortions in the economy arising from the heavy implicit subsidy on domestic energy consumption.

Jordan

The Board concluded the Article IV consultation with Jordan in February 1997 and completed the second review under the Extended Arrangement approved on February 9, 1996. Since the balance of payments crisis of the late 1980s and the regional disturbances associated with the Middle East crisis in 1990–91, Jordan had made impressive progress toward achieving macroeconomic stability and growth. In 1996, despite a difficult external environment, the overall economic performance remained favorable. Real GDP growth was estimated at 5.2 percent, and the 12-month inflation rate declined to 2.5 percent (Table 31). The external current account deficit (including grants) was estimated to have narrowed to 3 percent in 1996 from 3.9 percent in 1995, as the larger-than-envisaged trade deficit arising from a sharp increase in imports of foodstuffs (related to higher world prices) and transport equipment was offset by a pickup in workers’ remittances. The capital account, however, was adversely affected by regional developments, and the overall balance of payments deficit widened.

Table 31Jordan: Selected Economic Indicators(Data as of Board discussion in February 1997)
19931994199519961
In percent
Domestic economy
Change in real GDP5.68.16.95.2
Change in consumer prices (end of period)1.94.94.22.5
In billions of U.S. dollars2
External economy
Exports, f.o.b.1.21.41.81.9
Imports, c.i.f.3.53.43.74.3
Current account balance–0.6–0.4–0.3–0.2
Capital account balance–0.1–0.00.20.2
Gross official reserves0.60.40.40.7
Current account balance (in percent of GDP)–11.7–6.6–3.9–3.0
External debt (in percent of GDP)121112103100
Debt service (in percent of exports of goods and services)35.930.626.324.9
Change in real effective exchange rate
(in percent)2.7–3.8–6.8
In percent of GDP2
Financial variables
General government balance (excluding grants)–5.9–6.1–5.3–4.6
Gross national saving (including grants)25.727.929.432.0
Gross national investment34.333.131.833.4
Change in broad money (in percent)6.98.06.62.0
Six-month CDs of the Central
Bank of Jordan (in percent)4.17.99.09.5

Fund staff estimates.

Unless otherwise noted.

Fund staff estimates.

Unless otherwise noted.

The favorable 1996 macroeconomic performance was underpinned by the authorities’ continued steadfast and responsive policy implementation. Important steps were taken toward fiscal consolidation, mainly through containment of expenditures. Food and animal feed subsidies were reformed, and capital expenditures and spending on nonwage goods and services were reduced. Consequently, the fiscal deficit (excluding grants) as a percentage of GDP was estimated to have dropped to 4.6 percent in 1996 from 5.3 percent in the previous year.

Despite regional uncertainties and the deteriorating economic conditions in the West Bank and Gaza Strip, significant progress was made in building up official foreign exchange reserves in 1996 in the context of the exchange rate policy of maintaining a tight link between the Jordan dinar and the U.S. dollar. This involved sizable open market operations and an increase in interest rate spreads. The result has been a tight monetary policy, with low growth in money supply and net domestic assets of the banking system.

Structural reforms were implemented in public finance and the social safety net, the financial sector, trade, and the regulatory framework with a view to opening up further the Jordanian economy, to encourage competition, and to facilitate domestic and foreign private investment. Although progress in privatization was slow, institutions for implementing it were established.

The Board welcomed the authorities’ steadfast implementation of adjustment and reform policies, which, despite the difficult external environment, had led to an impressive economic performance. Directors emphasized that continued strong macroeconomic policies and an intensification of structural reforms would consolidate the economic gains and further reduce Jordan’s vulnerability to external developments.

Directors generally welcomed the policy package for 1997. Looking forward, a number of Directors stressed the importance of further budgetary revenue reform over the medium term in order to strike a better balance in the composition of fiscal adjustment. Directors considered that a greater effort by the government to address poverty issues, especially through the World Bank-supported social productivity program, was also essential for sustained adjustment and reform.

Directors noted that Jordan had maintained an appropriately tight monetary policy, accompanied by financial sector reforms, and that the exchange rate policy had contributed to financial stability. Monetary policy should continue to be geared toward building up official foreign exchange reserves. Directors indicated that, given the fluid regional conditions, the authorities should continue monitoring monetary developments carefully and adjust their policies in the event of an unanticipated decline in money demand. In that regard, they stressed the importance of a flexible interest rate policy and of monitoring external competitiveness.

Directors observed that the authorities’ far-reaching structural reforms in the regulatory framework, the financial sector, and the subsidy system were transforming the Jordanian economy. They emphasized that the pace of privatization should be accelerated to encourage private sector activity and attract much-needed foreign direct investment. Directors also called for progress in the reform of the public pension system and the civil service.

Kuwait

The Board concluded the Article IV consultation with Kuwait in August 1996. Economic performance had been generally good over the previous three years: overall nominal GDP growth had averaged 11 percent, and the program of reconstruction and rehabilitation following the Iraqi occupation had been successfully completed. In 1995, enhanced private sector confidence and high oil prices toward the end of the year contributed to strong overall nominal GDP growth of 8 percent (Table 32), Inflation remained low.

Table 32Kuwait: Selected Economic Indicators1(Data as of Board discussion in August 1996)
19931994199519962
In percent
Domestic economy
Change in nominal GDP23.61.68.01.9
Change in consumer prices (period average)0.42.31.0
In billions of U.S. dollars3
External economy
Exports, f.o.b.10.211.112.612.9
Imports, f.o.b.7.06.77.79.1
Current account balance1.92.43.73.0
Direct and portfolio investment–0.7–1.0–0.3–0.4
Capital account balance–0.9–1.5–4.5–3.8
Gross official reserves43.63.73.63.6
Current account balance (in percent of GDP)8.19.613.911.1
External debt (in percent of GDP)524.525.515.03.3
Change in real effective exchange rate (in percent)–2.1–3.6–0.2
In percent of GDP3
Financial variables
General government balance–22.4–17.7–11.7–6.9
Gross national saving (in percent of GNP)31.035.329.0
Change in broad money (in percent)5.65.49.44.5
Three-month interbank rate (in percent)7.436.277.076.84

Fiscal data are for year ending June; all other data are for calendar years.

Fund staff estimates.

Unless otherwise noted.

Central Bank of Kuwait reserves only.

Government external debt only.

Fiscal data are for year ending June; all other data are for calendar years.

Fund staff estimates.

Unless otherwise noted.

Central Bank of Kuwait reserves only.

Government external debt only.

Owing to higher oil revenues and the containment of expenditures, the fiscal position improved in 1994/95, as the deficit as a percentage of GDP dropped to 11.7 percent from 17.7 percent in the previous year. However, the budget structure remained weak, Kuwait’s dependency on oil receipts had increased in recent years because of the lower contribution of investment income to revenues, in connection with the drawdown of foreign assets. In addition, post-liberation current spending on wages, salaries, subsidies, domestic transfers, and defense had drifted upward.

Private sector confidence in the financial sector, shaken by the disruptions caused by the Iraqi invasion, revived with the encouraging repayments made under the Debt Collection Program (which covered nonperforming loans associated with the collapse of the informal stock market in 1982 and the 1990 invasion).

The overall improvement in the fiscal accounts carried over to the balance of payments in 1995, as the current account surplus rose to the equivalent of 13.9 percent of GDP from 9.6 percent in 1994. The overall balance also benefited from the reversal of the capital outflows associated with the 1994 military alert. Government external debt as a share of GDP fell from 25.5 percent at the end of 1994 to 12 percent at the end of March 1996, as the postliberation syndicated bank loan was amortized on schedule.

The Board commended the authorities for successfully implementing the reconstruction and rehabilitation program and for maintaining economic growth with low inflation. Those developments placed Kuwait in a good position to address forcefully its remaining economic and financial challenges, which included restoring a strong fiscal position, further enhancing the integrity of the financial system, reforming the labor market, and generating employment opportunities. Directors welcomed the incorporation of those policy priorities in the Five-Year Development Plan, which was supported by the Privatization Bill before parliament.

Directors noted that a reassessment of the role of the government and the elimination of the fiscal deficit held the key to restoring Kuwait’s tradition of accumulating assets for future generations. A front-loaded effort, starting with a large deficit reduction in 1996/97, would be needed to eliminate the deficit by 1999/2000 as envisaged. To that end, Directors recommended cutting subsidies and transfers, increasing customs duty rates, and containing the wage bill by slowing down new public sector employment. The authorities would also need to move aggressively to further rationalize expenditures and strengthen the domestic tax base and tax administration.

Directors noted the return of private sector confidence in the financial system, as indicated by the repatriation of capital, growth in domestic and foreign currency deposits, the narrowing of the Kuwaiti dinar–U.S. dollar interest differential, and the surge in stock market volume and prices. They called for strict implementation of the Debt Collection Program, together with a strengthening of the regulatory and supervisory regime, to further bolster confidence.

Directors emphasized that structural reform measures could minimize the impact on the non-oil sector of government expenditure reduction. They therefore welcomed the intensification of the privatization and deregulation program. Directors also stressed that the flexibility and functioning of the labor market should be improved by reducing market distortions, including by eliminating the salary and benefits differential favoring government over private sector employment, in order to promote private sector activity.

