Cape Verde: 2001 Article IV Consultation—Staff Report and Public Information Notice on the Executive Board Discussion

In the conclusion of the previous Article IV Consultation, Executive Directors welcomed the elimination of quantitative import restrictions and the liberalization of foreign exchange regulations, and Directors emphasized the need to consolidate the progress made in containing the fiscal imbalances by continuing with prudent expenditure policies and further strengthening the tax system and budgetary procedures. Fiscal slippages occurred in the second half of 1999 and led to pressures on the balance of payments. Structural reforms created an environment conducive to private sector activity.

Abstract

In the conclusion of the previous Article IV Consultation, Executive Directors welcomed the elimination of quantitative import restrictions and the liberalization of foreign exchange regulations, and Directors emphasized the need to consolidate the progress made in containing the fiscal imbalances by continuing with prudent expenditure policies and further strengthening the tax system and budgetary procedures. Fiscal slippages occurred in the second half of 1999 and led to pressures on the balance of payments. Structural reforms created an environment conducive to private sector activity.

I. Introduction

1. About two years have lapsed since the last Article IV consultation with Cape Verde because the preparation of the elections led the authorities to request the postponement of a mission twice in 2000. In concluding the last Article IV consultation with Cape Verde, Executive Directors welcomed the elimination of quantitative import restrictions and the liberalization of foreign exchange regulations. They emphasized the need to consolidate the progress made in containing the fiscal imbalances by continuing with prudent expenditure policies and further strengthening the tax system and budgetary procedures. They observed that, with the exchange rate pegged to the euro, it was essential that monetary policy be geared toward both containing inflation and strengthening the level of official reserves.

2. Between February 20, 1998 and March 15, 2000, Cape Verde’s macroeconomic stabilization and structural reform efforts were supported by a precautionary Stand-By Arrangement in the amount of SDR 2.5 million (or 26 percent of quota; see EBS/98/18; 02/04/98).1 The three reviews were completed in September 1998, May 1999, and March 2000, respectively.2 The program supported by the arrangement aimed at reestablishing a sound macroeconomic framework that would serve as a basis for a comprehensive, donor-supported domestic debt-reduction operation.

3. The year 2000 was marked by strong political activity that intensified after the ruling Movimento para a Democratia (MpD) fared unexpectedly poorly in the municipal elections in February. Internal divisions deepened, weakening the government’s popularity in the runoff to the legislative and presidential elections in early 2001. The Partido Africano da Independencia de Cabo Verde (PAICV), which had fought for independence and governed the country between 1975 and 1991, won the legislative elections decisively, allowing Mr. José Maria Neves to head the country’s new majority government. The transition of power took place peacefully on February 1, 2001. The largely ceremonial position of president, however, was decided only after two rounds of elections and the intervention of the constitutional court, giving the PAICV-supported candidate, former Prime Minister Pedro Pires, a razor-thin advantage of less than 0.01 percent of all votes cast over Carlos Veiga, Prime Minister between 1991 and 2000.

II. Recent Economic Developments

4. Under the program supported by the precautionary Stand-By Arrangement, Cape Verde made good progress in 1998–99, despite occasional backsliding. Structural reforms created an environment conducive to private sector activity. Periodic delays notwithstanding, progress was made in the comprehensive privatization program, a key element of the overall domestic debt-reduction operation. Subsequently, real GDP growth accelerated, driven by (i) the development of tourism; (ii) significant foreign investments in the export-oriented manufacturing sector; and (iii) sustained and substantial inflows of workers’ remittances, which stimulated construction activities. During 1998–99, real GDP grew by an average of 8 percent. Compared with 1997, inflation was halved to an average level of 4.4 percent in 1998–99.

5. Fiscal slippages occurred in the second half of 1999 and led to pressures on the balance of payments, mainly because extraordinary public expenditures were undertaken to cushion the social impact of a serious drought that had destroyed much of the 1998/99 harvest. The widening overall fiscal deficit including grants (11 percent of GDP, compared with 4 percent in 1998) was accommodated throughout much of the year by higher-than-programmed credit from the central bank. The government managed to repay some central bank credit at end-December because of substantially higher-than-expected privatization receipts. Given the economy’s high degree of openness and the fixed exchange rate regime, the expansionary fiscal and credit policies led to higher imports and a widening of the external current account deficit (including official transfers) to 14 percent of GDP. To some extent, these current account pressures were contained by the Bank of Cape Verde (BCV), which temporarily reintroduced foreign exchange rationing in late 1999. With the significant inflows of foreign direct investment, mainly related to privatization, and large disbursements of bilateral and multilateral credits, the external capital account improved markedly, turning the overall balance into a surplus and thereby allowing a strong year-end accumulation of official reserves to the equivalent of more than two months of imports of goods and services. On balance, these developments led to an acceleration in broad money growth and excess liquidity in the banking system.3

