Madagascar
Recent Economic Developments
Author: International Monetary Fund
Publication Date:
20 Jul 1995
eISBN:
9781451825206
Language:
English
Keywords:
ISCR; CR; exchange rate; broad money; trade balance; balance of payments
Download PDF (4 MB)

This paper describes the economic developments in Madagascar during the 1990s. In early 1994, the authorities prepared a medium-term policy statement with an outward orientation. Accordingly, a sweeping reform of the exchange and trade system was implemented in May 1994, including the floating of the Malagasy franc. However, financial policy was not sufficiently supportive: ad hoc tax exemptions were granted, particularly to foodstuffs and petroleum products, and other taxes were not fully collected. Thus, the fiscal deficit deteriorated, leading to a sharp acceleration in money creation and inflation, which rose to 61 percent by end-1994.

Abstract

This paper describes the economic developments in Madagascar during the 1990s. In early 1994, the authorities prepared a medium-term policy statement with an outward orientation. Accordingly, a sweeping reform of the exchange and trade system was implemented in May 1994, including the floating of the Malagasy franc. However, financial policy was not sufficiently supportive: ad hoc tax exemptions were granted, particularly to foodstuffs and petroleum products, and other taxes were not fully collected. Thus, the fiscal deficit deteriorated, leading to a sharp acceleration in money creation and inflation, which rose to 61 percent by end-1994.

I. Overview

In the late 1980s, Madagascar undertook adjustment programs supported by Fund resources, reversing a generally declining trend in real income per capita over the past two decades. However, civic strife and political tensions broke out in mid-1991 at the beginning of a political transition toward a multiparty democracy, hampering economic management and decision making. In this context, weaknesses in fiscal and monetary policies contributed to an acceleration in inflation, a sizable accumulation of external payments arrears, and a slowdown in economic activity. In addition, structural reforms were interrupted. The situation was made worse by a deterioration in the terms of trade.

The political transition culminated in the adoption of a new multiparty constitution, and a new Government taking office in August 1993. In early 1994, the authorities prepared a medium-term policy statement with an outward orientation. Accordingly, a sweeping reform of the exchange and trade system was implemented in May 1994, including the floating of the Malagasy franc. However, financial policy was not sufficiently supportive: ad hoc tax exemptions were granted, particularly to foodstuffs and petroleum products, and other taxes were not fully collected. Thus, the fiscal deficit deteriorated (despite deep cuts in expenditure), leading to a sharp acceleration in money creation and inflation, which rose to 61 percent by end-1994. Real GDP per capita declined for a fourth consecutive year. Furthermore, the external account also worsened substantially in 1994, despite some improvement in the trade balance with the surge of the international price of coffee, one of Madagascar’s main traditional exports (Chart 1).

CHART 1
CHART 1

MADAGASCAR MAIN ECONOMIC INDICATORS, 1982–94

Citation: IMF Staff Country Reports 1995, 064; 10.5089/9781451825206.002.A001

Source: Malagasy authorities.

II. Developments in Supply and Demand

1. Overall trends

National income accounts show a long-term decrease in real GDP per capita of almost 40 percent between 1970 and 1994. With a real GDP per capita of about SDR 165 in 1994, Madagascar is one of the poorest countries in the world. Real GDP per capita stabilized and even improved slightly at the end of the 1980s, following the adoption of a Fund-supported structural adjustment program, which included the liberalization of prices and most of exports, and a devaluation of the Malagasy franc (FMG) (Appendix III, Table I). However, it decreased sharply in 1991, when the political turmoil associated with the transition to a multiparty democracy had a profound impact on the economy, and it has continued to decline since then. With a growth rate of the population averaging 2.6 percent over the last ten years, Madagascar would need to maintain a real GDP growth rate of 6 percent for more than 15 years in order to return to its 1970 real GDP per capita level. The low level of capital investment as a percentage of GDP has certainly contributed to this performance, as reflected in the very poor quality of infrastructure (roads, railroads, telecommunications). The investment/GDP ratio was mostly below 10 percent during the two last decades, with peaks at around 15 percent in 1979 and 1990 (Chart 2). After having decreased to 8 percent in 1991, the investment ratio recovered somewhat, to slightly more than 11 percent over 1992-94. By comparison, however, assuming a capital stock of 2-3 times the level of GDP, a rate of depreciation of 5 percent, and a target GDP growth rate of 6 percent, an investment ratio of 25-35 percent would be required. Indeed, some Asian countries comparable to Madagascar (Indonesia or Thailand, for example) had investment ratios of around 30 percent during the 1980s, along with strong GDP growth.

CHART 2
CHART 2

MADAGASCAR SAVINGS AND INVESTMENT

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 064; 10.5089/9781451825206.002.A001

Source: Direction Generate de la Banque des Donnees de l’Etat.1/ Staff estimates.

Madagascar’s low investment can be associated in part with its low level of domestic saving. The domestic saving/GDP ratio averaged 5 percent between 1970 and 1994. It improved at the end of the 1980s, reaching almost 10 percent in 1989, before plunging to less than 1 percent in 1991. Over the last four years, nongovernment domestic saving has been very low, averaging minus 0.1 percent of GDP. Government saving deteriorated from 5.6 percent of GDP on average over 1987-90, to 2.5 percent of GDP over 1991-94 (Appendix III, Table II).

2. Sectoral developments

The Malagasy economy is dominated by the services sector and agriculture, accounting for approximately 50 percent and 30 percent of GDP, respectively. These two sectors contributed the most to GDP growth between 1991 and 1994, which averaged 1.5 percent over the period. The value added in the services sector grew by 2.3 percent on average between 1991 and 1994, owing mainly to banking activities and tourism. The industrial sector represents less than 13 percent of GDP, and value added in this sector stagnated over the same period, constrained in part by lack of inputs and competition from imported consumer goods.

a. Agriculture

Agriculture plays a central role in the economy of Madagascar, as it accounts for 85 percent of employment. Within this sector, there are three distinct subsystems: a paddy economy, located in the Hauts Plateaux; an export cash crop economy (coffee, vanilla, and cloves), located in the humid east coast; and a pastoral livestock economy in the arid west coast. Production of both food and export crops is dominated by smallholders.

Paddy is the single largest crop, accounting for about one fifth of total agricultural production and occupying more than 50 percent of cultivated land. After having fluctuated around 2.1 million tons a year throughout the 1980s, the production of paddy increased sharply in 1989-90, to 2.4 million tons, following the liberalization of the rice trade (Appendix III, Table III). This level was sustained in 1992-93 at around 2.5 million tons, as weather and rain conditions were good. The harvest declined to less than 2.4 million of tons in 1994, owing to a cyclone early in the year and the competition from subsidized imports. Rice consumption per capita has tended to decline since the 1980s. The increasing price of rice relative to other food products contributed to this shift in consumption (Appendix III, Tables IV and V). That trend, along with higher production in the past few years, led to the decline in net imports, which averaged 50,000 tons during 1988-92, compared with 170,000 tons during 1980-87. In 1994, thanks to various fiscal subsidies and tax exemptions, net imports increased to 159,000 tons. Given the current low yield of 2 tons per hectare, there is still room for rice output to increase further, if production techniques are improved.

Coffee, vanilla, and cloves are the major export crops. They have accounted for a declining share of export receipts, reaching 30 percent over 1992-94, compared with 50 percent over 1986-91 (Appendix III, Table VI). Other crops grown for export include pepper, cocoa, and sisal.

Coffee grown in Madagascar is mostly of the robusta variety. The coffee sector was liberalized at the end of the 1980s, with the liberalization of the domestic and international trade in coffee in January 1988, the elimination of export taxes in the late 1980s, and the elimination of the Stabilization Fund in June 1990. Nevertheless, production has declined slightly during the past few years, as a result of less attractive world market prices, and damage to plantations from several cyclones.

Vanilla has traditionally been a major export crop, but its importance as a source of budgetary revenue has dwindled, as it accounted for less than 3 percent of budgetary revenue in 1994. Annual agreements between the Indian Ocean producers, which had until recently governed international trade in vanilla, are no longer in effect. An official export price was fixed at US$60 per kilogram in 1994 by the Malagasy authorities, but, in fact, most of exports were made at lower prices. A Vanilla Institute, which is meant to control the sector, is still in place, but its elimination and the full liberalization of the sector are envisaged in the near future. In the context prevailing until now, Madagascar has seen its world market share in vanilla decline from near 80 percent in the early 1970s, to about 50 percent in the 1990s, with the emergence of new competitors such as Indonesia. The weak prices paid to small producers contributed to low levels of output, with substantial fluctuations mainly reflecting weather patterns.