Directors commended the authorities for maintaining an open trade and payments system, capital account convertibility, and a generous foreign assistance program. They also encouraged the authorities to place greater priority on improving the statistical system and the flow of information between government agencies.

Malaysia

The Board concluded the Article IV consultation with Malaysia in August 1996. The economy had continued to perform strongly in 1995, with real GDP growing by 9½ percent for the year as a whole, driven by buoyant investment and exports, as well as by a pickup in private consumption (Table 33). The risks of overheating had increased as demand pressures continued to mount during the second half of 1995. Real domestic demand growth reached 14½ percent for the year as a whole, capacity utilization rose, the output gap widened, and the labor market tightened further. As consumer price inflation declined slightly to 3½ percent—owing to lower import prices in ringgit terms, the tightening of monetary conditions, policies to address supply constraints and improve the distribution network, and administrative measures—demand pressures were vented largely through the current account deficit, which rose by 2½ percent of GDP, to 8¼ percent of GDP in 1995.

Table 33Malaysia: Selected Economic Indicators

(Data as of Board discussion in August 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real GDP8.39.29.58.88.2
Unemployment rate3.02.92.82.82.6
Change in consumer prices
(end of period)23.53.73.44.03.5
In billions of U.S. dollars1
External economy
Exports, f.o.b.246.056.671.381.076.6
Imports, f.o.b.242.854.971.081.073.1
Current account balance2–2.9–4.2–7.0–7.8–5.2
Private long-term capital, net23.23.62.52.74.5
Capital account balance210.81.56.411.29.2
Gross official reserves
(end of year)28.326.725.128.427.7
Current account balance
(in percent of GDP)–4.6–5.9–8.3–8.2–5.2
External debt (in percent
of GDP)42.837.537.541.538.1
Debt service (in percent of
exports of goods and services)7.35.87.17.45.7
Change in real effective exchange
rate (annual average; in percent)–0.4–3.20.44.2
In percent of GDP1
Financial variables
Consolidated public sector
balance2–4.71.30.6–1.01.2
Gross national saving230.532.732.432.036.0
Gross national investment235.138.740.740.141.2
Change in total liquidity
(M3; end of year; in percent)23.815.818.222.023.7
Three-month interbank rate
(annual average; in percent)7.25.16.17.237.2

Unless otherwise noted.

Official data provided subsequent to the Board discussion. Official data for 1993–95 were as follows; change in consumer prices—3.6 (1993); exports—71.6 (1995); imports—71.5 (1995); current account balance--3.1 (1993), -4.6 (1994), -7.5 (1995); private long-term capital, net—5.0 (1993), 4.3 (1994), 4.1 (1995); capital account balance—1.3 (1994), 7.4 (1995); consolidated public sector balance---2.2 (1993), 3.5 (1994), 2.9 (1995); gross national saving—33.0 (1993), 34.0 (1994), 34.7 (1995); gross national investment—37.8 (1993), 40.4 (1994), 43.2 (1995).

First quarter.

Unless otherwise noted.

Official data provided subsequent to the Board discussion. Official data for 1993–95 were as follows; change in consumer prices—3.6 (1993); exports—71.6 (1995); imports—71.5 (1995); current account balance--3.1 (1993), -4.6 (1994), -7.5 (1995); private long-term capital, net—5.0 (1993), 4.3 (1994), 4.1 (1995); capital account balance—1.3 (1994), 7.4 (1995); consolidated public sector balance---2.2 (1993), 3.5 (1994), 2.9 (1995); gross national saving—33.0 (1993), 34.0 (1994), 34.7 (1995); gross national investment—37.8 (1993), 40.4 (1994), 43.2 (1995).

First quarter.

Monetary policy was tightened between October 1995 and May 1996, through increases in reserve requirements and interbank rates and through restrictions on automobile and property loans. The general government surplus declined by 2¾ percent of GDP, to 1 percent of GDP for 1995 as a whole. Long-term capital inflows increased, but reserves declined by $1,5 billion, to $25 billion. The exchange rate, in both nominal and real effective terms, remained broadly constant during 1995, although it appreciated by about 3½ percent during the first five months of 1996.

During the Sixth Plan (1991–95), most macroeconomic objectives were met or exceeded, the exceptions being the targeted increase in the private saving rate and—associated with this—a reduction in the current account deficit. Because the current account deficit was largely financed by foreign direct investiment, and owing to continued rapid growth of GDP and exports, debt and debt-service indicators declined slightly throughout the period and remained low by international standards. The incidence of poverty was reduced from 17 percent in 1990 to 9½ percent in 1995. In the area of structural reforms, basic education was being gradually extended from 9 to 11 years, and other structural measures—including labor market, tax, trade, and financial sector reforms—were implemented.

In their discussion, Directors commended the authorities for Malaysia’s continued impressive economic performance, which had been marked by robust, outward-oriented growth, low inflation, and remarkable social progress in reducing poverty and improving income distribution. Sustained prudent macroeconomic management and wide-ranging structural reforms underpinned these achievements. The authorities were faced with the challenge of managing rapid growth to preserve the macroeconomic stability essential for sustainable growth.

Directors viewed pressures in factor markets and the widening current account deficit as signs of continued strong demand pressures. Although the national saving rate was high by international standards and the cut-rent account deficit largely stemmed from increased investment. Directors considered that the size of the deficit and the increased reliance on debt-creating flows gave rise to risks. The Board, therefore, urged the authorities to take early action to attenuate overheating and to place the deficit on a clear downward path. Given the constraints of monetary policy with large capital inflows, fiscal policy would have to play a key role in the needed policy mix. Directors urged the authorities to limit the deterioration of the overall public sector balance projected in 1996 and to restore fiscal surplus in 1997. They welcomed the authorities’ intention to consider proposals for expenditure-reducing and revenue-enhancing measures, including rescheduling lower-priority public investment projects, further cuts in investment incentives, and an early introduction of a value-added tax.

In view of the continued rapid money and credit growth, several Directors favored further tightening of monetary policy, and Directors noted that the authorities’ readiness to allow greater exchange rate flexibility should help to increase the effectiveness of monetary policy. But the difficulty of significantly reducing the current account deficit through higher private saving, particularly in the short run, underscored the need for greater reliance on fiscal policy to increase public saving.

Directors observed that Malaysia’s high level of investment and rapid total factor productivity growth augured well for sustainable growth in the future, provided that the momentum of liberalization and structural reform was sustained. The Board supported measures to strengthen the services sector, including through tax reforms. Directors also urged labor market reforms, including a more flexible, productivity-based wage system, and strengthening of education and training, A continuation of financial reform was also important, such as deregulation to promote development of the bond market and greater reliance on indirect monetary instruments, Continued strong emphasis on prudential supervision of commercial banks and other financial institutions would facilitate further financial liberalization. Directors also urged further trade and tariff reform and the elimination of controlled and administered prices.

Mexico

The Board concluded the Article IV consultation with Mexico in August 1996, Although the lingering effects of the 1994 financial crisis had led output to contract by around 6.2 percent in 1995, real GDP expanded by 2.8 percent during the first quarter of 1996 relative to the last quarter of 1995, Reflecting the recovery, the open unemployment rate fell from 7.4 percent in the third quarter of 1995 to 5.4 percent in May 1996. Meanwhile, the 12-month rate of inflation declined from 52 percent in December 1995 to 32 percent by June 1996.

Fiscal performance during 1995 was better than programmed, largely owing to lower wage payments and revenue sharing to the states, and a shortfall in planned investment expenditures. The fiscal outturn in the first quarter of 1996 was considerably stronger than expected, largely because of the impact of higher-than-expected international oil prices and lower-than-programmed expenditures. The restrictions faced by monetary policy in early 1995, when delays in the disbursement of external loans led to an increase in net domestic assets and a decline in net international reserves, were alleviated by mid-March as external financing became available. In October and November, a second round of financial market turbulence led the authorities to tighten the monetary stance. By the first quarter of 1996, larger-than-programmed external borrowing by the government boosted international reserves and was responsible for a sizable decline in net domestic assets.

Mexico’s main financial indicators improved steadily during the first half of 1996. The stock market index rose by about 15 percent. The interest rate on 28-day treasury bills fell from around 50 percent to 28 percent, and the peso appreciated slightly. Mexico registered a trade surplus in the first five months of 1996: merchandise exports increased 22 percent, and merchandise imports rose by 20 percent.

Directors noted with satisfaction the recovery in economic activity and employment, the sharp decline in inflation in 1996, and the strengthening of the balance of payments. They observed that the firm implementation of monetary policy aimed at lowering inflation had contributed to the decline in interest rates in the context of relative exchange rate stability. That in turn had reinforced investor confidence, leading to increased private capital flows.

Notwithstanding the improved economic performance, Directors stressed that areas of concern remained. In particular, the banking system remained fragile, and banks’ nonperforming portfolios had continued to increase, albeit at a slower rate, creating the need for various support programs. They were concerned at the high fiscal costs associated with those programs and the potential moral hazard they created; they welcomed the government’s intention not to provide further direct relief through new programs to bank debtors.

The Board stressed that the authorities should continue to resist pressures to relax policies and should be ready to take compensatory action as needed to achieve the main objectives of the program, A sustained tight monetary policy would be required to reduce inflation, which remained higher than expected.