6. In 2000, although real GDP growth slowed down, it still remained strong (about 7 percent), with exports rising sharply (nearly 30 percent). The import growth rate dropped to less than that of GDP, and there was an improvement in the external current account balance, Reflecting significant energy price subsidies, an improved 1999/2000 harvest, and the fixed exchange rate (limiting increases in import prices), consumer prices declined by almost 2½ percent. With this moderately negative inflation, the effective exchange rate depreciated in real terms (see Figure 1).

Figure 1.
Figure 1.

Cape Verde: Real and Nominal Effective Exchange Rates, January 1997-January 2001

(Index, July 1998= 100)

Citation: IMF Staff Country Reports 2001, 174; 10.5089/9781451809268.002.A001

7. In the context of the preparation of the elections and contrary to the commitment made by the government in place in February 2000,4 the deterioration in the fiscal stance that started in the second half of 1999 worsened in 2000. Much of the progress made in fiscal consolidation in previous years was reversed, endangering the peg to the euro.5 While revenue performance was satisfactory,6 the overall fiscal deficit, including grants, widened from 11 percent of GDP in 1999 to 19 percent, reflecting the impact of unforeseen restructuring costs in connection with the privatization of commercial banks7 (7 percent of GDP), the petroleum price subsidies (4 percent), and the newly budgeted student scholarships8 (1 percent). Moreover, the government did not adjust domestic petroleum prices in line with international prices, leading to subsidies equivalent to 4 percent of GDP. With no net foreign financing available, the deficit was largely monetized, while domestic and external arrears were accumulated, equivalent to 5 percent and 2 percent of GDP, respectively (see Box 1 and Figure 2). The sizable recourse to domestic bank credit (8 percent of GDP) increased the stock of domestic debt, including claims on the Trust Fund (the TCMFs),9 from 30 percent at end–1999 to 40 percent at end–2000; this largely reversed the impact of the donor-supported domestic debt-reduction operation launched in 1998.

Figure 2.
Figure 2.

Cape Verde: Selected Economic Indicators

Stock of Domestic Debt, 1992–2000

Citation: IMF Staff Country Reports 2001, 174; 10.5089/9781451809268.002.A001

8. With limited statutory independence, the central bank was not able to contain monetary expansion adequately. Broad money grew by almost twice the rate of nominal GDP, because, in terms of beginning-of-period broad money, credit to government expanded by 21 percent10 and resulted in an expansion of net domestic assets of the banking system of 16 percent. The central bank’ s task of restraining credit expansion was complicated by the delay in passing the supplementary budget until mid-November 2000, In an attempt to limit the large credit expansion during the last quarter of 2000, the BCV raised its rediscount rate by 100 basis points to 9.5 percent in December. Nevertheless, the banking system’s net foreign asset position, which was under pressure throughout 2000, declined by 2.7 percent.11

9. Faced with the unsustainable fiscal situation, the central bank accommodated the budget financing needs, partly as a result of its limited independence.12 Under the central bank law (Article 26), the BCV’s advances to the treasury “should not exceed 5 percent of the previous year’s current receipts.” This requirement was not observed as the BCV’s advances represented more than 20 percent of 1999 tax revenues throughout most of 2000 (see Figure 2). Moreover, the purchase by the central bank of securities (TCMFs) owned by commercial banks contributed to monetary expansion in 2000.

10. Cape Verde’s banking system appears to be sound,13 considering the substantial cleanup of the commercial banks’ balance sheets during their privatization and the implicitly privileged relationship of these banks with their main shareholders.14 Nonperforming loans in the banking system have decreased, both in absolute terms and relative to total credit.15 This outcome reflects the efforts made in cleaning up the balance sheets of the Banco Comercial do Atlântico (BCA) and the Caixa Econòmica de Cabo Verde (CECV) before their privatization and substantial provisioning in accordance with the prudential requirements defined by the BCV. The central bank’s supervision department follows supervision practices that are in broad conformity with the Basel Core Principles. However, greater reliance on short-term capital inflows in the form of deposits held by emigrants might increase the banking system’s vulnerability to shocks in the capital account (see Box 2).

