Chapter

II. The Setting

Author(s):
F. Rozwadowski, Siddharth Tiwari, David Robinson, and Susan Schadler
Published Date:
June 1993
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The economic and social structures of the 19 countries under review made them unusually vulnerable to adverse weather and world market conditions as well as poor domestic financial policies. Incomes per capita were among the lowest in the world; population growth rates were among the highest in the world; agriculture typically accounted for one-third, but in some countries as much as two-thirds, of measured GDP; exports tended to be concentrated in a few primary commodities; and almost all energy needs were met through imports. Most countries had elaborate networks of state intervention—price controls, government-run distribution systems, and public ownership of strategic industries—ostensibly to alleviate the fragility of their productive bases. In practice, however, the public sector’s dominance in the economy added to inherent weaknesses by rendering the supply side of the economy inefficient and unresponsive to market signals.

Initial Conditions

By the mid-1980s the interplay among the weak productive bases, periodic disruptions from poor weather or civil strife, sharp deteriorations in the terms of trade, and inadequate policy responses to emerging problems had left most of the countries with low growth and large external imbalances (Chart 2 and Appendix Table A1). In all but five countries, real GDP per capita had fallen during the three or more years preceding the first SA F or ESA F arrangement. Often, the most pronounced weakness was in the export sector. Absorption, however, was kept high by large public sector deficits financed by bank credit and external inflows.

Chart 2.Growth, Inflation, and Current Account Prior to SAF/ESAF Period1

(Annual average for the three preceding years; in percent)

Sources: International Monetary Fund, International Financial Statistics (Washington), various issues; and IMF staff estimates.

1 Data not available for Guinea or for Tanzania’s current account to GDP ratio.

This situation gave rise to economic pressures. External current account deficits, large throughout the 1980s, had averaged 12 percent of GDP during the three years preceding the first SAF/ESAF arrangement for the group as a whole. This large financing requirement resulted in a rapid increase in external debt, to levels that were for most countries clearly unmanageable. Thus, by the beginning of the SAF/ESAF period, 13 of the countries under review were unable to meet their debt-service obligations and resorted to reschedulings and arrears. Inflation rose—in five countries to more than 30 percent a year during the three years prior to the SAF/ESAF period. In the absence of fundamental policy adjustments, restrictions were placed on external trade and payments. Prospects for the medium term were compromised by savings rates that, at about 8 percent of GDP, were too low to support per capita income growth. The following paragraphs review the policy issues underlying these developments.

Fiscal Affairs

In each of the countries, large public sector deficits were believed to be the principal cause of the excess of absorption over output. However, data on consolidated public sector finances existed only for Bolivia and Guyana, so in other countries targets for the public sector had to be set without a quantified understanding of the size of the initial problem. More important, without data on financial flows between various levels of the public sector (central government, local governments, and public enterprises, including marketing boards), the origin of public sector imbalances was sometimes unclear. This uncertainty hindered the proper targeting of policies and the ability to assess their implementation and effectiveness.

Most of the countries entered the SAF/ESAF period with a history of large central government deficits (Chart 3). The median deficit (including grants) for the three years preceding the SAF/ESAF period was 6 percent of GDP: only Ghana. Madagascar, and Senegal had deficits smaller than 4 percent of GDP (Appendix Table A2). Two-thirds of the countries had made some progress in reducing fiscal deficits relative to GDP during the three years prior to the SAF/ESAF period—several by more than 2 percentage points and Bolivia, Burundi, and The Gambia by more than 5 percentage points.

Chart 3.Fiscal Conditions Prior to SAF/ESAF Period

(Annual average for the three preceding years; in percent of GDP)

Tax systems were nearly all narrowly based. Most countries in the group were heavily dependent on a single source of revenue—often, specific taxes on international trade—with many exemptions, especially to public enterprises. Only six countries entered the SAF/ESAF period with a significant generalized sales tax. Administration was a major problem. These characteristics resulted in serious distortions and generally low elasticities.