Directors noted that Mexico faced several key challenges over the next few years. Foremost was the urgent need to improve its economic growth performance to raise the living standards of the population. Further tax and expenditure reform would be required to maintain fiscal discipline over the medium term. Restoring and preserving macroeconomic stability was critical in strengthening investor confidence and facilitating Mexico’s access to long-term foreign financial assistance, particularly in light of the anticipated “hump” of external debt-service payments in 1998–2000. That needed to be accompanied by an increase in domestic saving to keep the external current account deficit at sustainable levels. Directors welcomed the authorities’ intention to formulate a comprehensive medium-term program to consolidate ongoing stabilization and structural reform efforts and viewed positively the government’s intention to seek Fund support for that program, which they considered should focus on structural measures.

Since the Board discussion, the economic recovery has become more entrenched. Real GDP grew by 5.1 percent in 1996, compared with an earlier projection (made prior to the Board discussion) of 3.6 percent (Table 34). The 12-month rate of inflation declined to 27.7 percent by year-end, compared with 52 percent in December 1995. By the end of 1996, the unemployment rate had fallen to levels close to those observed before the crisis. The external current account deficit in 1996 was estimated at about half (0.5 percent of GDP) the earlier projection (1.2 percent of GDP), contributing to an increase in net international reserves of $5.8 billion, more than quadruple the program target of $1.4 billion. Mainly reflecting stronger-than-expected oil prices, the overall public sector balance registered a small surplus of 0.2 percent of GDP, compared with a program target of balance. Reflecting the continued strengthening of confidence, capital inflows had remained strong, contributing to a real effective exchange rate appreciation of 9.9 percent in 1996, after a real depreciation of 95.9 percent in 1995. The capital inflows also permitted a restructuring of external debt to longer maturities at more favorable interest rates. In January 1997, the Mexican authorities liquidated ail outstanding obligations under the U.S. Exchange Stabilization Fund ($3.5 billion) and, in the first quarter of 1997, made advance repurchases to the Fund totaling $2.3 billion.

Table 34Mexico: Selected Economic Indicators

(Data as of Board discussion in August 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
GDP (annual change)2.04.4–6.23.65.1
Unemployment rate (average)3.43.76.35.55.5
Inflation rate (end of period)8.07.152.025.027.7
In billions of U.S. dollars1
External economy
Exports351.960.979.596.0
Imports3–65.4–79.3–72.5–89.5
Current account balance–23.4–29.7–1.6–3.4–1.9
Direct investment4.411.09.56.37.6
Portfolio investment428.98.2–9.714.2
Capital account balance532.514.615.43.3
Gross official reserves25.36.517.116.619.5
Current account balance
(in percent of GDP)–5.8–7.0–0.5–1.2–0.6
External debt (in percent of GDP)32.733.859.356.649.3
Debt service (in percent of exports
of goods and nonfactor services
and transfers)26.227.724.728.0
Change in real effective exchange
rate66.414.095.9–9.9
In percent of GDP1
Financial variables
General government balance70.7–0.10.0–0.1
Gross national saving15.214.719.217.820.3
Gross domestic investment21.021.719.719.020.9
(Change in broad money (M4;
in percent)26.524.120.730.1
Nominal interest rate (in percent)815.014.148.429.031.4

Unless otherwise noted.

Updated Fund staff estimates.

Includes in-bond industry.

Comprises equity investments, private and public bond placements in international markets, and purchases by foreigners of government securities.

Includes liabilities to the Fund, as well as all the financial support provided to Mexico in 1995 by other creditors.

End of period real exchange rate based on relative unit labor costs in the manufacturing industry; a positive sign indicates a depreciation of the peso.

Data for the general government do not exist. Figures shown are overall nonfinancial public sector (central government plus enterprises).

On one-month treasury bills (average of primary auction).

Unless otherwise noted.

Updated Fund staff estimates.

Includes in-bond industry.

Comprises equity investments, private and public bond placements in international markets, and purchases by foreigners of government securities.

Includes liabilities to the Fund, as well as all the financial support provided to Mexico in 1995 by other creditors.

End of period real exchange rate based on relative unit labor costs in the manufacturing industry; a positive sign indicates a depreciation of the peso.

Data for the general government do not exist. Figures shown are overall nonfinancial public sector (central government plus enterprises).

On one-month treasury bills (average of primary auction).

South Africa

The Board concluded the Article IV consultation with South Africa in May 1996. In 1995, for the third successive year, South Africa had made steady progress, successfully weathering the economic squalls that accompanied its political transition. Among its successes were a reduction in the 12-month rate of consumer price inflation (to 5.5 percent in April 1996 from 11 percent in April 1995), a 1½ percentage point of GDP increase in real net investment, and a 3.3 percent rise in real GDP (Table 35). Throughout this three-year period, the authorities maintained tight monetary and fiscal policies.

Table 35South Africa: Selected Economic Indicators

(Data as of Board discussion in May 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real GDP1.32.73.34.03.1
Unemployment rate32.0
Change in consumer prices
(period average)9.79.08.67.57.4
In billions of U.S. dollars1
External economy
Exports24.124.727.931.129.1
Imports, f.o.b.–18.3–21.5–27.1–29.5–27.1
Current account balance1.7–0.6–3.5–3.4–2.0
Direct investment–0.30.50.40.50.6
Portfolio investment1.00.32.01.50.5
Capital account balance–4.51.56.03.03.4
Gross official reserves2.73.14.32.22.2
Current account balance
(in percent of GDP)1.5–0.5–2.6–2.5–2.0
External debt (in percent of GDP)14.815.315.517.019.0
Debt service (in percent of
exports of goods and services)10.310.813.817.416.6
Change in real effective exchange
rate (in percent)–4.4–3.1–8.1
In percent of GDP1
Financial variables
General government balance3–6.0–5.7–5.5–5.1–5.1
Gross national saving17.217.216.717.316.5
Gross national investment15.717.719.319.818.0
Change in broad money
(in percent)7.015.715.112.013.6
Interest rate (in percent)412.013.015.017.0

Unless otherwise noted.

Updated Fund staff estimates.

Central government; fiscal-year basis (April–March).

Bank rate; end of period.

Unless otherwise noted.

Updated Fund staff estimates.

Central government; fiscal-year basis (April–March).

Bank rate; end of period.

Despite the abolition of exchange controls on nonresidents in March 1995, and the increase in the external current account deficit in 1995 to 2.6 percent of GDP (from 0.5 percent of GDP in 1994), the rand remained strong through 1995, reflecting a substantial improvement in foreign investor sentiment toward South Africa. This newfound confidence underlay a strengthening of longer-term capital inflows in the second half of 1995 and into 1996—these soared to S6 billion in 1995 compared with $ 1.5 billion in 1994. However, in mid-February 1996 and again in late March, the rand weakened amid political uncertainties and speculation that exchange controls on residents would be abolished wholesale. In response, the authorities reiterated their intention of liberalizing exchange controls on residents gradually and of persisting with the “market-friendly” policies that had been pursued since the 1994 election.

In late 1994, open unemployment stood at 32 percent of the total labor force and at more than 40 percent of the black labor force. Since then, private nonagricultural employment has grown by less than I percent, while the labor force has grown by more than 2½ percent. In part at least, the unemployment situation reflected the persistence of competitiveness problems.

In their discussion, Directors commended the authorities for pursuing prudent policies, which included reducing the fiscal deficit in 1995/96, tightening monetary policy in response to the emergence of inflationary pressures in late 1994, liberalizing trade and capital controls, and enacting new legislation on labor relations. They noted that these actions had been crucial in improving market confidence, but Directors underscored that a further tightening of monetary policy was key to restoring financial stability and to containing inflation. At the same time. Directors recognized that the authorities faced competing demands to respond to the population’s urgent social needs. In this regard, they welcomed the priority that the authorities attached to boosting growth and employment.

Directors took the view that the recent depreciation of the rand was appropriate, but that further policy action was needed to contain the inflationary impulse that had already resulted from the depreciation and to restore confidence in the foreign exchange markets. They cautioned that progress In these areas was necessary to prevent increased inflation from eroding the contribution of the depreciation to competitiveness. Although Directors welcomed the abolition of foreign exchange controls on nonresidents in March 1995, they noted that this action had exposed the economy more directly to shifts in investor sentiment and that financial policies therefore needed to respond accordingly. In that light, Directors endorsed the increase in the bank rate at the end of April 1996 and the authorities’ commitment to step-by-step liberalization of the exchange controls on residents.

Directors emphasized that investor confidence would be bolstered by the announcement of a medium-term structural reform package that would address high unemployment and low growth. Such a program should aim to increase the demand for unskilled labor and improve the overall competitiveness of South African industry. The important role of further trade liberalization in improving economic efficiency and growth was stressed in this context. Monetary policy should focus on maintaining control of inflation, exchange rate policy should support trade liberalization, and fiscal policy should be designed to strengthen domestic saving.

Subsequent to the Board discussion, in June 1996, the Minister of Finance presented the authorities’ growth, employment, and redistribution strategy, designed to raise medium-term economic growth and employment. It included commitments to more rapid fiscal consolidation and to exchange control reform, which were fully reflected in the budget for 1997/98, as well as further structural reform measures. In early 1997, the rand appreciated, reflecting renewed confidence in the policy framework and a strengthening in the external current balance.