11. Although the external current account deficit narrowed in 2000, despite higher interest payments associated the increased borrowing in 1998–99, the overall balance of payments turned to a deficit as a result of lower inflows of direct foreign investment and external assistance (Table 5). The suspension of external assistance reflected the deterioration in fiscal performance and the resulting accumulation of external arrears16 to both multilateral and bilateral creditors. In particular, the failure to repay, by year’s end, the credit line with Portugal, as required by the 1998 Exchange Cooperation Accord,17 blocked access to this facility; this, in turn, raised concerns about the sustainability of the exchange rate peg. The overall balance of payment deficit was financed by a drawdown of official reserves, which fell from US$63 million at end–1999 to US$35 million at end–2000, thereby reducing the import coverage from 2.2 months of goods and services to 1.3 months. In contrast to 1999, the central bank did not allow the foreign exchange queue to be used as an instrument to control the outflow of foreign exchange.

12. Over the last three years, external debt has been rising continuously as a share of GDP, from 44 percent at end–1998 to 57 percent at end–2000. Almost all of the additional external debt has been incurred vis-a-vis the World Bank and the African Development Bank, to which 56 percent of the total outstanding debt at end–2000 is owed. Bilateral debt represents only 27 percent thereof. As a result, external debt service increased from 7 percent of exports (of goods and nonfactor services) and private transfers in 1998 to 17 percent in 2000.

13. Progress was limited on the structural front. The preparation for the introduction of a value-added tax (VAT) and the tariff reform was delayed, as well as the reform of the budget management and monitoring system. Privatization efforts slowed (the status of the comprehensive privatization program is summarized in Box 3). The domestic debt-reduction operation under the Trust Fund (see Box 4) was also delayed on account of shortfalls in both external assistance and foreign exchange receipts from privatization.

III. Report On Policy Discussions

14. The authorities concurred with the mission on the seriousness of the deteriorating economic situation and reaffirmed their commitment to macroeconomic stability and the present exchange rate regime. Against this background, the discussions focused on ways to (i) rapidly redress the fiscal situation and address the resulting problem of an unsustainable debt burden and increasing arrears; (ii) strengthen the relatively low level of official external reserves; and (iii) implement reforms to achieve a sustainable rate of economic growth. The authorities expressed a strong interest in the preliminary macroeconomic framework, which had been developed with the help of the mission, and indicated that they intended to use it in the preparation of the budget for 2001, which is scheduled to be presented to parliament soon. They also plan to approach the donor community to obtain support for their macroeconomic framework. Portugal, the European Union and the World Bank have already expressed their willingness to support Cape Verde once the authorities adopt a program with the Fund.

A. The Macroeconomic Framework for 2001

15. Economic growth is expected to slow further to 3–4 percent in 2001, due to a number of factors. First, activity is not expected to increase in the agriculture and fishing sectors, which represent 11 percent of GDP. Second, construction activity (8.4 percent of GDP) is projected to contract, reflecting lower public investment and a stagnation in workers’ remittances (resulting from a slower growth in the host countries). Finally, despite some dynamism in the private sector, investors are still gauging the policies of the new government, and, hence private investment is likely to drop as a share of GDP. At the same time, inflation is likely to increase to about 5 percent, mainly on account of the significant expansion of money in 2000 and the impact of the recent increase in domestic prices of petroleum products. With exports projected to grow more rapidly than imports (12.8 percent and 2.3 percent, respectively), the external current account deficit (excluding official transfers) is likely to decline by about 1 percentage point of GDP. Consistent with these targets, the authorities plan to limit the overall fiscal deficit (including grants) to about 6–7 percent of GDP; although this deficit was 19 percent of GDP in 2000, the underlying permanent part of it was 8 percent after excluding the one-time exceptional outlays related to restructuring (7 percent of GDP) and petroleum price subsidies (4 percent).

16. In contrast to the very short-term outlook, the authorities’ medium-term objectives are to achieve real GDP growth rates of at least 6 percent, reduce the inflation rate to the euro zone rates, and continue to narrow the external current account deficit to about 7 percent of GDP by 2003. The planned fiscal adjustment is expected to be accompanied by a restrained monetary policy.