Expenditure control was weak in most of the countries, usually reflecting inadequate monitoring or institutional weaknesses. As an extension of this problem, capital and current budgets were poorly integrated, giving rise to inadequate expenditure on maintenance and to levels of public investment that ranged widely: public investment during the three years prior to the SAF/ESAF period varied from less than 4 percent of GDP in three countries to more than 10 percent in another six. In most countries, transfers to public enterprises (either explicitly through cash payments and tax exemptions or implicitly through tax arrears and loan defaults) and excessive wage bills (stemming mainly from excessive employment) were a major burden on the budget.

State Intervention and Control

Public enterprises played an important role in production and employment in each of the countries under review. Such enterprises were typically concentrated in mining, manufacturing, and utilities. In addition, publicly owned marketing boards and trading monopolies for agricultural products and imports provided such services as transportation, marketing, price stabilization, credit provision, and processing (Appendix Table A3). For most countries, however, there are not systematic data on the role of public enterprises or on financial flows between public enterprises and the central government. It is, therefore, impossible to quantify the contribution of public enterprises to the overall public sector deficit, domestic activity, or employment. Sketchy data that are available suggest that many public enterprises operated with significant losses, earned low returns on investments, or were unable to generate resources for adequate investment.

Official control over prices was prevalent, but the extent varied widely—from comprehensive controls in Mozambique and Tanzania to a virtual absence of control in Lesotho and Bolivia (Appendix Table A3). Typically, prices of many strategic items were administered by state trading monopolies, marketing boards, or public enterprises. Affected prices included producer prices of agricultural exports, domestic prices of key imports (fertilizer, petroleum products, foodstuffs), and producer and consumer prices of domestically produced food grains. The distortionary impact of price controls depended on whether they were designed to subsidize production or consumption, shield domestic producers or consumers from fluctuations in international prices, or raise revenue. In many countries, agriculture was promoted by subsidizing imported fertilizer or paying high producer prices. In other countries, producer prices were kept low in order to generate revenues for the marketing boards or subsidize consumption.

A number of the countries under review maintained overvalued currencies supported by restrictive exchange and trade systems. The degree of exchange control prior to countries’ first SAF- or ESAF-supported programs varied enormously (Appendix Table A4). In six countries where the exchange rate was broadly fixed, comprehensive foreign exchange controls were administered through the centralized allocation of surrendered export receipts, and parallel market premia were typically in excess of 100 percent. Another six countries were essentially free of restrictions on current transactions. Four of these (Lesotho, Niger, Senegal, and Togo) maintained fixed exchange rates in the context of currency unions; in the other two (Bolivia and The Gambia), exchange rates were determined in recently established auctions or interbank markets. The remaining seven countries had partial controls exercised through various institutional structures including secondary exchange markets and foreign exchange retention schemes.

In all but 5 of the 19 countries, aggressive nominal depreciations had resulted in real depreciations over the three years leading up to the SAF/ESAF period, in spite of high inflation rates.3 In addition to Burundi, exceptions were Mozambique and Uganda (where high inflation had produced large real appreciations) and Senegal and Togo (where the strength of the French franc combined with expansionary domestic policies had appreciated the real effective exchange rate).

In most of the 19 countries the state exercised tight control over interest rates and the allocation of credit. Interest rates were either administered directly or controlled through floors and ceilings or limits on spreads. Real interest rates (nominal rates less contemporaneous inflation) were negative in eight countries, mostly those with high inflation and inflexible nominal interest rates (Appendix Table A2); in contrast, countries with low inflation and more flexible nominal interest rates often had positive real interest rates. Most countries allocated credit through quantitative ceilings imposed by bank or by sector. Because these policies tended to accommodate the deficits of the public enterprises, nonperforming loans were significant. This situation, together with poor incentives for depositors, frequently resulted in bank insolvencies.

The design and implementation of reforms in each of these areas was frequently impeded by weak administrative capacity, although countries varied widely in this regard. For example, in Bolivia, consolidated accounts for the nonfinancial public sector were available, whereas in Guinea there was not even a monetary survey. The most serious problems were in the capacity to formulate and monitor the government budget, administer tax collection, and manage externally funded public investment projects. Weak administrative capacity sometimes stemmed from a large, but inefficient and unmotivated. civil service.