Tanzania

The Board concluded the Article IV consultation with Tanzania in November 1996. Compared with an average of about 3.7 percent in the three preceding years, real GDP growth, led by agriculture, increased to an estimated 4.5 percent in 1995/96 (Table 36).

Table 36Tanzania; Selected Economic Indicators1(Data as of Board discussion in November 1996)
1993/9421994/9521995/962
In percent
Domestic economy
Change in real GDP3.53.84.5
Change in consumer prices (period average)30.234.025.7
In millions of U.S. dollars3
External economy
Exports, f.o.b.485.9592.9659.1
Imports, c.i.f.–1,590.5–1,509.7–1,538.9
Current account balance4–1,075.8–861.7–835.9
Direct investment563.067.3105.6
Capital account balance256.6113.9118.8
Change in gross official reserves (increase –)–11.751.215.0
Current account balance (in percent of GDP)5–30.5–20.6–16.2
External debt (in percent of GDP)194.7171.8143.7
Debt service (in percent of exports of goods and services)659.941.638.4
Change in real effective exchange rate (in percent; end of period)–3.5–3.822.2
In percent of GDP3
Financial variables
Central government balance4–7.9–6.9–4.9
Gross national saving6.89.911.7
Gross national investment729.426.627.7
Change in broad money (in percent)35.037.715.0
Interest rate (in percent)838.251.522.0

Data are for fiscal years (July–June).

Data provided by the Tanzanian authorities, and Fund staff estimates.

Unless otherwise noted.

Excluding grants.

$32 million of privatization proceeds is included in 1995/96.

Excluding Fund; before rescheduling.

Based on national accounts data, which are not fully consistent with the balance of payments data.

Discount rate of the Bank of Tanzania, end of period.

Data are for fiscal years (July–June).

Data provided by the Tanzanian authorities, and Fund staff estimates.

Unless otherwise noted.

Excluding grants.

$32 million of privatization proceeds is included in 1995/96.

Excluding Fund; before rescheduling.

Based on national accounts data, which are not fully consistent with the balance of payments data.

Discount rate of the Bank of Tanzania, end of period.

Although manufacturing activity continued to decline, owing especially to inefficiencies in the parastatal sector, newly privatized enterprises expanded robustly. Slower monetary expansion and improved agricultural production led to a fall in the inflation rate on a year-end basis to 22.7 percent in June 1996 and to 18 percent in August 1996 from a peak of 38 percent for the year ended February 1995.

The new government, elected in November 1995, faced major deficiencies in budgetary and financial institution management. In the fiscal area, these deficiencies were reflected in weak tax administration, exacerbated by widespread tax exemptions and evasion, with the result that revenue collection remained below potential. Weakness in expenditure control also enervated budgetary management. The dominance of a wide range of allowances in the government wage bill and an inability to eliminate low-priority activities contributed to expenditure overruns. In the financial sector, institutional weaknesses have compromised the effectiveness of indirect monetary instruments in promoting greater efficiency in providing financial services.

To address the budgetary weakness during the first half of fiscal year 1995/96 (July-June), the government adopted a mini-budget that Included both revenue measures and expenditure cuts. As a result, for 1995/96 as a whole, the government’s overall deficit amounted to 3.3 percent of GDP, compared with a deficit of 5.8 percent of GDP in 1994/95. The fiscal improvement in 1995/96 contributed critically to the decline in the rate of broad money growth to 15 percent in the year ended June 1996, compared with 38 percent a year earlier. A credit ceiling on state-owned banks and sales of foreign exchange by the Bank of Tanzania also contributed to the slower pace of monetary expansion. During the second half of 1995/96, the government also adopted several structural measures designed to remove the institutional deficiencies indicated above.

Despite a modest deterioration in the terms of trade, the external position strengthened in 1995/96. Import volume declined owing to tighter customs control and the uncertainties of an election year. The external current account deficit, excluding grants, declined to 16.2 percent of GDP in 1995/96, compared with 20.6 percent of GDP in 1994/95. Gross official reserves declined from the equivalent of 8.8 weeks of imports at end-June 1995 to 8.1 weeks of imports at end-June 1996, but they recovered to 10.0 weeks of imports at end-August 1996 owing to purchases of foreign exchange by the Bank of Tanzania during the traditional export season.

Although Directors welcomed the marked improvement in Tanzania’s macroeconomic performance, they emphasized in their discussion that the financial situation remained fragile. In this light, they stressed the importance of strong financial policies and structural reforms—particularly fiscal consolidation and financial sector reform—in order to stabilize the economy, sustain more broadly based growth, and improve living standards.

Directors applauded the new government’s initiatives to address persistent fiscal imbalances and structural impediments that hindered sound financial management. They welcomed the pay reform in the civil service, the establishment of the Tanzania Revenue Authority, and the strengthened expenditure control and budgetary processes. Some Directors, noting the government’s determination to increase transparency and accountability by public officials, encouraged the authorities to intensify their efforts in the tight against corruption. Directors regretted the delay in introducing the value-added tax and noted the importance of improving tax administration and widening the tax base. In particular, extension of the Tanzania Revenue Authority to include Zanzibar, together with the programmed harmonization of import taxes, would eliminate an important source of tax evasion. They stressed that Tanzania should try to meet fiscal goals without accumulating domestic arrears.

In the area of structural reform. Directors welcomed the progress made to date, but they stressed the importance of intensifying the parastatal reform and deepening financial sector reform. Directors expressed concern about the risks to macroeconomic stability and the central bank’s ability to implement an effective monetary policy posed by the serious problems of the state-owned banks, particularly the National Bank of Commerce, for which many Directors thought privatization would be necessary. They urged the authorities to address these problems without delay and to introduce more competition in the banking system.

Directors commended the authorities for their success in liberalizing the exchange and trade system, which allowed Tanzania to accept the obligations of Article VIII of the Fund’s Articles of Agreement in July 1996. Directors urged the authorities to clear external payments arrears as quickly as possible. Observing that Tanzania’s economy remained vulnerable to external shocks, Directors indicated that sustained commitment to the medium-term program and its full implementation would be needed for continued donor support.

Data available subsequent to the consultation show that the improvement in the fiscal position during July-December 1996 was greater than expected. Strong revenue performance and tight expenditure control allowed the government to generate savings equivalent to 1.4 percent of annual GDP. Government net repayments to the banking system kept broad money growth at 9 percent by end-December 1996, contributing to a decline in inflation to 14 percent by end-January 1997. The external position strengthened substantially, mostly reflecting an improvement in the current account, with gross official reserves of the Bank of Tanzania reaching the equivalent of 16 weeks of imports by end-December 1996.

Thailand

The Board concluded the Article IV consultation with Thailand in July 1996. In response to the global economic recovery, overheating reemerged in Thailand during 1995 and the first quarter of 1996. For 1995 as a whole, demand remained strong, as GDP—driven by investment and exports—expanded by nearly 9 percent (Table 37). As a result, factor markets tightened further, with the unemployment rate failing slightly, to 2½ percent. Average inflation rose to 5.8 percent in 1995—the highest since 1991—and remained high in the first quarter of 1996, as a result of higher world commodity prices as well as the strength of demand, increases in wages, and the effect of floods.

Table 37Thailand: Selected Economic Indicators

(Data as of Board discussion in July 1996)1

1996
1993199419952Projections at

time of Board

discussion
Outturn3
In percent
Domestic economy
Change in real GDP8.38.88.78.36.7
Unemployment rate2.62.62.52.0
Change in consumer prices
(period average)3.35.05.86.05.9
In billions of U.S. dollars1
External economy
Exports, f.o.b.36.644.656.063.954.7
imports, c.i.f.45.153.470.980.570.8
Current account balance–6.1–7.8–13.1–14.5–14.4
Direct investment, net1.40.91.31.417.1
Portfolio investment, net3.91.23.21.1
Capital account balance10.512.222.020.518.0
Gross official reserves25.430.337.043.038.7
Current account balance
(in percent of GDP)–5.4–5.6–8.1–7.9–8.0
External debt (in percent of GDP)41.745.349.552.449.9
Debt service (in percent of exports
of goods and services)10.911.411.012.411.4
Change in real effective exchange
rate (in percent)0.9–0.5–0.96.6
In percent of GDP1
Financial variables
Overall public sector40.91.62.52.52.2
Gross domestic saving35.035.635.035.734.5
Gross national investment40.441.243.143.642.5
Change in broad money
(in percent)18.412.917.017.312.6
Interbank lending rate (in percent;
end of period)54.387.2212.1

Unless otherwise noted.

Fund staff estimates.

Updated Fund staff estimates.

Fiscal years ending September 30.

Weighted average.

Unless otherwise noted.

Fund staff estimates.

Updated Fund staff estimates.

Fiscal years ending September 30.

Weighted average.

Monetary policy was progressively tightened, and the overall public sector surplus increased. Nevertheless, the current account deficit rose to 8 percent of GDP but was more than covered by capital inflows. These inflows continued at a high level in early 1996, resulting in some downward pressure on interest rates. The slow progress in reducing the external current account deficit was in part due to the increase in private saving being inadequate to keep up with investment. External debt, about half of which was short term, rose from about 39 percent of GDP in 1991 to 49.5 percent of GDP in 1995.