B. Fiscal Policy

17. The authorities concurred with the need to tighten the fiscal stance for 2001 in order to curtail the recourse to monetary financing and the growth of the domestic public debt and start to eliminate arrears to both domestic and external creditors. However, given the modest fiscal adjustment planned for 2001, the total financing required to cover the targeted overall deficit (including grants), the scheduled amortization, and the planned reduction of domestic and external arrears would be large (CVEsc 14.3 billion or 21 percent of GDP). After accounting for the expected privatization receipts (CVEsc 2.2 billion), the planned recourse to domestic bank credit (CVEsc 1.0 billion), and the likely foreign loan disbursements for projects (CVEsc 2.5 billion), the financing gap remains sizable (CVEsc 8.6 billion or 12.5 percent of GDP). The authorities plan to contact donors for assistance in rescheduling external arrears and current debt service (5 percent and 8 percent of GDP, respectively) and for budget support. In early 2001, progress has been made in rescheduling bilateral arrears; however, most of the debt service is due to multilateral development banks. To service this debt,18 the government will need additional external aid. If such an assistance is not forthcoming, the authorities will not be able to eliminate existing arrears and may have to postpone payment of some external amortization obligations.

18. Taking into account outlays already incurred in the first three months of the year,19 the authorities agreed that, in order to achieve the deficit target noted above, the budget for 2001 will have to include both revenue-enhancing and expenditure-restraining measures. Quick-yielding revenue measures could include the introduction of an airport tax, increases in the excise tax on alcohol, and a rise in the tourism tax. The mission emphasized that the reform of the tax system, launched with technical assistance from FAD in 1998, needed to be pursued vigorously. The introduction of the VAT, along with the new tariff, should be implemented in the context of the 2002 budget. The authorities agreed to take the necessary steps to present the draft VAT legislation to parliament in the coming months. In addition, the mission emphasized that the generous system of tax holidays and exemptions from customs duties, which had been granted as an incentive to new enterprises (or for extensions of existing ones), needed to be reviewed. On the expenditure side, the recent increase in petroleum product prices of 20–25 percent is expected to reduce subsidies by almost 3 percent of GDP. The authorities indicated that they would be ready to consider further increases in petroleum prices, if needed, while awaiting the results of a World Bank-financed study aimed at introducing an automatic and transparent pricing mechanism. Wage increases will also be strictly resisted, so as to contain the wage bill.20 The authorities informed the mission that they had started discussions with labor unions on this matter. Finally, transfers and current outlays for goods and services will not increase in nominal terms, and student stipends will be reviewed.

19. To restore fiscal discipline without delay, the authorities agreed to (i) implement, in coordination with the BCV, weekly cashflow plans and prepare monthly public finance statements consistent with the monetary program; (ii) eliminate all extrabudgetary outlays and prepare, with World Bank assistance, a public expenditure review; and (iii) promptly adopt the necessary decisions to relaunch the reform of budget management and monitoring, with the objective of starting implementation by January 1, 2002. In addition, the authorities intend to adopt an organic budget law and the new public accounting plan, and to strengthen the budget department.

C. Monetary and External Reserve Policies

20. The authorities recognized that the large expansion in credit in 2000 that had resulted from expansionary fiscal policies raised concerns about (i) the central bank’s independence; (ii) its ability to maintain sufficient reserve cover; and (iii) the long-run viability of Cape Verde’s pegged exchange rate. The authorities agreed that, in addition to a restrained fiscal stance, central bank independence was an essential element of the policies needed to support the exchange rate peg. They recognized that the central bank law and the constitution should be amended to ensure that it was institutionally empowered to maintain price stability. A draft revision of the above law, which clearly defines the 5 percent limit on central bank financing of the budget, is ready for the government to approve and present to parliament. The staff recommended a complete ban on central bank cash advances.

21. The authorities also concurred with the mission that a tight monetary stance would help to contain pressures on the exchange rate and stem the further loss of foreign reserves. The central bank explained that while its instruments to control liquidity (interest rates, reserve requirements, TCMFs, and the newly created liquidity absorption facility21) were adequate, its ability to control credit expansion had been limited by the lack of adequate information to assess economic activity accurately. The mission was assured that the central bank would use available indirect instruments of monetary control more actively22 and would soon start to work, in coordination with the National Institute of Statistics (INE), on developing economic activity indicators.