The production of cloves follows a four-year cycle, with two or three years of high output followed by one year of low output. The volume of production has been quite steady over the past few years, in keeping with cyclical trends. In an effort to improve operations in this sector, the Stabilization Fund for cloves was abolished in 1990, and export taxes were eliminated in the late 1980s.

Madagascar also produces industrial crops, including mainly cotton, sugarcane, and groundnuts. Cotton is the main raw material for the textile industry, the most important industrial sector in the country. Output was low during 1992-94, owing to bad weather, with a combination of drought and cyclones, a surge in parasites, and better opportunities for producers to produce more profitable crops, such as tobacco. Output in sugarcane was also low during the same period, because of the weather conditions and strikes in the major sugar factory.

With vast natural pastures, Madagascar has a considerable potential for expanding output in livestock, yet total production in tons was fairly stable over the last few years, increasing by only 3 percent between 1990 and 1993. Madagascar has also substantial, but underexploited, fishing resources; high value crustaceans offer significant possibilities for expansion. Exports of shellfish have already accounted for an increasing share of export receipts, reaching 13 percent in 1994.

b. Industry

The industrial sector, including mining and energy, is quite small, representing less than 13 percent of GDP. Data on industrial production are highly tentative, but indicate that the industrial base is fragile and little diversified. Agricultural processing is predominant, as 50 percent of total production is related to food and textiles. Thus, developments in industry depend largely on agricultural production conditions. Expansion of industrial activities has been hampered by poor transport conditions, and by shortages of foreign exchange prior to the creation of the foreign exchange market, which resulted in shortages of fuel and spare parts (Appendix III, Tables VIII and IX).

Legislation on a free trade zone and a new investment code were adopted on December 29, 1989. The legislation on the free trade zone allows for an exemption of all export and import taxes, and of profit taxes for a period of 2-15 years. More than 70 enterprises received an agreement under this legislation between 1990 and 1992; 38 enterprises were operational in early 1993, and had created 7,728 new jobs at this stage. Net exports of free trade zone enterprises, however, remained negative in 1993-94, at some SDR 7 million, and this sector accounted for less than 0.3 percent of GDP during this period. The new investment code simplified administrative procedures for creating new enterprises, and allowed for exemptions of profit taxes for at least five years, and of import taxes on capital goods. As of November 1994, 235 new enterprises had received an agreement under this new investment code, and were expected to create around 10,000 new jobs and to invest some FMG 200 billion.

Madagascar faces major problems in the energy sector, as forest resources are overexploited, and the country depends completely on imports for its petroleum products. Thus, deforestation has been severe around the large urban areas, and has exacerbated the problems of soil erosion. Other significant potential energy resources, including solid fossil fuels, heavy oil, and coal, remain largely underexploited. Madagascar consumes 300,000-350,000 tons of petroleum products a year, which are used to generate around 80 percent of commercial energy consumed. A monopoly over all petroleum activities, including purchasing, transporting, refining and distributing, is exercised by the state-owned enterprise, SOLIMA. An edict of the Government in 1993 envisaged the elimination of this monopoly over importing, transporting and distributing activities for all petroleum products in 1995. Domestic prices are set by the Government, with adjustment being made infrequently (Appendix III, Table XIII). As a consequence, the amount of taxes on petroleum products actually paid by SOLIMA to the Government has been irregular. The national electric and water utility, JIRAMA, became a corporation with financial and managerial autonomy in May 1991. Its production of electricity increased over 1988-93, with an average annual growth rate of 4.2 percent, stemming mainly from hydroelectric production (Appendix III, Table XII).

c. Services

The services sector is dominated by transport, tourism, and trade. This sector was the main source of growth in GDP in 1988-90, when the Government embarked on an adjustment program, as it increased by an average 4.2 percent a year in real terms. After a sharp decrease in 1991, owing to the political turmoil, output grew moderately in 1992-94.

Madagascar is in great need of better transport infrastructure, as the population is unevenly distributed over a large area and concentrated in a few regional centers, and large distances exist between producing areas and major domestic ports and export points. Development in this sector is made difficult by a rugged topography, and a climate with heavy rains and frequent cyclones. In addition, maintenance of the existing infrastructure has often been lacking. Of the 50,000 km road network in Madagascar, one tenth is paved and only one half is suitable for vehicles. The poor condition of this network entails heavy recurrent costs, and often leads to disruptions in the supplying of goods to some isolated areas. The railroad network consists of two separate single track lines, one in the north of about 700 kilometers, and the other in the south of about 160 kilometers. It is operated by a state-owned enterprise under the Ministry of Transport. The decreasing trend in traffic observed during the last two decades has recently accelerated, with the number of passengers falling by 65 percent between 1987 and 1992, to 1.04 million, and the volume of goods decreasing by 35 percent over the same period. Maritime shipping plays a key role in foreign and internal trade. There are 4 international ports, of which one handles 70 percent of all freight, 13 coastal shipping ports, and numerous minor ports. Also, a navigable canal extends along part of the east coast. The freight tonnage has recently fluctuated a great deal, reflecting fluctuations in international trade and domestic activity. Air Madagascar, a state-owned enterprise, has a monopolistic position in air transport. The domestic market, however, was opened to some competitors in 1991 for small planes, and the opening of international routes to competitors is envisaged for 1995. Developments in the total number of passenger reflect mainly fluctuations in tourism. Following an increase in the late 1980s, total ridership fell sharply in 1991, and recovered somewhat in 1992.

Tourism has great potential in Madagascar. It experienced a boom in the past few years, but is still at an early stage of development (Appendix III, Table XI). This boom was briefly interrupted in 1991, because of political turmoil and the Gulf war. Between 1988 and 1994, the number of nonresident tourists almost doubled, to around 65.000. In the same period, the average length of stay also doubled, from one to two weeks. Nearly 60 percent of tourists come for leisure, and 30 percent for business. During this period, total hotel capacity expanded by 125 percent, to 4,000 rooms. Tourism receipts totaled SDR 32.2 million in 1994, compared with SDR 15 million in 1988. The authorities are trying to develop an ecologically oriented tourism, as unique fauna and flora exist in Madagascar.

III. Population. Employment. Wages, and Prices

1. Population

The last population census took place in August 1993. The population of Madagascar is estimated to have grown at an average annual rate of 2.6 percent over the last six years, and was just above 12 million in 1993 (Appendix III, Table XIV). Madagascar’s population is very young, as more than 40 percent of the people are less than 15 years old, and around 70 percent are less than 30 years old. It also remains extensively rural, with an urbanization rate lower than 25 percent. As mentioned above, real GDP per capita has been declining for more than two decades. The latest figures on income distribution indicate that the top fifth of the population receives about 60 percent of national income, and the bottom fifth only 5 percent. Health conditions remain very poor. Madagascar has about 1 hospital bed per 1,000 inhabitants, fewer than 17 physicians per 100,000 inhabitants, and fewer than 6 nurses and nursing auxiliaries per 10,000 inhabitants. This young population is also in need of more education, as only 1.17 million children are enrolled in primary education, that is, 54 percent of the population aged between 6 and 12 years.

2. Employment

Data on the labor force are fragmentary, consisting of a few surveys and estimates of nongovernment employment based on contributions to the Social Security Fund (Caisse Nationale de Prévoyance sociale, CNaPS), and on censuses and surveys of the civil service. Estimates of the total labor force indicate that it increased by an average rate of 2.5 percent between 1987 and 1993 (Appendix III, Table XIV). That seems to be underestimated, however, as the total population aged between 15 and 64 is estimated to have increased by an average rate of 5 percent over the last three years. More than 85 percent of the total labor force is in agriculture.

Data on nongovernment wage employment, albeit incomplete, suggest that it decreased by 3.6 percent between 1990 and 1992, to 270,000. The services sector is the major source of this category of employment, accounting for 40 percent of the total. The number of civil servants is also estimated to have decreased over this period, as the Government sought to streamline its work force, mainly by not replacing retired civil servants. Hence, there are indications of high unemployment, although the informal sector is said to have expanded. A detailed survey of the informal sector is envisaged for 1995, with the help of foreign assistants.