In structural developments, poverty had been reduced substantially in recent years, but rural-urban income disparities continued to grow, and income distribution deteriorated. Infrastructural developments to alleviate bottlenecks were temporarily delayed because of a change in government. Measures had been taken to improve education and training, including by increasing the transition rate from primary to secondary schooling, but shortages of skilled labor remained.

Directors strongly praised Thailand’s remarkable economic performance and the authorities’ consistent record of sound macroeconomic policies. They noted that financial policies had been tightened in 1995 in response to the widening of the external current account deficit and the pickup in inflation, and this had begun to bear results, but they cautioned that there was no room for complacency.

Directors supported the authorities’ intention to maintain a tight monetary stance. The authorities had, however, sought to address the growing openness of the capital account and the large and volatile capital inflows through a combination of monetary and prudential measures, supported most recently by price-based controls on short-term inflows. Directors considered that these were not an effective substitute for more fundamental policies over the medium term.

The stability of the baht had served the Thai economy well in the past, but Directors recommended a greater degree of exchange rate flexibility to improve monetary autonomy and to reduce the incentive for short-term capital inflows. The increased flexibility should be supported by development of additional indirect monetary instruments and reduced reliance on the credit plan.

The recent increase in the current account deficit had increased Thailand’s vulnerability to economic shocks and adverse shifts in market sentiment. On the one hand, Directors noted, economic fundamentals remained generally very strong, characterized by high saving and investment, a public sector surplus, strong export growth in recent years, and manageable debt and debt-service returns. On the other hand, the level of short-term capital inflows and short-term debt were somewhat high. Also, the limitations of present policy instruments constrained the authorities’ ability to manage shocks. Caution in the use of foreign savings was warranted, Directors observed, and early action was required to reduce the current account deficit. While fiscal policy could play a role in the short term, over the medium term the emphasis should be on measures to increase private saving.

Directors noted that Thailand’s remarkable growth performance owed much to structural policies that fostered strong total factor productivity growth. They encouraged the authorities to maintain and strengthen the momentum of reform, particularly in the financial and trade sectors, and recommended a further strengthening of supervision of the banking sector. Much progress had been made in reducing poverty, but the deterioration in distribution was a serious concern, and the authorities could improve their efforts in this regard. Directors welcomed measures to improve education. Directors encouraged the authorities to strengthen their efforts to improve the statistical base.

Uruguay

The Board concluded the Article IV consultation with Uruguay in July 1996, together with a first review under the Stand-By Arrangement approved in March 1996. In 1995 real GDP had declined by about 2.0 percent, and unemployment rose significantly. The decline in output continued during early 1996 in construction, commerce, and industry, but agricultural output rose. The 12-month rate of inflation fell from 44 percent during 1994 to 30 percent in May 1996.

The combined public sector deficit was reduced in 1995 to 1.75 percent of GDP, from 3 percent in 1994. The central administration wage bill and outlays on goods and services were restrained, and investment spending was scaled back relative to GDP. Social outlays increased, however, as inflation declined. Although the net revenue effect of the tax package implemented in May 1995 was positive, tax revenue fell relative to GDP in 1995, reflecting a sharp fall in domestic demand.

The expansion of currency in circulation slowed from 43 percent in 1994 to about 31 percent in the year ended May 1996, and the growth of broad money and credit to the private sector also declined. The interest rate on short-term treasury bills also declined significantly during that period, as did the prime lending rate.

Uruguay’s external position strengthened during 1995 and early 1996, with the external current account deficit narrowing from 2 percent of GDP in 1995 to 1.8 percent of GDP by March 1996 (Table 38). Nevertheless, export growth slowed during this same period, reflecting declining demand from Argentina and Brazil. The monthly rate of depreciation of the exchange rate band vis-à-vis the U.S. dollar, which had remained unchanged at 2 percent since 1992, was lowered to 1.8 percent in April 1996. In real effective terms, the Uruguayan peso appreciated by 3½ percent from early 1995 to April 1996, and in April 1996 it was appreciated by about 14 percent relative to its average level in 1990–95.

Table 38Uruguay: Selected Economic Indicators

(Data as of Board discussion in July 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real GDP3.06.8–2.44.9
Unemployment rate (end of
period)7.69.911.111.9
Change in consumer prices
(end of period)82.944.135.423.624.3
In billions of U.S. dollars1
External economy
Exports, f.o.b.1.61.92.12.32.4
Imports, c.i.f.–2.3–2.7–2.8–2.9–3.3
Current account balance–0.3–0.4–0.3–0.3–0.3
Capital account balance0.60.70.60.30.4
Gross official reserves1.41.71.81.9
Current account balance
(in percent of GDP)–2.6–2.7–2.0–1.7–1.5
External debt (in percent
of GDP)38.535.534.034.333.8
Debt service (in percent of exports
of goods and services)23.023.528.325.419.4
Change in real effective exchange
rate (in percent; end of period)15.5–1.63.22.6
In percent of GDP1
Financial variables
Consolidated public sector balance–1.9–3.1–1.7–1.3–1.7
Gross national saving12.012.012.111.411.7
Gross domestic investment14.614.614.113.113.2
Change in broad money
(in percent)36.037.331.623.236.9
Interest rate (in percent)348.244.739.429.2

Unless otherwise noted.

Updated Fund staff estimates.

For 1993, the rate is for central bank treasury bills; thereafter the rate is for treasury bills with a maturity of up to 63 days.

Unless otherwise noted.

Updated Fund staff estimates.

For 1993, the rate is for central bank treasury bills; thereafter the rate is for treasury bills with a maturity of up to 63 days.

During their meeting. Directors commended the authorities on the progress made over the past year in fiscal consolidation and implementing structural reforms, which had helped to reduce Uruguay’s external vulnerability to declining demand from its main trading partners during the period. They were concerned, however, that inflation remained high, output had declined substantially, and unemployment had risen. To sustain rapid output and employment growth in the medium term, saving and investment needed to be increased.

The Board stressed that it was urgent to reduce inflation. To that end, further fiscal adjustment would be needed during 1996. Measures to broaden the tax base and improve the administration of taxes and social security contributions, together with close monitoring of the financial performance of public enterprises, were also needed.

Directors urged the authorities to continue and not delay their plan to slow the depreciation of the exchange rate band, in line with targeted inflation and supported by appropriately restrained financial and wage policies. At the same time, to improve external competitiveness and increase productivity. Directors urged the authorities to accelerate tax changes and structural reforms. In particular, it was extremely important to undertake a fiscal package that included reducing social security contribution rates paid by employers, lengthening the adjustment period of wages, and removing backward wage indexation arrangements, as well as other measures to help deliver the programmed narrowing of the fiscal deficit in 1996 and its further decline in 1997.

Directors emphasized that credit policy should continue to be restrained until signs were clear that fiscal adjustment was taking place and inflation was declining as planned. In that context, Directors welcomed the authorities’ intention to restrain credit expansion by the state banks.

Directors commended the authorities on the implementation of the reform of the main social security system and encouraged them to press for prompt passage of legislation for reforming the other social security plans. They welcomed the ongoing effort to implement the reform of the central administration. Those efforts, as well as institutional changes and other steps to strengthen tax administration, would be instrumental in making room in the public finances for reducing producer taxes further in the medium term. Directors encouraged the authorities to develop further the private sector by deepening deregulation and privatization and accelerating the planned restructuring of the state banks to enhance economic efficiency and raise private investment. Directors considered that the authorities should also seek a deepening of trade liberalization.

Republic of Yemen

In July 1996, the Board concluded the Article IV consultation with the Republic of Yemen and completed the first review under the Stand-By Arrangement approved on March 20, 1996. To reverse the disappointing macroeconomic and policy performance over 1990–94, the authorities had launched in 1995, and strengthened in 1996 under the Stand-By Arrangement, a financial adjustment and structural reform program. The program was comprehensive and entailed substantial fiscal adjustment; the elimination of domestic bank borrowing for the budget; a supportive, tight monetary stance directed at realizing positive real interest rates; and far-reaching structural reforms. These reforms encompassed a broadening of the excise tax base, excise tax harmonization, and introduction of government debt instruments; the freeing of interest rates and basic monetary management reforms; the freeing of exchange markets, unification of the exchange system, and adoption of a floating-rate regime; and full one-step tariff reform, elimination of import licensing, and removal of virtually all import prohibitions for economic reasons.

Real non-oil GDP recovered strongly in 1995—following the civil-war-induced contraction in 1994—rising on a net basis by 3 percent, and growth was expected to accelerate to 4 percent in 1996 (Table 39). The core inflation rate, moreover, was declining sharply as a result of the continued tight financial policies and the appreciation of the free market exchange rate. Over February–May 1996, the annualized rate was about 20 percent, compared with 48 percent in 1995 and 71 percent in 1994.