22. The current level of the Cape Verde’s escudo appears to be broadly adequate, as evidenced by the strong growth in receipts from tourism and exports and the sizable inflows of private investment and foreign remittances since 1998 (the date when the escudo was last adjusted). The recent loss of reserves is closely linked to the fiscal slippages and could be reversed, provided a strong fiscal adjustment is implemented, supported by a tight monetary stance.

D. External Policy

23. The authorities indicated that they were committed to maintaining the liberalized exchange and trade system. Except for one outstanding exchange restriction regarding payments for the rendering of financial services related to authorized capital transactions, Cape Verde has eliminated all previously identified exchange restrictions on the making of payments and transfers for current international transactions. The authorities have prepared a draft decree to eliminate the outstanding restriction. Staff are monitoring progress in this regard. In addition, the authorities have indicated that they do not intend to reintroduce the foreign exchange queue in the future to protect official reserves. As regards the trade regime, following the elimination of all remaining quantitative import restrictions and their replacement with revised customs duties, effective January 1, 1999 (EBS/99/71, paragraph 18), it has remained unchanged during 1999–2000. The mission noted that progress should be made to reduce the external tariffs, which have remained high, with maximum and simple average tariff rates of 50 percent and 25 percent,23 respectively. The authorities indicated that they intend to reduce these rates at the time of the introduction of the VAT, so as to limit the revenue impact on the budget.

E. Structural Reform and Social Policy

24. Privatization and the related debt-reduction operation are among the key structural reforms being implemented with World Bank assistance.24 As summarized in Box 3, several enterprises remain to be privatized, mainly the ports (ENAPOR), the airline (TACV), the ship repair facility (CABNAVE/CABMAR), and the food import and distribution company (EMPA). However, the authorities indicated that, except for the privatization of the TACV, they did not expect much progress in 2001, as the financial resources for the retrenchment of enterprises’ staff were lacking (particularly for EMPA). The staff stressed the importance of accelerating at least the privatization of other public enterprises, as the related receipts could be used to cover both retrenchment benefits and domestic debt reduction. The authorities noted that the distribution of pharmaceutical products had now been privatized, and that a regulatory agency would be created soon to oversee the provision of medicine. Finally, they emphasized that food imports had been liberalized with the end of EMPA’s monopoly.

25. The donor-supported domestic debt-reduction operation was delayed (Box 4). At end–2000, the Trust Fund, which had been established in 1998 to retire domestic public debt, had accumulated resources amounting to US$100 million (or 56 percent of the outstanding debt at end–1997), compared with an objective of US$180 million. Multilateral and international donors contributed up to US$63 million (or 63 percent of their programmed share in Trust Fund resources). However, foreign exchange receipts from privatization25 amounted only to US$37 million (or 47 percent of the programmed amount). This leaves an amount of about US$80 million to be financed to reach the initially programmed amount. In the meantime, the domestic debt has increased to about US$220 million. The mission noted that these developments highlight the urgent need to correct the deficits in the public sector and press ahead with the privatization process.

26. The National Poverty Alleviation Plan (NPAP), which was adopted in 1997 as an integral part of the 1997–2000 National Development Plan (NDP), aims at achieving sustained poverty reduction by promoting the integration of poor communities and social groups into Cape Verde’s economic development efforts (Box 5). A broad-based participatory process involving municipal and nongovernmental organizations has been developed. The authorities indicated that the NPAP, which effectively started in 2000, would focus in the next three years on the preparation of the administrative decentralization. The authorities intend to continue to enhance expenditure tracking through a decentralized and computerized accounting system. The NDP, together with the NPAP, will need to be updated soon. In this regard, the authorities will be using the forthcoming household survey to update information on poverty in Cape Verde.

F. Statistics

27. The mission emphasized the need to improve the quality of data and their timeliness, mainly in the real and external sectors. The concerns about the national accounts, described in the staff report for the third review under the Stand-By Arrangement,26 remain to be addressed as the INE’s work is constrained by the lack of resources. Nevertheless, in 2001, the INE’s staff expects to (i) finalize the national accounts for 1996–97 by end-July (including accounts in constant prices and of final uses); (ii) collect data for 1998–2000 by end-September and issue provisional national accounts by October; and (iii) launch annual surveys of public sector investment, enterprises’ financial data, and agricultural sector activity. As already mentioned, work is also progressing on an household survey, to be carried out in July, and the preparation of the new consumer price index (CPI). Finally, the authorities noted that the balance of payments statistics were weak because of the lack of information on private capital flows, particularly foreign direct investment and commercial credits.