3. Wages

Minimum wages are set for a variety of skills. Thus, within 16 professional categories, minimum wage levels are determined for up to 14 different grades. A few years ago, it was estimated that approximately 40 percent of employees were paid the minimum in their category. The magnitude of salary adjustments has increased in recent years (Appendix III, Table XV). However, real wages (measured as wages deflated by the consumer price index for low-income households) fell sharply between July 1985 and December 1994, by 41 percent for the lowest category of skills and 61 percent for the highest category (Chart 3). Minimum wages for the lowest category are now close to the subsistence level, equivalent to US$16.4 a month in December 1994. By comparison, the average monthly consumption of rice per person--about 11 kg--would cost about US$5 in the Malagasy markets.

CHART 3
CHART 3

MADAGASCAR REAL WAGES, 1984–94 1/

(End of period; index 1984 = 100)

Citation: IMF Staff Country Reports 1995, 064; 10.5089/9781451825206.002.A001

Source: Direction Generale de la Banque de Donnees de l’Etat.1/ Defined as the minimum wage for the nonagricultural lowest category deflated by the CPI.

4. Prices

Consumer price statistics are maintained for traditional (low-income) and modern (high-income) households in Antananarivo. They are based on consumption patterns that prevailed from August 1971 to July 1972, and as a result, are no longer a very accurate measure of price trends. Inflation as measured by the traditional consumer price index accelerated sharply in 1994 (Appendix III, Table XVI). After having fluctuated in the range of 8-15 percent over the period 1989-93, the year-to-year inflation rate rose to 61.2 percent at end-1994. Rice prices increased by 77 percent and contributed significantly to this high inflation, given their weight of 16 percent in the index for traditional households. The main factor behind this acceleration was the sharp increase in the money stock, added to the monetary overhang that had built up during 1989-93. On average, the consumer price index rose by 39.1 percent, which was very close to the 40.3 percent increase in the GDP deflator.

IV. Public Finance

1. Recent developments

In the 1990s, Madagascar’s overall fiscal performance has deteriorated significantly. The deterioration began after the stabilization and adjustment program (which had started in 1987 and was being supported by Fund resources), came to a halt in mid-1991, as civic strife and political tensions broke out during the transition toward a multiparty democracy. In a short period of time, the fiscal deficit (on a commitment basis and excluding grants) doubled, reaching 10 percent of GDP by 1992, owing to an across-the-board increase in expenditure and a sharp decline in revenue (Table 1). Since then, the authorities have been unsuccessful in reversing the deterioration, as revenue has continued to decline significantly. In 1994, total revenue reached 7.9 percent of GDP, the lowest level in more than a decade, contributing to a further deterioration in the fiscal deficit, to 12 percent of GDP from 10.7 percent in 1993 (Table 2). The worsening in the fiscal accounts has also been reflected in the primary balance, with annual deficits of about 1 percent of GDP since 1991. 1/ The overall deficit has been increasingly financed by central bank credits and an accumulation of external payments arrears, fueling inflation and hindering the country’s access to resources from multilateral institutions and bilateral donors.

Table 1.

Madagascar: Central Government Financial Operations, 1989–94

article image
Source: Ministry of Finance and Budget.

Mainly the Export Stabilization Fund (FNUP) until 1989 and Caisse Vanille from 1990. It also includes the net position of other treasury operations.

As of 1993, the increase in foreign debt service represents the consolidation of the debt between the Central Bank and the Treasury.

Noninterest current expenditure plus domestic financing of public capital outlays.

Total revenue minus noninterest current expenditure minus domestic financing of public capital outlays.

Table 2.

Madagascar: Fiscal Indicators, 1989-94

article image
Source: Ministry of Finance and Budget.

Includes current, capital, and additional expenditures; excludes payment delays and arrears.

2. Expenditure trends

Total expenditure has fluctuated widely since the mid-1980s. Much of this fluctuation has been related to capital outlays. Noninterest current expenditure had, until recently, remained relatively stable at about 8 percent of GDP, whereas total interest payments have climbed steadily. During 1992-93, total expenditure averaged 20.3 percent of GDP, compared with an average of 17.5 percent in the period 1984-90. However, in 1994, the sharp drop in total revenue posed a harsh constraint on noninterest current expenditure. In addition, the decline in foreign disbursements hindered capital expenditure. As a result, in 1994, total outlays (excluding total interest payments) declined by 2.8 percentage points of GDP from the 1992-93 level, to 13.8 percent. However, including total interest payments, total outlays declined by 0.7 percentage point of GDP, to 19.9 percent, as late interest payments rose sharply because of the increase in the stock of external payments arrears (Chart 4).

CHART 4
CHART 4

MADAGASCAR MAIN FISCAL INDICATORS, 1982–94

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 064; 10.5089/9781451825206.002.A001

Source: Ministry of Finance and Budget.

Madagascar has devoted relatively few resources to the social sectors, which comprise education, health, and social and community services. In the period 1988-93, current expenditure on these sectors remained at about 3 percent of GDP (Appendix III, Table XVIII).

a. Current expenditure 2/

(1) Budgetary expenditure

Noninterest expenditure declined from about 10 percent of GDP in the mid-1980s to 6 percent in 1994. This decline was due entirely to lower personnel outlays, as nominal salary increases were generally kept below price increases. This trend was temporarily reversed in 1991 when the authorities granted a substantial rise in nominal salaries, ranging from 13 percent to 33 percent. However, real average salaries continued to decline in the following years as no increases were granted until the beginning of 1994, when the rise ranged from 8 percent to 42 percent depending on the category. 1/ Nevertheless, this was not enough to compensate for past losses. Thus, average salaries in the public sector fell in real terms in 1994 by almost 20 percent from their peak in 1991 (Appendix III, Table XIX). As a result, the wage bill declined from almost 6 percent of GDP in the mid-1980s to 3.5 percent in 1994, one of the lowest levels in Sub-Saharan African countries.

Personnel outlays also declined as the authorities reduced the number of (permanent) civil servants by 8 percent during a three-year period starting in 1989. In the subsequent years, as the Government adopted a hiring freeze, the civil service labor force continued to decline because of normal attrition, retirement, and voluntary departures, falling by a further 2.5 percent through end-1993. 2/ However, this policy, together with a slow redeployment of the remaining public employees, has weakened key areas of public administration, such as tax collection agencies, because of inadequate manpower. Furthermore, the civil service is aging rapidly, with the average age being over 50 at present.

In contrast, expenditure on other goods, services, and transfers has remained stable, at around 3 percent of GDP, since the mid-1980s. However, transfers have been growing more rapidly, particularly since 1991, owing to the expansion of transfers to local governments and autonomous public entities. The rise in interest payments as a percentage of GDP was due to higher domestic interest payments, as the deficit was increasingly financed through the domestic banking system; and, since 1992, to the transfer of most of the foreign debt service from the Central Bank to the Treasury under a consolidation agreement reached; and to the use of the current exchange rate when determining the debt service in local currency instead of the rate in effect at the time the debt was incurred. As a result, total interest payments (including moratorium interest) as a percentage of GDP reached about 6 percent in 1993 (Table 2). In terms of functional classification, general public services, a category that includes national defense and security expenditure, has continued to account in the 1990s for over one third of noninterest budgetary expenditure, with defense outlays explaining about half of this amount (Appendix III, Table XVIII).

(2) Extrabudgetary expenditure 1/

Extrabudgetary expenditure reached 0.8 percent of GDP on average in the period 1984-89, but declined to just 0.1 percent of GDP by 1991. However, since then, it has increased continuously, reaching almost 1 percent of GDP by 1994. The decline was associated with the lower expenditure of the export stabilization fund (FNUP) as the levies on exports of coffee, cloves, and other agricultural exports, with the exception of vanilla, were abolished in the late 1980s (Appendix III, Table XXI). In contrast, the expansion was mostly related to the operations of the other treasury accounts (AONT). In particular, the authorities lent traders over FMG 50 billion (equivalent to almost SDR 9.5 million) in 1994, to finance about one third of the year’s total rice imports, and transferred FMG 20 billion to IVAMA, the Vanilla Institute, which in turn used the money to finance the purchase of vanilla by traders from the local producers. In addition, the net operations of several funds deteriorated, as the Government increased pensions without raising employees’ contributions.

b. Capital expenditure

Capital expenditure has varied significantly since the mid-1980s as a result of its increasing dependence on foreign sources of financing. 2/ During the early 1980s, central government investment represented about half of total investment in the economy (Appendix III, Table XXII). Productive sectors such as agriculture and public works generally accounted for over 50 percent of public investment allocation in Madagascar, as in many other sub-Saharan African countries.