Table 39Republic of Yemen: Selected Economic Indicators

(Data as of Board discussion in July 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real non-oil GDP3.7–4.57.54.04.0
Change in core inflation
(period averages)71.348.020.011.1
In billions of U.S. dollars1
External economy
Exports, f.o.b.1.21.81.92.12.2
Imports2.11.72.02.42.3
Own current account (excluding
oil company transactions)–0.50.2–0.1–0.5–0.3
Overall balance–0.4–0.7–0.5–0.9–0.3
Own gross official reserves (in months of imports, excluding oil company transactions)0.00.00.00.00.1
Own current account (in percent
of GDP, excluding oil company
transactions)–12.13.5–1.8–9.1–5.0
External debt (in percent of GDP)209.1200.6188.1171.8167.0
Debt service (commitment basis;
in percent of current account
receipts, excluding oil company
transactions)59.340.736.730.830.2
Change in real effective exchange
rate (parallel/free market rate;
in percent)–14.7–6.221.6
In percent of GDP1
Financial variables
Central government balance
(cash basis)–16.5–16.5–5.9–3.1–2.5
Gross national saving–10.617.621.413.720.1
Gross national investment15.09.615.115.519.1
Change in broad money (in percent)4634201411
Effective deposit rate (in percent)3–53–520–2225–2720–22

Unless otherwise noted.

Provisional actual data and updated Fund staff estimates.

Unless otherwise noted.

Provisional actual data and updated Fund staff estimates.

The overall cash budget deficit, which had declined to 6 percent of GDP in 1995 from 17 percent in 1994, was forecast to narrow further to 3 percent. This improvement reflected the benefits to oil revenues deriving from the depreciation of the official exchange rate and to a large increase in non-oil revenues deriving from the tax and tariff reforms and improved administration. On the expenditure side, the GDP ratios for the wage, subsidy, and defense bills were all targeted to decline to allow for increased outlays for public investment and civil service reform.

With no bank borrowing, broad money growth was targeted to slow from 20 percent in 1995 to 14 percent. Nominal deposit interest rates had been raised to 25–27 percent in early 1996; with the core inflation rate of 20 percent, real rates had become positive. In those circumstances, the composition of broad money began to shift toward quasi-money, and the government treasury bill auctions continued to experience successful outcomes.

The tightened fiscal and monetary conditions of 1995–96 and the integration of the freed commercial bank and money-changer exchange markets helped to stabilize the floating free market exchange rate after late October 1995, indicating restored confidence in the currency and the economy.

Directors in their discussion commended the authorities for demonstrating a strong sense of ownership of the comprehensive financial adjustment and structural reform program, and for its successful implementation. They were encouraged by the deceleration in the core inflation rate, the stabilization of the free market exchange rate, and the increase in gross foreign exchange reserves to near the end-year target despite a shortfall in external financing.

Directors welcomed the marked strengthening of fiscal policy in 1995–96, which had led to substantial reductions in the budget deficit and the rate of monetary expansion. They urged the authorities to continue the fiscal consolidation by further reducing subsidies through front-loaded increases in administered prices for wheat, flour, and energy, and they endorsed the adoption of a general sales tax. Directors considered it essential to establish a well-designed social safety net to mitigate the impact of the reform program on the more vulnerable segments of the population.

Directors welcomed the authorities’ increased reliance on interest rate policy and recommended that interest rates be reduced only when inflation had clearly receded. Because the goal of high growth depended on more active intermediation by the banking system to ensure the extension of credit to the private sector, Directors stressed the need for legal reforms to address loan contract enforcement.

Countries in Transition

Armenia

The Board concluded the Article IV consultation with Armenia in September 1996 and conducted the mid-term review of Armenia’s first annual ESAF arrangement. Following a period of steep decline in GDP and of high inflation, Armenia had stabilized its economy (Table 40). Real GDP increased by 6.9 percent in 1995, and by 4.3 percent during the first half of 1996, compared with 5.4 percent in 1994, In 1995, end-of-period inflation fell to 32 percent, from 1,885 percent in the previous year. However, at the end of 1996, regional instability and the blockade of Armenia’s transportation routes through Azerbaijan and Turkey continued to pose a threat to sustained growth.

Table 40Armenia: Selected Economic Indicators

(Data as of Board discussion in September 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real GDP–14.85.46.96.55.8
Change in consumer prices
(end of period)10,8961,884.531.918.05.7
In millions of U.S. dollars1
External economy
Exports209.3270.9295.2290.3
Imports401.2672.9767.6757.9
Current account balance3–231.4–483.0–486.6–424.3
Direct investment2.619.933.812.3
Gross official reserves4.932.3107.1132.7161.9
Current account balance
(in percent of GDP)–35.6–37.6–29.5–26.7
External debt (in percent
of GDP)30.828.935.037.8
Debt service (in percent of exports
of goods and services)0.83.020.620.219.7
Change in real effective exchange
rate (in percent)6.7–14.2
In percent of GDP1
Financial variables
General government balance–22.0–14.8–11.0–10.8
Gross national saving–23.5–24.0–20.8–20.8
Gross national investment11.08.88.17.1
Change in broad money (in percent)684.069.025.035.0
Interest rate (in percent)4285.083.053.0

Unless otherwise noted.

Updated Fund staff estimates.

Excluding official transfers.

Average refinance rate.

Unless otherwise noted.

Updated Fund staff estimates.

Excluding official transfers.

Average refinance rate.

The accrual budget deficit was reduced from 16.4 percent of GDP in 1994 to under 10 percent in 1995 and to 6.8 percent for the first six months of 1996, through a combination of tax measures and expenditure restraint. However, the repayment of substantial expenditure arrears led to a cash deficit amounting to 8.4 percent of GDP during the first half of 1996. The most important budgetary problem was weak revenue performance stemming from gaps in the tax base (notably the failure to capture the emerging private sector) and tax arrears.

The government continued its program of fiscal institution building in 1996. It established a treasury department as well as a debt-management unit and large-taxpayer unit within the Ministry of Finance and set up 40 field treasuries. It targeted the social safety net better, facilitating an increase in benefits, and enacted a new pension law raising the retirement age and bringing the Pension and Employment Fund into balance.

Reserve and broad money expanded rapidly during the second half of 1995, declined in the first quarter of 1996, and increased slightly during the second quartet. The central bank’s refinance rate was constant at 52 percent between October 1995 and August 1996, whereas lending and deposit interest rates varied substantially. The nominal exchange rate remained stable through May 1996 before undergoing a slight depreciation, while the real effective exchange rate depreciated by 5 percent during the first six months of 1996.

As a result of high import levels and slow export growth, the ratio of the current account deficit (excluding official transfers) to GDP increased from 36 percent in 1994 to 38 percent in 1995.

At the time of the consultation, privatization was practically complete in the agriculture and housing sectors and on track for small-scale enterprises. Although privatization of medium- and large-scale enterprises had slowed in early 1996 and fallen behind schedule, it had subsequently begun to accelerate. Most prices had been liberalized, and electricity prices were raised 40 percent between October 1995 and April 1996. Progress had also been made with legal reform, particularly in the banking sector, with the passage in 1996 of the Central Bank Law establishing the central bank’s independence, the Law on Banks and Banking, and the Law on Banking Insolvency.

Directors complimented the authorities on the economic growth and low inflation achieved under the ESAF-supported program and welcomed progress in systemic reforms across all sectors. However, major problems remained to be addressed, notably with regard to fiscal policy, financial sector reform, and privatization.

Directors supported the introduction of a treasury system and elimination of all expenditure arrears. They expressed concern, however, over declining tax collections and the persistence of tax arrears. They urged the authorities to strengthen the fiscal position by broadening the tax base to include the expanding private sector and further rationalizing expenditures.

Directors welcomed the improved implementation of the monetary program and encouraged the authorities to take measures, such as expanding the use of treasury bills, to deepen the financial sector and enhance the central bank’s flexibility. With respect to the exchange rate, they welcomed the move from the de facto peg to a more flexible arrangement.

The fragility of the banking system and the increase in disintermediation were of concern to Directors.

They urged the authorities to take bold steps to strengthen the banking system and build public trust, including the reorganization of the Savings Bank and the restructuring or, if necessary, liquidation of large commercial banks deemed to be insolvent.

The Board stressed that the current account deficit was unsustainably high. While Armenia would continue to depend on sizable concessional assistance in the foreseeable future, it would also have to create the necessary environment for attracting foreign investment and promoting export growth.

Directors expressed concern that some structural reforms had fallen behind schedule, notably the privatization of medium- and large-scale enterprises, and that, as in other countries, reliance on voucher-based privatization had not yielded desired improvements in enterprise governance. They urged the authorities to accelerate privatization, legal reform, and the restructuring of the energy and agricultural sectors.

Following the Board discussion, updated estimates showed that real GDP increased by 5.8 percent in 1996, compared with a program projection of 6.5 percent. The current account deficit, at 26.6 percent, was lower than projected. Despite a sharp increase in broad money during the second half of 1996, inflation was lower than projected owing to a strong increase in the demand for money.

Azerbaijan

The Board concluded the Article IV consultation with Azerbaijan in December 1996 and considered Azerbaijan’s requests for an Extended Arrangement and an arrangement under the ESAF, Targets for macroeconomic stabilization under the Systemic Transformation Facility and the Stand-By Arrangement in 1995–96 had been largely met. Real GDP grew by 1 percent in 1996, encouraged by large investments in the oil fields, and foreign direct investment increased substantially (Table 41), Inflation was sharply reduced; twelvemonth inflation in October 1996 was 11.7 percent. The fiscal deficit, financed almost exclusively through foreign sources, also declined. The large oil investments helped to reverse the output decline, but the external current account deficit widened from 11 percent of GDP in 1995 to an estimated 19 percent of GDP in 1996. With higher world oil prices, the terms of trade were expected to improve in 1996. Gross official reserves, virtually nil in 1994, reached approximately $215 million in 1996. External debt in 1996 was projected to reach 16.3 percent of GDP.