G. Prospects for the Medium Term

28. The policies of structural adjustment implemented during the 1990s had helped to improve Cape Verde’s balance of payment viability. A more dynamic private sector has emerged and the export base has become larger and more diversified, driven by important investments in recent years in the tourism, transport, and manufacturing sectors. In 2000, these improvements were reflected, for instance, in the accumulation of foreign reserves by the commercial banks: for the first time they have been able to sell foreign currencies to—rather than being obliged to buy them from—the central bank.

29. Nevertheless, Cape Verde’s external vulnerability remains high, largely due to fiscal slippages (Table 6) The trend decline in official foreign reserves and the increasing burden of servicing the external debt, as well as the recent unavailability of the Portuguese credit line, pose great risks to the sustainability of the fixed exchange rate regime. The staff has, therefore, advised the authorities to adopt appropriate policies to correct the weak macroeconomic situation and support the promising developments in the export-oriented private sector. The country could benefit from (i) the expected real economic growth in Portugal,27 which buys 80–90 percent of Cape Verde’s exports; and (ii) the recent improvements in external competitiveness as evidenced by the depreciation in the real exchange rate and, compared with Portugal, lower labor cost increases.

30. The staff prepared a medium-term scenario on the assumptions of continued fiscal consolidation, appropriately tight monetary policy and progress in structural reforms (Tables 1 and 2). Real GDP growth is projected to increase after 2001 and to reach at least 6 percent by 2003. Inflation would average 3 percent per year, consistent with the exchange rate peg. The scenario relies heavily on the authorities’ implementation of a coherent set of macroeconomic policies, which would increase private sector confidence and facilitate the resumption of28 external assistance. It also assumes a sustained growth in exports of goods and tourism, expected to be the main engines of Cape Verde’s economic development. Given the heavy import dependency of the country and the low reserve cover of imports, the scenario envisages a halt to the decline of international reserves and their eventual buildup.

31. With the fiscal deficit (including grants) projected to decline from 19 percent of GDP in 2000 to about 3½ percent by 2003 and the projected net inflows of foreign financing, the government is expected to repay the domestic banking system and thus free up resources for private sector activity. This outcome would be mainly achieved through a reduction of public expenditure from 34 percent of GDP in 2000 (net of exceptional bank restructuring costs and petroleum price subsidies, which accounted for about 11 percent) to 30½ percent by 2003. At the same time, government revenue is projected to grow by about 1 percentage point of GDP to about 27 percent of GDP, as a result of the strengthening of the tax system. Total domestic consumption would fall from 114 percent of GDP in 2000 to about 107 percent in 2003.

32. The external current account deficit (including official transfers) would narrow from 12 percent of GDP in 2000 to just above 7 percent by 2003. Export earnings would grow by an average of 9 percent per year, reflecting private investments in tourism and manufacturing. Assuming adequately restrained demand-management policies, import growth would be kept at a yearly average of around 4½ percent. Strong direct investment and private capital inflows, spurred by a strengthening of private sector confidence, would maintain a strongly positive capital account. Reflecting these developments, foreign reserves are forecast to rise from a low of 1 month of imports at end–2000 to about 2½ months by 2003.

IV. Staff Appraisal

33. The recent progress made in macroeconomic stabilization was partly undone by the fiscal derailment observed in 2000, with the consequence that, in 2001, the government is faced with the challenges of (i) substantial fiscal adjustment; (ii) bolstering central bank independence through appropriate changes in related laws; and (iii) the regularization of relations with its creditors. These tasks will have to be completed with urgency given the large imbalances in the public sector, the delays in the preparation of the 2001 budget, a slowing economy, and rising prices. The staff regrets that there were no discussions with the authorities during 2000, nor regular communication of information, which prevented an early warning of the deterioration that took place during the year.

34. The sharp decline in official reserves, the unsustainable debt burden, and the suspension of the Portuguese credit line pose risks to the sustainability of the fixed exchange rate between the Cape Verde’s escudo and the euro. While welcoming the authorities’ commitment to the current exchange rate arrangement, the staff urges them to implement promptly appropriate macroeconomic policies to ensure the viability of the exchange rate peg.

35. A strong fiscal adjustment is needed to reduce domestic and external imbalances. The staff welcomes the authorities’ intention to rely on both revenue-raising and expenditure-restraining measures to ensure an appropriately tight budget for 2001 that is strictly consistent with the need to reduce domestic bank financing. It commends the authorities for their decision to increase petroleum prices without delay and recommends the urgent implementation of an automatic and transparent pricing mechanism. The authorities are also strongly advised to resist wage increases, so as to contain the wage bill. In addition, the staff urges them to resume preparations for introducing the VAT with the 2002 budget.