Since the late 1980s, there have been some changes in the composition of public investment, given the slight increase in the allocation for social sectors, including education, health, and social and community services. These sectors accounted for 8 percent of total capital expenditure in 1987, and increased to 12 percent by 1994, mostly as a result of the expansion in education and health, whereas social and community services declined. Over the same period, public works--heretofore the largest recipient of public investment--lost ground to industry, energy and mining, and general public services.

3. Revenue trends

a. Overview

Total revenue (budgetary, extrabudgetary, and capital revenues) performance weakened sharply during the period, after having reached a peak of almost 15 percent of GDP in 1987. 1/ By 1994, the deterioration deepened dramatically as total revenue declined to 7.9 percent of GDP. The decline was mostly brought about by a deterioration in tax administration, and by a reduction in the tax base that occurred in the late 1980s with the elimination of all export taxes (except on vanilla exports), whose yield had previously averaged around 1.4 percent of GDP. In addition, generous tax incentives granted under the Investment Code, the creation of a tax-free zone in 1989, and the implementation in 1994 of ad hoc tax exemptions and exonerations, particularly for imported foodstuffs and petroleum products, have also narrowed the tax base. 2/ A complex income tax system and frequent changes in indirect taxation have also hindered the tax effort (Appendix II). 3/ As a result, the increase in tax collections has generally lagged behind the increase in nominal GDP. This lack of dynamism in the tax system is reflected in a tax buoyancy estimated at 0.73 (Chart 4). 4/

Tax revenue has become increasingly dependent on the taxation of imported goods since the mid-1980s. Revenue from imports rose from around one third of budgetary revenue in the mid-1980s to over 45 percent after 1988, whereas the share of revenue from taxes on goods and services declined slightly, to close to 30 percent. The adoption of a value-added tax (VAT) in September 1994 was expected to boost the contribution of taxes on goods and services.

b. Tax receipts

Tax revenue declined from a peak of 11 percent of GDP in 1987 to 7.2 percent in 1991, a time of general strikes and social turmoil (Table 2). In the following years, the reduction in social tensions contributed to an improvement in tax collection, which increased to about 8.8 percent of GDP in 1992-93; however, it deteriorated again in 1994, reaching only 7.3 percent of GDP. 1/

An important reason behind the decline in tax revenue was the deterioration in tax administration. This was reflected in sharp variations in the effective tax on imports over the years and in the accumulation of tax arrears.

In this context, in 1994, the Government granted a wide range of tax exemptions for imported foodstuffs and farm inputs, which contributed to the decline in the effective tax on imports. Moreover, prices of petroleum products and wheat flour were not adjusted despite the significant exchange rate depreciation after the float was introduced, which contributed to a decline in collection of excise taxes. The cost in forgone revenue amounted to about FMG 170 billion. 2/ In addition, the Government also exempted some vanilla exporters from the export taxes, and failed to collect the tax on almost half of the volume exported in 1994 (the tax revenue loss was estimated at FMG 41 billion). 3/ Furthermore, at the beginning of 1994, direct tax arrears were estimated at FMG 55.1 billion and indirect tax arrears at FMG 36 billion. However, toward end-1994, the authorities managed to recover about FMG 45 billion in tax arrears, of which FMG 15 billion corresponded to direct taxes. 4/

V. Money and Credit

1. Financial structure and instruments of monetary policy

The period of instability in Madagascar beginning the second half of 1991 interrupted the gradual move from direct to indirect monetary and credit controls. It resulted also in a serious deterioration in the situation of major banks. The banking system now has a dichotomous nature, consisting of three private commercial banks that are foreign controlled, basically sound, and overliquid, on the one hand, and two state-owned banks in a precarious financial situation, on the other. That dichotomy complicates considerably the conduct of monetary policy.

a. Structure

The financial sector consists of the Central Bank, five commercial banks, a postal savings and checking system, an insurance company, and a national investment fund. 1/

The Central Bank of Madagascar (BCM) was established in 1973 following the decision of the Government to withdraw from the franc zone. New statutes were adopted June 10, 1994, making it independent from the Government. According to these statutes, the Central Bank is responsible for the internal and external stability of the national currency, and to this end, it formulates and implements monetary and credit policies. The Central Bank is working with the Bank Control Commission (Commission de Contrôle des Banques et Etablissements Financiers, or CCBEF), which is responsible for the supervision of the commercial banks. The BCM is also responsible for the management of official foreign assets.

The commercial banking sector comprises two state-owned banks: the National Bank for Rural Development (BTM), and the National Bank of Commerce (BFV); and three private foreign-controlled banks: the National Bank for Industrial Development-Crédit Lyonnais (BNI-CL), the Banque Malgache de l’Océan Indien (BMOI), and the Union Commercial Bank (UCB). The financial position of the two state-owned banks continued to deteriorate during the last few years, reflecting substantial loans to troubled public enterprises and other doubtful borrowers. Although two clearing operations to restructure their portfolios were mandated in the late 1980s, the burden of losses and provisions for doubtful loans remained heavy, amounting to 63 percent of net bank earnings and 7 percent of the average loan portfolios for the two banks over 1990-93. In 1994, further provisions were made, resulting in estimated negative net worth, the amount of which has to be confirmed after the accounts have been audited. Thus, during the recent years, these two banks have not met prudential ratios, and have experienced reserve deficiencies, even though the Central Bank has recently provided them with liquidity. The private banks, in contrast, have made substantial profits and accumulated excess liquidity, but have been reluctant to lend to the state-owned banks because of a lack of confidence.

b. Instruments of monetary policy

(1) Credit ceilings

Credit ceilings are still the principal instrument used to control the monetary aggregates. They are established quarterly for the total amount of credit, excluding credits financed with external resources, and are derived from targets for credit expansion based on projections for monetary aggregates and the balance of payments, and according to the usual seasonal pattern. The global credit ceiling is then apportioned among the commercial banks, on the basis of the deposit share of each bank. If the ceiling is exceeded, a compulsory deposit must be made with the Central Bank, in addition to payments of interest fees. At end-1994, the two state-owned banks exceeded their ceilings. Until end-1994, they did not pay penalty interest fees on excess credit, which reduced incentives for not exceeding the ceilings.

(2) Reserve requirements

The current system of reserve requirements was established in November 1990. The reserve base consists of the total deposits in local currency by residents, calculated at month-end; the corresponding reserves have to be maintained beginning a month thereafter. The reserve requirement was increased from 6 percent to 12 percent in April 1994; in May, it was fixed at 25 percent, of which a minimum of three fifths (i.e., 15 percent) must consist of banks’ average daily balances with the BCM over the month or cash in vault, and a maximum of two fifths of treasury bills. This dual system was chosen for two reasons. It provided banks with a return on the reserves they hold, as current deposits with the BCM are not remunerated. It also made it possible to stabilize the outstanding balance of treasury bills, at a time when the Government was thought to have financing problems. These sharp increases in the rate helped to absorb part of the excess liquidity of the banking system, and forced the state-owned banks to look for refinancing from the BCM. The penalty for reserve deficiency consists of interest fees computed on the average amount of deficiency during the reference period, at an annual rate which was recently increased from 25 percent to 35 percent.

(3) Interest rates

The authorities have progressively decontrolled interest rates, beginning in 1983 when the minimum lending rates were abolished and all deposit interest rates were decontrolled. However, in a December 1986 circular, the Central Bank invited the commercial banks to set lending rates on the basis of the discount rates. Thus, at that time, a change in the discount rates directly affected all lending rates, which were typically established by adding a margin to the appropriate discount rate. 1/ In 1990, the two discount rates were unified into a basic rate (taux directeur) of 12 percent, which remained unchanged until April 1994. The rate was raised to 16 percent in May 1994, and to almost 24 percent in December 1994. However, only the first of these increases was followed--partially--by an increase in lending rates, as private commercial banks did not need refinancing from the BCM, and they were afraid of creating doubtful debtors by making interest rates too high. Thus, the main impact of increasing the basic rate has been an increase in rates at which the BCM has intervened in the money market, and in penalty rates for exceeding credit ceilings and for reserve deficiencies. Under these conditions, as soon as payments of interest fees are enforced, the credit ceilings and reserve requirements systems will be strengthened.