Table 41Azerbaijan: Selected Economic Indicators(Data as of Board discussion in December 1996)
199319941995119962
In percent
Domestic economy
Change in real GDP–23.1–18.1–11.01.2
Unemployment rate16151720
Change in consumer prices
(period average)1,130.01,664.4411.719.9
In millions of U.S. dollars3
External economy
Exports, f.o.b.697682680849
Imports, f.o.b.8198459551,318
Current account balance
(including transfers)–160–121–311–654
Direct investment422275601
Capital account balance554456562
Gross official reserves2119214
Current account balance
(in percent of GDP)6–12.3–6.6–11.2–19.1
External debt (in percent of GDP)15.116.3
Change in real effective exchange rate
(in percent)37.03.9
In percent of GDP3
Financial variables
General government balance–12.7–11.4–4.3–2.7
Gross national saving2.82.3
Gross national investment14.321.4
Change in broad money (in percent)508.6175.256.3
Interest rate (in percent)7107

Fund staff estimates.

Program or projected.

Unless otherwise noted.

Including portfolio investment.

Capital and financial account.

Including oil consortiums.

Central bank refinancing rate; end of period, compounded.

Fund staff estimates.

Program or projected.

Unless otherwise noted.

Including portfolio investment.

Capital and financial account.

Including oil consortiums.

Central bank refinancing rate; end of period, compounded.

Monetary expansion was stronger than programmed in 1995, but in 1996 the velocity of broad money declined in line with projections. Although the nominal exchange rate remained stable during 1995, the manat appreciated in relation to the U.S. dollar (7 percent) and the Russian ruble (20 percent) during the first 11 months of 1996. The government took steps in 1996 to streamline the exchange and payments system; however, some restrictions on current international transactions remained. Enterprise and land privatization picked up during the second half of 1996, but progress was slower in implementing the treasury system, raising residential energy prices to meet cost-recovery targets, and increasing competition in domestic markets.

During their discussion, Directors commended the authorities for implementing the stabilization and reform program supported by the Fund and welcomed the gains achieved: a sharp reduction in inflation, higher international reserves, a strengthening of the exchange rate, and resumption of economic growth. Directors were encouraged by the authorities’ decision to accelerate structural reforms, stressing that maintaining momentum in this regard would be crucial to achieving sustained and balanced growth.

Achievement of program objectives would require that the hesitancy of the past few years in implementing structural reforms not be repeated, and that reforms receive strong support from both the government and the public. Expected income flows from Azerbaijan’s oil wealth should not lead to complacency and delays in restructuring the economy, Board members emphasized. Balance of payments prospects would likely improve in the medium term as oil revenues came on stream, but Directors stressed the importance of structural reforms to ensure balanced growth. Strong and early implementation of structural reforms would also enhance productivity growth. Privatization, land reforms, termination of the government’s involvement in production and trade, and a regulatory and legal framework were critical for allocative efficiency and the transformation to a market economy that could support the growth potential of agriculture and other non-oil sectors.

Directors welcomed the authorities’ commitment to adhere to tight financial policies. They supported the authorities’ intention virtually to eliminate the general government fiscal deficit by 1999 and to maintain monetary policies consistent with low inflation, Directors agreed that the projected appreciation of the real exchange rate over the medium term was appropriate and that it should occur through nominal appreciation of the currency.

Directors stressed that achieving fiscal targets and improving the structure of the budget would require improved tax collection. At the same time, expenditure policies must remain tight, and current spending should be rationalized and prioritized in fight of absorptive capacity. Directors noted that introduction of a treasury system would improve budgetary management, and that the authorities’ establishment of a separate oil account at the central bank would strengthen discipline in the use of oil revenues. The magnitude of interenterprise arrears was a matter of concern, and Directors emphasized the importance of imposing measures to harden budget constraints on enterprises.

Directors stressed that it was crucial to adhere to the restructuring program for state banks; banks that failed to restructure and restore solvency should be liquidated. At the same time, concerted efforts were needed to encourage development of the domestic money market and the payments system. Directors urged the authorities to eliminate barriers to the operations of foreign banks, in order to spur competition and facilitate privatization. The Board also emphasized the importance of strengthening prudential standards and banking supervision and of increasing central bank independence. Although progress had been made in liberalizing the exchange, system and trade regime, further improvements in the functioning of the foreign exchange market and the international payments system were warranted. Directors strongly urged elimination of remaining restrictions on access to foreign exchange auctions, advance import payments, and transfer of foreign exchange for current international transactions by individuals.

Estonia

The Board concluded the Article IV consultation with Estonia in July 1996 and considered Estonia’s request for a new precautionary Stand-By Arrangement, Economic performance under the 1995–96 precautionary Stand-By Arrangement had broadly met policy objectives. Activity picked up, inflation declined, the external current account deficit was contained at a level that could be financed by foreign direct investment, restructuring of the banking system accelerated, and enterprise privatization was almost completed except for infrastructural enterprises. Financial imbalances emerged in late 1995 and early 1996, however, as a decline in public saving and increased reliance on foreign borrowing for public investment caused the general government deficit to grow.

Real GDP grew by 4.3 percent in 1995, up from negligible growth in 1994 (Table 42), and was led by expansion in the services sector and by export-based growth in manufacturing and other industrial sectors.

Table 42Estonia: Selected Economic Indicators

(Data as of Board discussion in July 1996)1

1996
199319941995Projections at

time of Board

discussion
Outturn2
In percent
Domestic economy
Change in real GDP–8.4–0.14.33.14.0
Unemployment rate35.55.45.05.5
Change in consumer prices
(end of period)35.741.628.823.715.0
In millions of U.S. dollars1
External economy
Exports, f.o.b.811.51,328.61,861.32,330.32,060.4
Imports, f.o.b.956.31,689.92,553.53,100.93,144.0
Current account balance23.3–171.0–185.2–302.9–428.5
Direct investment154.4212.2202.3210.093.7
Portfolio investment–0.2–14.1–16.360.130.8
Capital account balance4222.2175.2258.9442.5478.5
Gross official reserves388.4447.0582.8706.2639.6
Current account balance
(in percent of GDP)1.4–7.5–5.1–6.9–10.1
External debt (in percent of GDP)8.67.46.67.67.2
Debt service (in percent of exports
of goods and services)1.40.40.50.80.8
Change in real effective exchange
rate (in percent)30.89.86.5
In percent of GDP1
Financial variables
General government balance–0.71.3–1.2–1.4–1.5
Gross national saving522.417.718.117.517.1
Gross national investment626.528.926.826.129.9
Change in broad money
(in percent)29.631.236.736.8
Interest rate (in percent)722.121.316.113.8

Unless otherwise noted.

Updated Fund staff estimates.

Unemployed job seekers as a percentage of total labor force; period average.

Financial and capital account.

Gross domestic saving.

Gross domestic investment.

Weighted average annual interest rates (end-December) on 6- to 12-month commercial bank kroon loans to individuals and companies.

Unless otherwise noted.

Updated Fund staff estimates.

Unemployed job seekers as a percentage of total labor force; period average.

Financial and capital account.

Gross domestic saving.

Gross domestic investment.

Weighted average annual interest rates (end-December) on 6- to 12-month commercial bank kroon loans to individuals and companies.

The decline in public saving was largely offset by gains in private saving. Owing to the absorptive capacity of the emerging private sector, unemployment remained low in 1995 at 5 percent. Consumer price inflation was 28.8 percent at the end of 1995, compared with 41.6 percent at the same time in 1994. General government operations registered a deficit of 0.8 percent of GDP in 1995. The fiscal policy stance for 1996 aimed at limiting the overall fiscal deficit to no more than 1.4 percent of GDP.

Net domestic credit rose by 63 percent in 1995, more than double the projected increase, owing to buoyant demand by the private sector. Interest rates on kroon deposits and loans drifted downward in 1995 and early 1996, but rates of return offered by Estonian banks continued to attract foreign inflows. Interest rate differentials and risk premiums narrowed further, but real interest rates remained negative.

Export volume grew by about 20 percent in 1995, while import volume growth exceeded 30 percent, causing the trade deficit to widen to almost 20 percent of GDP. Increases in net receipts from nonfactor services, however, more than offset the rise in the trade deficit. The external current account deficit was lower than expected, the overall balance of payments was in surplus, and gross international reserves remained at the equivalent of close to three months of imports.

Most of the structural reforms under the 1995–96 stand-by program were implemented. However, progress in reforming the fiscal system and in land privatization continued to be slow.

In their discussion, Directors praised Estonia’s strong record in implementing stabilization and structural reforms, which were paying off: economic recovery had gained momentum, a viable private sector had developed, unemployment remained low, and foreign direct investment flows had continued. However, Directors were concerned about persistent high inflation and the financial imbalances that had emerged in late 1995 and early 1996, resulting in a decline in public saving and a widening general government deficit.