36. To avert future fiscal slippages, fiscal discipline needs to be restored. In this regard, the staff considers it important to establish weekly cashflow plans in coordination with the central bank, and monthly public finance statements that are consistent with the monetary program. In addition, to ensure a close and reliable control of expenditure, the staff urges the government to take the decisions needed to resume preparation of the new budget management and monitoring system.

37. The independence of the central bank is crucial to its ability to control inflation and protect the exchange rate peg. The staff welcomes the authorities’ intention to constitutionally enshrine the central bank’s statutory independence. The monetary authorities should be commended for their decision to raise the discount rate and refrain from resorting to foreign exchange rationing mechanisms to stem the loss of reserves. The BCV should actively use all its indirect instruments to control inflation.

38. Strong efforts to reduce the domestic debt remain key to achieving medium-term fiscal sustainability. This is all the more important, given the significant increase in the domestic public debt in 2000. The staff urges the authorities to push forward with the privatization of the remaining public enterprises and to work with the principal donors to ensure that the debt conversion process can be completed as soon as possible.

39. Despite recent progress, there is an urgent need for further improvements in the statistical system. The staff welcomes the INE’s work program for the coming months and strongly supports its efforts in updating the base of the national accounts and the CPI, especially in view of the substantial changes in the economy in recent years. Moreover, the household survey, scheduled for July 2001, is critical for updating Cape Verde’s poverty profile and as a foundation for future reform of the CPI. The staff also urges the central bank to improve the compilation of balance of payments data by focusing on direct foreign investment and private financial flows—the weakest elements of the balance of payments. Government expenditure recording and public accounting also need improvement; and implementation of the new budget management and control system should make an important contribution in this area.

40. It is proposed that the next Article IV consultation with Cape Verde be held on the standard 12-month cycle.

The Supplementary Budget in 2000

The supplementary budget—approved by parliament in mid-November 2000—represents the central factor behind the rapid deterioration in Cape Verde’s fiscal stance in 2000. It allowed for additional expenditures based on (i) an expected 8 percent improvement on the revenue side, (ii) considerably higher domestic financing, and (iii) a projection of lower interest payments. However, by year’s end, it became evident that expenditure needs had exceeded the budget projections, while revenue projections had proven to be overly optimistic. Notwithstanding considerably lower public investments (and excluding the unbudgeted bank restructuring costs), the ultimate fiscal gap exceeded projections by CVEsc 3.4 billion (or 5.3 percent of GDP), which mainly stemmed from underestimated projections for petrol price subsidies (CVEsc 1.7 billion) and interest payments (CVEsc 1 billion). In the absence of foreign financing, the developing gap (CVEsc 8 billion) was closed by using domestic resources, including arrears (CVEsc 1.5 billion).

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Sources: Cape Verdean authorities; and staff estimates.

The Banking System

There are currently four banks1 with 30 branches operating in Cape Verde. Branches are mainly concentrated in the islands of Santiago and Sao Vicente. In addition to the banks, there arc three nonbank financial institutions and two insurance companies. The nonbank financial institutions consist of a risk capital company (Promotora), a foreign exchange agency (Câmbios 24 Horas), and a company issuing credit cards (Sociedade Interbancaria e Sistemas de Pagamentos).

The commercial banking system is largely privatized, although the state retains a substantial minority interest. Control is now vested in Portuguese banks and insurance companies, although the banks are all incorporated in Cape Verde and there is no explicit obligation on the part of the majority shareholders. The BCA and the CECV together account for 88 percent of the banking system’s deposits. With the privatization of state-owned banks largely completed and the opening of the banking system to foreign banks, the role of the state has been redefined to become one of regulating the financial system.

Banking supervision is the responsibility of the BCV under the terms of Article 21(2) of the Organic Law of the Bank of Cape Verde, approved pursuant to Law 2/V/96 of July 1, 1996. The Department of Supervision of the BCV is subdivided into two sections—one for insurance companies, the other for credit and parabanking institutions. Besides the commercial banks, the latter section is also responsible for the supervision of the future stock market and any offshore banks.