(4) Money market intervention

In November 1990, the previous arrangements that had provided for the refinancing of all eligible loans and for the placement of commercial banks’ deposits in interest-bearing accounts with the BCM were replaced by a dual system of auctions to inject or absorb liquidity from the banking system.

Under these new arrangements, to inject liquidity, the BCM may request bids from banks to borrow funds for an announced period, normally ranging from three to seven weeks (appels d’offres positifs, or AOPs). When requesting bids, the BCM also publishes the minimum acceptable interest rate, as well as the amount and maturity date of previous financing operations. It also determines but does not publish the amount to be auctioned. The Central Bank accepts bids, starting with the highest one (i.e., the bid with the highest interest rate), in descending order, up to the total amount it has decided to auction. Eligible credits, defined in principle as economically useful credits, are used as collateral for AOPs. The AOPs may be supplemented by two- to ten-day advances (pensions), and in exceptional circumstances, by special short-term advances (one- or two-day, in principle). Interest rates for those operations are, respectively, 1.5 percentage points and 2.0 percentage points above the latest weighted average rate for AOPs. 2/

There are parallel arrangements for the absorption of liquidity from commercial banks through a similar system of auctions (appels d’offres négatifs, or AONs), with the maximum acceptable interest rate and the maturity (about three weeks in general) announced in advance. The facility is supplemented as needed by special short-term interest-bearing deposits with the Central Bank.

When treasury bill auctions were resumed in July 1993, after a two-year hiatus (see Section b.(1) below), AONs were suspended to encourage the banks to participate in the auctions. Since May 1994, following the increase in reserve requirements, the BCM has provided the two state-owned banks with AOPs and two- to ten-days advances. Rates in the money market were extremely stable between November 1991 and May 1994, owing to the intervention of the BCM, as the rate for AONs did not diverge from 9 percent. Between May and November 1994, minimum acceptable and maximum rates for AOPs remained between 16 percent and 17 percent. Accordingly, throughout this period, the rate for two- to ten-day advances remained at 18.5 percent. In December 1994, following the increase in the basic rate of the BCM, rates for AOPs were increased to almost 24 percent, and those for advances to 26.5 percent.

(5) Interbank money market

While the Central Bank, through its intervention in the money market, deals with the overall liquidity of the banking system, the interbank market ensures in principle the distribution of the liquidity within the system and the correction of temporary imbalances among banks. Terms and conditions in the interbank market are freely negotiated between participants, subject to daily reporting to the Central Bank of the interest rate, the maturity, and the volume of each operation. Market activity has been very sluggish, owing to the reluctance of the private banks to lend to the two state-owned banks. As a result, private commercial banks have accumulated excess liquidity (defined as cash, deposits with the BCM, and treasury bill holdings in excess of reserve requirements), amounting to FMG 80 billion at end-1994, while the two state-owned banks experienced reserve deficiencies of FMG 74 billion at end-1994. The range of interest rates in the interbank market has tended to fluctuate within the limits set by the arbitrage opportunities between the interbank and the money markets.

(6) Treasury bills

Auctions of treasury bills (bons du trésor par adjudication, or BTAs) can be subscribed by banks and the insurance company. The transactions are paperless, and the computerized accounts are kept by the BCM, which facilitates their use as collateral in repurchase agreements. The auction is a pure Dutch system (the subscriber pays what he offered), and bids are expressed in term of a discounted value from par. When the auctions were resumed in July 1993, after a two-year suspension, sales of 6-, 9-, and 12-month treasury bills took place. Since October 1993, only three-month treasury bills have been auctioned. The amounts auctioned reached FMG 151 billion in 1993, and fluctuated between FMG 10 billion and FMG 120 billion a month in 1994, providing for a volume of FMG 151 billion and FMG 191 billion outstanding at end-1993 and end-1994, respectively. The average yield on 3-month bills was 11-13 percent from October 1993 to April 1994. From May to December 1994, the yield increased to a range of 15.4-16.8 percent. All the interest received on BTAs is tax free. The Government also issued, once in 1993, five-year treasury bills on a tap basis (bons du tr𠃩sor classiaues, or BTCs), in an amount of FMG 40 billion, with the interest payable in advance. Neither BTAs nor BTCs are negotiable, and accordingly no secondary market has been able to develop.

(7) Banking supervision

An ordinance to regulate the establishment and operation of banks and other financial institutions was enacted in 1988. It defines the jurisdiction over the financial system, which is divided among the Ministry of Finance, the Central Bank, and the newly created supervisory body, the CCBEF. It also determines some prudential rules setting specific limits on some of the banks’ operations.

To control the solvency of the banks, the Central Bank establishes two minimum ratios. The first ratio, which relates the capital and reserves to the gross loan portfolio, is set at 8 percent. The second ratio relates capital and reserves, after deducting doubtful loans, to the net loan portfolio, also after deducting doubtful loans, and is set at 4.5 percent. As a result of the deterioration in the state-owned banks’ portfolios, this second ratio has not been respected by these banks.

New credit ratios were established in addition to the above ratios in the 1988 banking law. According to these stipulations, first, outstanding credit to one client should not exceed 5 percent of a bank’s loan portfolio. Second, a bank’s lending to any given enterprise should not exceed 50 percent of the total borrowing of the enterprise from the banking sector. Third, the combined total of large loans of a bank--that is, those exceeding 25 percent of a bank’s equity capital--should not exceed the limit of ten times its available equity capital (fonds propres disponibles).

Some of the provisions of the 1988 banking law need to be reviewed, to take into account recent developments in the sector and give the supervisory body more flexibility and authority. Solvency rules should be redefined with more precision, and confusion with regard to jurisdiction over the financial system needs clarification as well. A revised banking law is scheduled to be submitted to Parliament in mid-1995.

2. Recent developments

a. Overall developments. 1991-94

In 1990-93, the main objective of monetary policy was to limit the increase in broad money in line with that of projected nominal GDP so as to avoid pressures on domestic prices and the external current account. However, broad money increased on average by 23.8 percent per annum between end-1990 and end-1993, while nominal GDP increased by only 11.9 percent (Tables 3 and 4). Therefore, the income velocity of broad money declined further, from 5.6 in 1990 to 4.6 in 1993. Broad money stock deflated by the CPI grew by 11 percent per annum, possibly reflecting the building up of a significant monetary overhang rather than a deepening of the banking intermediation (Chart 5). This growth in money supply was in good part due to the increasing monetization of the budget deficit, reflected in a substantially larger change in net credit to the Government from FMG 61 billion in 1990 to FMG 142 billion in 1993. Credit to the rest of the economy, including credit to the private sector and to public enterprises, grew in line with nominal GDP, at 11.5 percent per annum on average between 1990 and 1993. In addition, there was a further expansion of net foreign assets stemming from the commercial banks. Net foreign assets of commercial banks increased from SDR 32 million at end-1990 to SDR 79 million at end-1993, while net foreign assets of the BCM, excluding arrears related to foreign debt, remained broadly constant in SDR terms. 1/

Table 3.

Madagascar: Monetary Survey, 1991-94

(In billions of Malagasy francs; end of period)

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Source: Central Bank of Madagascar (BCM)

Credit to economy, which includes “credit to the private sector and state enterprises”, has been revised to show gross credit outstanding. Previously, commercial banks had been reporting it net of provisions for loan losses.

Table 4.

Madagascar: Selected Monetary Indicators, 1989-94

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Source: Central Bank of Madagascar.

Calculation for 1992 are based on “After Consolidation” figures.

CHART 5
CHART 5

MADAGASCAR MONEY, EXCHANGE RATE, AND PRICES

Citation: IMF Staff Country Reports 1995, 064; 10.5089/9781451825206.002.A001

Sources: International Financial Statistics; and staff estimates.1/ Malagasy franc per SDR, deflated by the CPI. An increase (decrease) Indicates depreciation (appreciation).