Most Directors agreed that the currency board arrangement at its current peg remained appropriate. Directors emphasized the need to continue monitoring capital inflows and to ensure that banks could adjust to a reversal of short-term inflows. Concern was also expressed that credit growth might be too rapid. Board members stressed that continued flexibility in the goods and labor markets, as well as productivity growth, would be essential given the inflationary pressures generated by ongoing adjustment to relative prices.

Directors cautioned that continuing deterioration of public finances could undermine inflation reduction and credibility of the currency board; the fiscal position, therefore, should be strengthened as soon as possible. They welcomed the commitment to reduce public expenditures in 1996–97, to exert greater control over local government borrowing, and to strengthen tax administration. Additional revenue measures should be taken if a revenue shortfall reappeared.

Directors encouraged the authorities to streamline further the government’s role in the economy, including through structural reform of public expenditures and the pension system. They welcomed the progress made in banking supervision and the restructuring of commercial banks. Although some elements of the financial system remained fragile, Directors commended the authorities’ commitment to seek market-based solutions to problem banks and to limit the risks to public funds. Directors urged decisive movement on plans to commercialize and privatize infrastructural enterprises and to accelerate land privatization. Speedy adjustment of administered prices, particularly of energy prices, was also needed. Noting Estonia’s remarkable record on free trade, Directors urged the authorities to resist pressures to introduce protective import tariffs, especially in the agricultural sector.

Hungary

The Board concluded the Article IV consultation with Hungary in August 1996 and conducted the first review under the Stand-By Arrangement approved in March 1996. Macroeconomic conditions in Hungary had improved significantly since the beginning of 1995, owing to the stabilization program enacted by the authorities. Adjustment measures included an up-front devaluation of the forint; a preannounced crawling peg for the exchange rate, along with tight incomes policies to anchor wage increases and drive down inflation; fiscal retrenchment; and acceleration of structural reforms.

As a result, the balance of payments improved (Table 43). The external current account deficit dropped to $2.5 billion in 1995, from almost $4 billion in 1994, and declined further to $934 million during the first half of 1996. Output rose 1½ percent in 1995, although production declined slightly in the second half of the year, unemployment increased slightly, and domestic demand contracted sharply. Export and import flows had increased considerably since 1994, a sign of further opening of the economy. The strengthened external position was accompanied by a surge in direct investment and other private capital inflows, which boosted gross official reserves and led to a drop in the ratio of net external debt to GDP.

Table 43Hungary: Selected Economic Indicators

(Data as of Board discussion in August 1996)1

1996
1993199419952Projections

at time

of Board

discussion
Outturn3
In percent
Domestic economy
Change in real GDP–0.62.91.52.01.0
Unemployment rate12.110.410.410.5
Change in consumer prices
(end of period)21.121.228.316.619.8
In billions of U.S. dollars1
External economy
Exports8.17.612.812.614.2
Imports11.311.215.314.216.8
Current account balance–3.5–3.9–2.5–1.8–1.7
Foreign direct investment, net2.31.14.41.62.0
Capital and financial account balance46.13.47.82.10.4
Gross official reserves6.76.812.011.49.8
Current account balance
(in percent of GDP)–9.0–9.5–5.6–4.0–3.8
External debt, net (in percent of GDP)38.845.836.839.531.7
Gross interest payments (in percent of exports of goods and nonfactor services)514.618.213.812.1
Net interest payments (in percent of exports of goods and nonfactor services)610.412.19.46.1
Amortizations (excluding prepayments; in percent of exports of goods and nonfactor services)724.130.529.932.6
Prepayments (in percent of exports of goods and nonfactor services)86.49.55.78.8
Change in real effective exchange rate
(in percent; based on consumer price index)9.3–0.8–4.02.2
In percent of GDP1
Financial variables
Consolidated government balance–7.6–6.4–3.80.6–0.2
Excluding privatization receipts–7.8–7.1–6.6–3.9–3.5
Gross national saving (national accounts basis)10.614.418.821.621.7
Gross national investment
(national accounts basis)20.022.222.424.423.7
Change in broad money
(M2; in percent)16.813.018.513.720.9

Unless otherwise noted.

Estimated.

Updated Fund staff estimates.

Includes errors and omissions but excludes the change in reserves. In 1996, includes concepts of the capital and financial accounts in IMF, Balance of Payments Manual fifth edition (1993).

Interest expenditure on all external obligations.

Interest expenditure on all external obligations minus interest receipts arising from external assets and foreign exchange reserves.

Principal repayments on all external obligations minus payments made during the year on obligations falling due after the end of the year.

Principal repayments made during the year on obligations falling due after the end of the year.

Unless otherwise noted.

Estimated.

Updated Fund staff estimates.

Includes errors and omissions but excludes the change in reserves. In 1996, includes concepts of the capital and financial accounts in IMF, Balance of Payments Manual fifth edition (1993).

Interest expenditure on all external obligations.

Interest expenditure on all external obligations minus interest receipts arising from external assets and foreign exchange reserves.

Principal repayments on all external obligations minus payments made during the year on obligations falling due after the end of the year.

Principal repayments made during the year on obligations falling due after the end of the year.

After devaluation of the forint and increases in administered prices in early 1995, inflation picked up and then abated, but it lingered at 24–25 percent through June 1996. Real wages dropped by more than 10 percent in 1995, and in June 1996 the 12-month rate of increase in gross wages was holding at about 25 percent. The deficit of the consolidated government (excluding privatization receipts) fell by ½ of 1 percentage point of GDP in 1995, and further cuts were budgeted for 1996. The better-than-expected performance of the central government budget during the first half of 1996 more than compensated for the growing deficit of the social security funds.

The goal of monetary policy was to support the exchange rate policy and keep interest rates positive in real terms despite pressures arising from the conversion into forint of foreign exchange assets. Exchange rate pressures intensified in early 1996, entailing sterilized intervention by the central bank, owing to an interest rate differential (adjusted for the announced rate of crawl) of 13–14 percentage points. Nevertheless, broad money accelerated, and treasury bill rates dropped by some 7 percentage points during early 1996. Market rates stabilized, and intervention subsided during May and June as the interest rate differential narrowed to about 5 percentage points.

Privatization increased, marked by the sale of some major public utilities at the end of 1995, but the downsizing of health care facilities, the tightening of pharmaceutical subsidies, and disability pension reform lagged. However, the retirement age was raised for both men and women (after a transition period), and progress was made in preparing a comprehensive pension reform, including introduction of a fully funded component.

In their discussion, Directors welcomed the marked improvement in macroeconomic conditions: the fiscal and external current account deficits had declined sharply, structural reform had gained momentum, and the stronger external performance had led to a sizable decline in net external debt. The international financial markets were rewarding the authorities’ strong adjustment efforts. Moreover, the rebound in exports had made possible positive economic growth, despite the sharp contraction in domestic demand. Progress in reducing inflation, however, had been slower than expected, and Directors highlighted the consequent risk to the adjustment program. They regretted the authorities’ decision to raise inflation targets rather than to tighter policy. Entrenchment of inflationary expectations, Directors cautioned, could undermine the progress achieved, and they urged strengthened policy implementation. This would require tight financial policies and structural reforms to alleviate supply constraints and to enhance competition, as well as wage moderation.

Directors commended the authorities’ continued commitment to fiscal consolidation. In light of the slippage in inflation, they stressed that it was essential to achieve, as a minimum, the 1996 deficit target of 4 percent of GDP, Several risks threatened achievement of that goal, in particular the social security deficit and delays in structural reforms. Directors urged the authorities to take swift corrective action if revenue from consumption taxes and the recovery of social security arrears did not pick up as the authorities expected.

Capital inflows. Directors observed, had complicated the implementation of monetary policy. Although the decline in the interest rate differential could lessen these inflows, they cautioned against underestimating the potential for continued inflows and the cost of continued sterilized intervention. As elements of an anti-inflationary strategy, some Directors suggested a more flexible exchange rate policy, while others felt that moving to a new anchor might undermine credibility; other Directors suggested slowing the rate of crawl. Directors emphasized that success in structural reform was a prerequisite for strong macroeconomic performance in the medium term. Although important steps had been taken—most notably on acceleration of privatization and an increase in the retirement age—delays in health and pension reforms, and the continuing large deficits in the social security budget, were worrisome. Directors welcomed the authorities’ intention to seek parliamentary approval of pension and disability pension reforms.

Subsequent to the Board’s August meeting, macroeconomic performance continued to improve in 1996. The current account deficit dropped below $1.7 billion, while the consolidated government deficit (excluding privatization receipts) was 3½ percent of GDP (below the program target), with a primary surplus of 5 percent of GDP, After stagnating in the first half of 1996, economic activity expanded by an annualized 3 percent in the fourth quarter, boosting GDP growth to 1 percent for the year as a whole. The discipline imposed by the crawling-peg regime, containment of domestic demand, and the postponement of energy price increases contributed to a marked decline in inflation in the second half of 1996. However, the deficit of the social security funds exceeded 1 percent of GDP, compared with a target of ¼ of 1 percent of GDP under the program, owing to delays in structural reform.

During the 1996/97 financial year, Hong Kong was administered by the United Kingdom. It was returned to the People’s Republic of China as of July 1, 1997, and became a Special Administrative Region of China.

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