Previous Reform Efforts

Most of the 19 countries had begun the process of reform and macroeconomic stabilization—often with IMF support—prior to their SAF/ESAF arrangements. Typically, previous programs had included reductions in financial imbalances and adjustments to prices and exchange rates. In several countries—Bolivia. The Gambia, Ghana, Guyana, and Niger—significant reform efforts were under way at the inception of the first SAF or ESAF arrangements. The SAF/ESAF arrangements were therefore designed to sustain and extend the reform. In several other countries, promising reform efforts had stalled (Guinea, Kenya, Mauritania, and Sri Lanka). Some countries (Lesotho and Mozambique) were undertaking IMF-supported reforms for the first time.

External and Domestic Environment During SAF/ESAF Arrangements

The external environment during the SAF/ESAF period presented both adverse and positive influences. On the negative side, growth in the major industrial countries slowed, particularly from 1990 on. This slowdown, together with commodity-specific developments, resulted in deteriorating terms of trade for most of the ESAF countries—on average for the group as a whole by 5 percent a year. There was, however, considerable diversity across the 19 countries (Chart 4 and Appendix Tables A3. A6). In Bangladesh, Malawi, and Senegal, the terms of trade actually improved during their SAF/ESAF arrangements, while at the other extreme, in Uganda and Madagascar, the average annual decline during the arrangements exceeded 10 percent. In almost half of the countries, declines in export prices were an important component of the weakening terms of trade. This trend strained the process of making conditions for exporters more responsive to world prices—an important focus in most SAF- and ESAF-supported programs.

Chart 4.External Developments During SAF/ESAF Period

Sources: Statistical Appendix Tables A5 and A7.

1 Average annual percent change between the first year of the SAF/ESAF arrangement and 1991.

2 Defined as all official loans and grants plus net IMF purchases less actual debt-service payments made.

On the positive side, net resource transfers from the rest of the world rose sharply, and new borrowing was on increasingly concessional terms. Not only were resources secured through consultative/support groups and bilateral contacts, but new undertakings (like the World Bank’s Special Program of Assistance for Debt Distressed Countries in Sub-Saharan Africa) added to the support. Thus, for the countries as a group, the net resource transfer increased by 60 percent during the SAF/ESAF period to more than US$6 billion in 1991 (Appendix Table A7). Grants, which rose by two-thirds, constituted the bulk of this increase. There was a wide range across countries both in the size of and changes in net resource transfers. In the most recent year, the transfer was about I percent of GDP in Kenya and slightly over 50 percent of GDP in Mozambique; this represented a slight drop relative to the pre-SAF period in Kenya but an increase relative to GDP of almost 40 percentage points in Mozambique.

Before the ESAF programs. Paris Club creditors had responded flexibly to the need for cash flow relief on existing debts of countries that adopted IMF-supported programs. They also safeguarded the flow of new external financing to rescheduling countries. In response to the protracted problems of the heavily indebted countries, however, Paris Club creditors introduced in late 1988 a menu of options (the “Toronto terms”) including partial cancellation, extensions of maturities, and concessions on interest rates. Eleven of the countries rescheduled their debt under Toronto terms options (Appendix Table A8).

By the early 1990s, it was recognized that even with sustained adjustment efforts, greater concessions would be needed if debt burdens in the low-income countries were to become manageable. Enhanced concessions were incorporated into Paris Club reschedulings beginning in December 1991. This new menu provided for a 50 percent reduction (in net present value terms) of debt-service payments consolidated on non-ODA (Official Development Assistance) debts through either an outright cancellation of 50 percent of the consolidated claims or a rescheduling at concessional interest rates. The menu also included the nonconcessional options available under Toronto terms. Creditors agreed to provide an effective debt reduction of the same order of magnitude on concessional loans. The agreements also provided for creditors’ reexamining whether to cancel part of the remaining stock of debt after a few years, if previous reschedulings were fully implemented, other nonmultilateral creditors granted comparable relief, and appropriate arrangements with the IMF were continued. As of the end of 1992, 5 of the 19 ESAF countries had availed themselves of the enhanced concessions. Creditors have also provided debt relief to several of the ESAF countries outside the Paris Club.

Several countries faced adverse domestic conditions during their SAF/ESAF period. Civil unrest created serious economic disruptions in Madagascar, Mozambique, Sri Lanka, and Togo. In Southern Africa, a drought beginning in 1990 took a large toll on agricultural output and exports.

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