In 1994, the broad money growth accelerated sharply, to nearly 50 percent. Money supply expanded by 54 percent, while quasi-money, including newly authorized deposits in foreign currency, grew by 37 percent. The main contribution to money growth was a strong increase in domestic credit, particularly in net credit to the Government. Domestic credit rose by 25 percent, equivalent to 31 percent of beginning broad money stock. The further widening fiscal deficit lead to a larger change in net credit to the Government, equivalent to 13 percent of beginning broad money stock. Net foreign assets remained broadly constant in SDR terms between end-1993 and end-1994. However, there was a drop in midyear, when commercial banks released part of their foreign assets to comply with a new requirement that the external position should not exceed 40 percent of equity capital and to meet higher reserve requirements. The increase then observed during the rest of the year was in parallel with the building up of deposits in foreign currency.

b. Operations of the Central Bank

The operations of the Central Bank (BCM) are summarized in Appendix III, Table XXV. The balance sheet of the BCM was restructured at end-1992, following an agreement with Treasury on foreign debt management. Since 1983, the Central Bank had been responsible for the servicing of the rescheduled debt. The arrangements then in force provided for the domestic debtor, in particular the Treasury, to continue to repay its loans according to the terms and conditions of its initial contract, at the existing exchange rate, and for the BCM to reimburse the foreign creditors on the basis of the rescheduling agreement, at the exchange rate on the day of reimbursement. As a result, the BCM accumulated huge losses, resulting from additional interest charges stemming form the rescheduling and valuation losses, and large external payments arrears, resulting from nonpayment by the initial debtors. Under the restructuring, the balance sheet of the BCM was cleaned up in three stages. First, there was an offsetting of the reciprocal claims between the Government and the BCM. Second, all the central bank claims on the Government arising from changes in the valuation of BCM foreign assets and liabilities, cumulative operating losses, and claims on delinquent debtors were regrouped in a consolidated account. Finally, the central bank liabilities resulting from rescheduling operations and external arrears were transferred to a newly established fund for management of the external debt, which is managed and administered by the Central Bank on behalf of the Treasury, but whose accounts are separated from those of the BCM.

During the period 1991-94, the Central Bank accounted for a broadly stable proportion of total domestic credit, at some 36 percent. Its assets are dominated by gross credit to the Government in the form of ordinary advances. Net foreign assets of the Central Bank were broadly constant in SDRs, at about SDR 50 billion between 1990 and 1993, but dropped to SDR 40 billion at end-1994. On the liabilities side, reserve money grew at an annual average rate of 21 percent during 1991-93, and surged by 70 percent in 1994. An increase in currency in circulation of 58 percent and an even faster accumulation of commercial bank deposits at the Central Bank, following the increase in reserve requirements and the building up of penalty deposits for exceeding credit ceilings, were the major reasons for the expansion in reserve money in 1994. Government deposits at the Central Bank grew from FMG 327 billion at end-December 1992 to FMG 390 billion at end-December 1993, but decreased to FMG 283 billion at end-December 1994, then consisting almost exclusively of domestic counterpart funds of foreign aid.

c. Operations of the commercial banks

The commercial banks’ loan portfolios are dominated by credit to the private and public enterprise sector. In terms of maturity, most of the credit operations of the banks relate to short-term lending. Credit to the private and public enterprise sector, which had grown by an average of 12.5 percent a year during 1991-93, increased by another 26 percent in 1994 (Appendix III, Table XXVI). The commercial banks were in a net debtor position vis-à-vis the Central Government until mid-1993, with deposits of the Government exceeding credit to Government by FMG 121 billion at end-1992. After issuance of treasury bills resumed in July 1993, the commercial banks shifted to a net creditor position, with their balance amounting to FMG 108 billion at end-1994. The foreign assets of the commercial banks grew substantially between 1990 and 1993 in SDR terms. The commercial banks continuously increased their working balances throughout this period, with a view to ensuring that their correspondents abroad could be timely in meeting documentary credits on imports as they fell due.

Deposits with the commercial banks grew at an average annual rate of 25 percent over the period 1991-93. In 1994, when deposits in foreign currency were allowed for all residents, they reached FMG 217 billion at year-end, from FMG 19 billion at end-1993, while deposits in Malagasy francs increased by an additional 23 percent. Since the expansion of the commercial bank deposit base outpaced that of credit operations until end-1993, the commercial banks, as mentioned above, accumulated sizable liquid assets, in the form of reserves with the Central Bank, foreign assets, and treasury bills. Although the reserve requirement rate was increased to 25 percent in May 1994, the three private commercial banks are still in a position of excess liquidity, estimated at FMG 80 billion at end-1994.

VI. External Sector

1. Balance of payments

a. Overview

Since the late 1980s, Madagascar’s balance of payments has deteriorated sharply because of a number of factors, both exogenous and policy-related. Persistently unfavorable terms of trade between 1987 and 1992, expansionary demand policies, and a worsening political and social situation led to a substantial loss in international reserves of the Central Bank. The authorities responded by adopting a rationing system to allocate foreign exchange; accumulating external payments arrears; intensifying restrictions on current account transactions, in a reversal of previous efforts to liberalize the country’s international trade and payments system; and interrupting the nominal exchange rate adjustments according to the inflation differential with its main trading partners (Table 5).

Table 5.

Madagascar: Balance of Payments, 1989-94

(In millions of SDRs)

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Source: Central Bank of Madagascar.

Includes valuation adjustment; short-term capital; and errors and omissions.

In percent of GDP.

Gross foreign exchange reserves of the Central Bank declined from the equivalent of 23 weeks of imports of goods and nonfactor services at end-1989 to less than 6 weeks at end-1993, and external payments arrears, which had been eliminated in 1990, rose to SDR 873 million at the same time. Furthermore, reflecting adverse developments in the trade balance, the current account deficit, excluding official transfers, deteriorated to an average of 11.0 percent of GDP between 1990 and 1993, compared with 8.8 percent of GDP in the previous four years. However, during the first half of 1994, the authorities took important measures to reverse this deterioration, particularly a sweeping reform of the exchange and trade system, including the free float of the Malagasy franc; the termination of practically all import prohibitions; the liberalization of most current transactions; a reduction in import tariffs; and the elimination of restrictions on residents and nonresidents wishing to open foreign exchange accounts at local commercial banks. Although these measures quickly improved the foreign exchange position of the Central Bank and the trade balance, the current account, excluding official transfers, deteriorated further, to 12 percent of GDP in 1994, and the stock of external payments arrears rose to SDR 1,140.1 million (Chart 6).

CHART 6
CHART 6

MADAGASCAR EXTERNAL SECTOR MAIN INDICATORS, 1984-94

(In millions of SDRs)

Citation: IMF Staff Country Reports 1995, 064; 10.5089/9781451825206.002.A001

Source: Central Bank of Madagascar.1/ As of 1989, including exports from the export processing zone.2/ Coffee, vanilla, cloves, and pepper.3/ Excluding official transfers.

b. Trade

Except for a brief interlude between 1986 and 1987, Madagascar’s trade balance has been in a continuous deficit over the last decade. A sharp fall in the terms of trade, particularly between 1987 and 1990 caused the deficit to peak at SDR 183 million in 1990, while a persistent appreciation of the real effective exchange rate since end-1991, of over 40 percent, resulted in the deficit averaging SDR 100 million, despite a recovery in the terms of trade during the 1990s.

(1) Merchandise exports

Foreign exchange earnings from exports have remained relatively flat in SDR terms despite a 7 percent average annual growth in export volume in the last decade, as exporters responded to the increase in their international competitiveness resulting from the sharp depreciation of the real effective exchange rate in 1986-87, the elimination of most export taxes, and the liberalization of agricultural prices. However, the volume gains were curtailed by a sustained decline in the export unit prices of around 38 percent in the period 1987-90 and another 13 percent in 1991-93. The fall in export prices was especially marked in the traditional exports of coffee, vanilla, cloves, and pepper (Chart 6).

During the last decade, Madagascar has been relatively successful in diversifying its export base from traditional to nontraditional products. The latter’s share in total exports rose steadily from 31 percent in 1985 to around 75 percent in 1993. Among non-traditional exports, exports of shellfish performed particularly well over the period, rising from SDR 21 million in 1984 to SDR 29 million in 1993, as ocean catches were supplemented by an expansion in prawn cultivation during a period of favorable international prices. Exports from the export processing zone, consisting largely of textiles and clothing, rose dramatically since its establishment in 1989, to SDR 35 million in 1993 (Appendix III, Table XXVII).

Total exports increased 24 percent in SDR terms in 1994 to SDR 294 million, thanks mainly to the rebound in traditional exports. The threefold increase in the international price of coffee offset the reduction in coffee export volumes resulting from the damage inflicted by two cyclones in the early part of the year, and the volume of vanilla exports doubled as local production expanded in response to the significant rise in its minimum producer price established by the authorities in 1992-93.

(2) Merchandise imports

During the last decade, imports experienced wide fluctuations mostly associated with nonfood imports. Imports (c.i.f.) declined from SDR 430 million in 1984-85 to SDR 298 million in the period 1986-89 as a result of a sharp depreciation of the real effective exchange rate, rising import prices in SDR terms, and a slowdown in economic activity (Appendix III, Table XXVIII). In contrast, during the 1990s, imports have risen steadily, practically surpassing their 1984-85 level (Chart 6), owing to fewer import restrictions, and rising food imports, as well as imports associated with the free trade zone. This increase also took place as the real exchange rate experienced an important appreciation from end-1991 to early 1994. During this period, import demand was increasingly met by imports without recourse to foreign exchange (importations sans cession de devises) as a result of the foreign exchange shortage. 1/

As a result of a sharp depreciation of the real effective exchange rate after the float was introduced in May 1994, modest economic growth, and a contraction in the public investment program, nonfood imports declined in 1994 to SDR 367 million from SDR 393 million in the previous year. However, total imports continued to increase as rice imports rose sevenfold, owing to the damaging effects of the cyclones on domestic rice crops in the early part of the year.

c. Services and transfers

During the last decade, the services account has been dominated by the fluctuation in the number of tourist arrivals and the related swings in transport and travel receipts, the quasi-depletion of reserves of the Central Bank, and the unilateral decisions taken by France and Germany to cancel close to 20 percent of total external public debt outstanding at end-1990. During the 1990s, the service balance, particularly for nonfactor services, has deteriorated significantly as payments for public services, including those linked to projects, increased by about 75 percent from 1991 to 1993 because of higher public investments, and as freight and insurance rose, owing to higher imports. In addition, the accumulation of external payments arrears has caused late interest payments to rise significantly.

The upward trend in private transfers received in 1992 and 1993 is largely due to the rise in inflows from the counterpart of imports without recourse to foreign exchange (Chart 3, panel A). Excluding these inflows, private transfers averaged around SDR 30 million.

d. International reserves

Between 1989 and 1993, the net foreign asset position of the Central Bank remained broadly constant, except for a sharp fall in 1991 that was linked to an increase in arrears of the Central Bank (Appendix III, Table XXIX). However, this relative stability masked a persistent downward trend in holdings of freely available foreign exchange reserves, from a peak of SDR 124 million at end-1989 to only SDR 10.2 million at end-1993 and less than SDR 4 million at end-April 1994. The adoption of the floating exchange rate system at the beginning of May 1994 helped to reverse this trend and by end-1994, foreign exchange reserves of the Central Bank had risen to SDR 21.5 million, reflecting the fact that the Central Bank has been a net buyer in the interbank foreign exchange market. The large decline in medium- and long-term foreign liabilities owing to the consolidation of the foreign debt at the Treasury has helped mitigate the adverse impact of the loss of foreign exchange reserves on the net foreign asset position of the Central Bank.

2. External debt

a. Outstanding stock of external debt

The outstanding stock of external debt increased in the period 1991-94, from 126 percent of GDP to 139 percent of GDP, owing in part to an accumulation of external payments arrears estimated at SDR 1,140.1 million at end-1994 (Table 6). However, excluding external payments arrears, the outstanding stock of external debt declined over the same period from just over 100 percent of GDP to 83 percent.

Table 6.

Madagascar: Outstanding External Debt and Debt Service Payments, 1989-94

(In millions of SDRs)

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Source: Central Bank of Madagascar.

After debt rescheduling by Paris Club and other official creditors, and by commercial banks.

In 1991, the increase represents, in part, a reclassification of debt to other than Paris Club creditors as arrears.

Including late interest payments on arrears and interest on rescheduled debt. nonfactor services.

Total external debt (excluding external payments arrears) owed to the 14 Paris Club creditor countries declined from SDR 784 million at end-1991 to SDR 581 million at end-1994 as a result of debt cancellations from Belgium, Canada, France, Germany, Sweden, and the United States, averaging just under SDR 58 million a year over the period. 1/ The external debt owed to other official bilateral creditors also declined over the same period from SDR 247 million to SDR 41 million. The largest reduction occurred in respect of external debts owed to the Former Soviet Union (FSU), which were taken over by the Russian Federation in early 1994. In contrast, total external debt owed to multilateral organizations (excluding external payments arrears) increased from SDR 964 million at end-1991 to SDR 1,058 million at end-1994, most of it owed to the World Bank Group. The conclusion of debt-for-nature swaps with some London Club creditors, combined with a continued preference for contracting external public debt on concessional terms, contributed to the fall in debts owed to commercial banks and other private creditors, from SDR 42.6 million (excluding external payments arrears) at end-1991 to SDR 24 million at end-1994.

On June 2, 1991, Madagascar and the FSU agreed on the framework of a program that entailed both debt reduction and debt conversion, covering the period 1993-95, under which part of the debt would be settled in the following ways (the amounts were not specified): (i) in freely convertible currencies; (ii) in exchange for Malagasy goods; (iii) by netting out expenditures of Russian representatives and organizations operating in Madagascar; and (iv) by setting up debt conversions for mixed Russian-Malagasy enterprises to be established in the sectors of agriculture, mining, and public works. The 1991 agreement has been only partially implemented and new arrears have been accumulating. In particular, delays occurred in negotiating and making arrangements for setting up the seven enterprises.

b. External payments arrears

(1) Distribution by creditor groups

The authorities estimate that at end-1994, external payments arrears amounted to SDR 1,140.1 million, equivalent to 56 percent of GDP. With regard to the distribution among creditors, SDR 538.1 million (47 percent) was owed to Paris Club members; SDR 557 million (49 percent) to non-Paris Club official bilateral creditors, including Arab funds; 1/ SDR 25.1 million (2.2 percent) to multilateral organizations; 2/ SDR 18.2 million (1.6 percent) to London Club members; and SDR 1.7 million (0.2 percent) to private creditors.

(2) Structure of external payments arrears

The classification used by the authorities in reporting external arrears owed to official bilateral creditors (Paris Club and other official creditors) is based on the last Paris Club rescheduling agreement of July 10, 1990 (PC VII), and distinguishes between arrears on non previously rescheduled debt (NPRD) and arrears on previously rescheduled debt (PRD), as well as between arrears on pre-cutoff-date debt (pre-COD) and arrears on post-cutoff-date debt (post-COD). 3/

Of the estimated SDR 538 million in external arrears to Paris Club creditors at end-1994, SDR 524 million constituted arrears on pre-COD debts of which SDR 448 million corresponded to arrears on debt that had already been rescheduled under previous Paris Club- agreements. External payments arrears on post-COD debts reached SDR 13.8 million at end-1994. Arrears to non-Paris official bilateral creditors reached SDR 557 million, of which SDR 314 million was owed to the Russian Federation. Under the Agreed Minute of the 1990 Paris Club rescheduling agreement, Madagascar was to conclude comparable bilateral rescheduling agreements with all non-Paris Club official bilateral creditors. As of December 1994, only one bilateral agreement following the 1991 agreement and covering a small portion of total debts owed to the FSU had been signed (in late September 1994), establishing a debt-for-equity type arrangement, whereby external debt worth the equivalent of US$1.5 million is to be set aside in a special account at the BCM in the name of the Russian Bank of External Economic Affairs. The deposited amount is to be converted into Malagasy francs and used by Interferma, a Russian agricultural company operating in Madagascar, to finance investments. 1/

3. Exchange and trade systems

a. Exchange and trade arrangements

Madagascar continues to maintain exchange restrictions in accordance with the transitional arrangements under Article XIV, Section 2, of the Articles of Agreement, in the form of limitations on travel allowances and on transfers abroad of personal income earned by foreigners working in Madagascar. In particular, Malagasy residents are subject to the following exchange restrictions: 1) tourists are authorized to take up to F 6,000 per trip abroad (F 3,000 for children below 15 years old); 2) business travel, up to F 25,000 per trip; 3) travel for professional reasons, F 10,000 per trip; 4) travel for medical reasons: i) evacuation, F 15,000; ii) medical treatment, F 7,000; iii) accompanying a sick person abroad for treatment, F 6,000; 5) student: i) installation, F 6,000; ii) starting school, F 3,000; iii) monthly allowance, F 3,000; and 6) foreign workers can repatriate up to 35 percent of their net salary if their family also lives in the country; otherwise they can repatriate up to 60 percent. Transfers of dividends, profits, and proceeds from the sale of assets are also subject to certain restrictions.

Madagascar also maintains exchange restrictions that are subject to Fund approval under Article VIII, Section 2(a), evidenced by external payments arrears. 2/ After some progress in liberalizing the exchange and trade system during the first two years of the ESAF arrangement, which started in May 1989, the country suffered a serious setback beginning in 1991 as a result of the authorities’ decision to suspend the open general license (OGL) system and to adopt a rationing system to allocate foreign exchange and to discontinue adjusting the exchange rate according to the inflation differential with Madagascar’s main trade partners. Expansionary demand policies have also exacerbated the lack of foreign exchange. The resulting appreciation of the real effective exchange rate fostered illegal exports (e.g., vanilla and shellfish) and further stimulated import demand, which was increasingly met by imports without recourse to official foreign exchange as the foreign exchange reserves of the Central Bank dried up.

In line with the liberalization of the exchange rate regime in mid-1994, the authorities also terminated practically all import prohibitions and reduced the maximum import tariff from 50 percent to 30 percent. However, this reduction had a small impact on the import structure as most imported products fell in the 10-20 percent range. In addition to import tariffs, imports are also subject to import duties, VAT, and VAT surcharges. Import duties vary between 5 percent and 25 percent but most of the products fall in the 10-20 percent range; the VAT is set at 25 percent for all products (with many exceptions); and VAT surcharges vary between 5 percent and 150 percent (very few products are subject to this surcharge, namely alcoholic beverages, and tobacco). Therefore, total import taxes (excluding VAT surcharges) fall in a range of 40-55 percent for those subject to VAT and 15-30 percent for those exempted.

b. Exchange rate regime

Between April 2, 1982 and May 6, 1994, the exchange rate of the Malagasy franc was pegged to a basket of several currencies weighted by trade shares. Since May 9, 1994, the exchange rate has been determined by a daily interbank foreign exchange market. 1/ Participants in the market include the five commercial banks (three of which are branches of foreign banks and two are stated owned) and the Central Bank. 2/ The buying and selling of foreign exchange is conducted between banks and their clients at a rate that is freely negotiated among themselves. The Central Bank does not intervene in the market to influence the exchange rate in any sense. The intervention currency is the French franc (F) and orders denominated in other currencies are converted into French francs at the previous day’s closing rate in Paris. There are no taxes or subsidies on the purchase or sale of foreign exchange. Commercial banks are not permitted to accumulate foreign exchange assets in amounts greater than 40 percent of their capital base (see Appendix II).

In the ten-year period following the adoption of the currency basket in 1982, the exchange rate of the Malagasy franc was devalued frequently and experienced sharp nominal devaluations on several occasions. Beginning in November 1991, the authorities ceased to adjust the exchange rate according to the inflation differential vis-à-vis trade partner countries. As a consequence, the external competitiveness of Madagascar was reduced and the real effective exchange rate appreciated by over 40 percent between December 1991 and April 1994. With the adoption of the interbank foreign exchange market, external competitiveness improved as the real effective exchange rate depreciated by some 39 percent through end-January 1995. On April 28, 1995, the midpoint exchange rate vis-à-vis the SDR was FMG 6,495.08 = SDR 1, equivalent to FMG 846 = F 1.

APPENDIX I Madagascar: The Interbank Foreign Exchange Market

The following appendix analyzes the functioning of the interbank foreign exchange market since it began operating on May 9, 1994, and offers explanations for the swings in the exchange rate recorded during the first three months of the interbank market and for the remarkable stability of the exchange rate experienced through 1994.

1. The interbank foreign exchange market

a. Characteristics

Prior to the introduction of the interbank foreign exchange market, the exchange rate of the Malagasy franc had been pegged to a basket of several currencies since April 2, 1982, when the peg to the French franc was discontinued. Effective May 9, 1994, the exchange rate of the Malagasy franc is determined by a daily interbank foreign exchange market (Chart 1). Sessions are held between 10 a.m. and 12 p.m. and participants include the five commercial banks (three of which are branches of foreign banks) and the Central Bank. 1/ The BNI-CL and the BTM account for about 50 percent of the market. The buying and selling of foreign exchange are carried out between banks and their clients at a rate that is freely negotiated among themselves. The intervention currency is the French franc (F) and orders denominated in other currencies are converted into French francs at the previous day’s closing rate in Paris. There are no taxes or subsidies on the purchase or sale of foreign exchange. For prudential reasons, commercial banks are not permitted to accumulate foreign exchange assets in amounts greater than 40 percent of their capital base, although there are no limits on working balances. Export proceeds have to be repatriated and 90 percent must be sold in the interbank foreign exchange market within 90 days from the date of shipment of goods.

CHART 1
CHART 1

MADAGASCAR SELECTED EXCHANGE RATE INDICES, 1970–94

(1980=100; foreign currency per Malagasy franc)

Citation: IMF Staff Country Reports 1995, 064; 10.5089/9781451825206.002.A001

Source: IMF (IFS and INS).
b. Exchange rate movements. May 9 - November 30. 1994

On the first day of operation of the interbank foreign exchange market, 15 transactions totaling F 3.7 million were recorded and the mid-point transactions-weighted exchange rate reached FMG 513 = F 1, representing a 54 percent depreciation with respect to the last midpoint closing rate of FMG 333 = F 1 published by the Central Bank of Madagascar (BCM) on April 29, 1994 prior to the change in the exchange arrangement. In subsequent days, owing to a backlog of unmet orders to buy foreign exchange and the pressing needs of the Central Bank to service debt obligations arising from purchases of flour and petroleum products, and despite the large accumulation of foreign exchange by commercial banks (see below), the midpoint rate depreciated further, reaching FMG 662 = F 1 on May 17, 1994 (Chart 1; top panel). From then until the end of the month, the price of foreign exchange expressed in French francs fell as the supply of foreign exchange exceeded the demand, leveling out at FMG 553 = F 1 on May 31, 1994, representing a 16 percent appreciation from the middle of the month. From the beginning of June until mid-July, notwithstanding a slight appreciation in the last two weeks of June, the midpoint rate depreciated by a cumulative 26 percent. Finally, following a brief spell in late July during which the rate appreciated slightly once again, the midpoint exchange rate between late July and end-November remained remarkably stable at around FMG 700 = F 1.

The depreciation of the exchange rate over the period masks three distinct episodes during which the exchange rate appreciated against the French franc: in the last two weeks of May and of June, and again toward the end of July. During 1993 and until the May exchange rate liberalization, commercial banks’ foreign assets increased substantially, in part because of their concern about excess liquidity in the context of a shortage of foreign exchange. Having the necessary cash in foreign exchange allowed them to take commitments on behalf of their customers. In addition, although daily data are not available, from June onward, commercial bank holdings of foreign exchange were being fed by the surrender requirement of export proceeds. However, the Central Bank’s directive to limit commercial bank open foreign exchange positions to 40 percent of their capital base compelled the banks, at various times, to sell foreign exchange so as to comply with the directive. 1/ Thus, at times, commercial bank holdings of foreign exchange were more than adequate to meet the rising demand and the exchange rate appreciated.

c. Volume of transactions in the interbank market

Chart 2 reveals two striking features. First, fluctuations in the daily volume of transactions were not accompanied by adjustments in the exchange rate against the French franc. Second, the exchange rate against the French franc was remarkably stable in nominal terms beginning in early August (see also Table 1).

CHART 2
CHART 2

MADAGASCAR The Interbank Foreign Exchange Market May 9 - November 30. 1994

Citation: IMF Staff Country Reports 1995, 064; 10.5089/9781451825206.002.A001

Source: Commission de Controle des Banques et Etablissements Financiers.
Table 1.

Madagascar: Volume of Transactions in the Interbank Foreign Exchange Market, May 1994 - January, 1995

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Source: Commission de Contrôle des Banques et des Etablissements Financiers (CCBEF).