The banking supervision department has followed the Basel Core Principles. The department conducts both off- and on-site inspections of the banks and informs the board of the BCV on a monthly basis on the situation of the individual banks and their compliance with prudential regulations. It also advises the Minister of Finance on the granting of new banking licenses.

The following regulations govern the activities of financial institutions:

  • The purchase of real estate is limited to what is necessary for their operations, and the market value of real estate holdings may not exceed the bank’s capital.

  • Equity stakes in firms not supervised by the BCV may not exceed certain maximum limits; an institution may not invest in any single firm more than 15 percent of its capital, nor may this particular equity stake represent more than 25 percent of voting rights. These equity stakes count toward the risk exposure limits.

  • Equity and loans exceeding 10 percent of the bank’s capital are considered to be of high risk. Exposure to one client may not exceed 25 percent of the institution’s capital, and the total amount of high risks cannot exceed eight times the amount of the institution’s capital.

  • The minimum capital of a bank is CVEsc 300 million, and the risk-weighted capital adequacy ratio is 10 percent. The definition of the various components of own capital and the criteria for weighting off-balance-sheet assets and accounts follow closely the rules adopted by the European Union.

  • The institutions are obliged to establish provisions for overdue loans, general credit risks, retirement pensions, survivors’ benefits, and capital losses on securities and other investments. Nonperforming loans are divided into five groups (up to 3, 6, 12, 36, and more months), with nonperforming loans secured by collateral requiring lower provisioning.

  • Banks have to keep unremunerated legal reserves of 18 percent at the BCV, with a minimum of 5 percent of deposits invested in government bonds (2 percent for nonbank financial institutions).

  • Banks need to have adequate internal risk management and audit procedures. External audits have to be conducted by one of the large international audit firms.

So far, the BCV has not imposed sanctions, and all banks have complied with the regulations.

1 Banco Comercial do Atlântico (BCA), Caixa Econòmica de Cabo Verde (CECV), the subsidiary of Banco Totta & Açores (BTA), and Banco Interatlantico (BIA), formerly Caixa Geral de Depositos.

Cape Verde’s Privatization Program, 1998–2002

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Sources: Cape Verdean authorities; and staff estimates and projections.

Domestic Debt Reduction and the Trust Fund

Design. At end–1997, after years of running large bank-financed fiscal deficits, the stock of domestic debt stood at CVEsc 17.7 billion, equivalent to US$180 million or 40 percent of GDP. The elimination of the debt overhang through a privatization-cum-domestic debt-reduction operation (DDRO) represented a key element in the fiscal consolidation program supported by the 1998 99 Stand-By Arrangement. During the program period, donors were to contribute US$100 million in grants and loans, while the government was to earmark all foreign-currency denominated privatization receipts (net of retrenchment costs)—up to an amount of US$80 million—to an offshore Trust Fund. The CVEsc 17.7 billion in domestic debt was to be swapped for securities issued and serviced by the Trust Fund (the TCMFs), thus helping to consolidate the budget. As the fiscal and monetary situation would allow, the government was to buy back the TCMFs over a 20-year period, thereby permitting it to fully retire the debt overhang without injecting inflationary pressures into the economy.

Implementation. Delays in the comprehensive privatization program (Box 3) and shortfalls in donor assistance led to a deferment in the establishment of the Trust Fund. By end-February 2001, the domestic contributions represented less than one-half of the envisaged amount, and foreign ones about two-thirds. These shortfalls necessitated the government’s requesting two foreign “bridge” loans (US$15 million) in 1998 and 1999 to finance domestic debt-service payments in those years. These had originally been programmed to be paid with Trust Fund resources. As of mid-February 2001, one of the bridge loans was in arrears, with the other one due in July. In addition, the fiscal expansion in 2000 has increased domestic debt by another CVEsc 7.9 billion, thereby reversing much of the progress made during the program period in reducing the budgetary impact of the domestic debt overhang (Figure 2).

Trust Fund Contributions

(In millions of U.S. dollars, unless otherwise indicated)

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Under the Stand-By Arrangement, the authorities were temporarily allowed to reschedule the government’s debt to the central bank under terms similar to that of the TCMF’s (low-interest claims on the Trust Fund), but without placing resources in the Trust Fund.

Sources: Cape Verdean authorities; and World Bank and Fund staff estimates and projections.

Main Poverty Alleviation Programs

The newly elected government stressed that poverty alleviation would remain high on its agenda. According to the latest available household survey (1988), about one-third (one-fourth) of the population lives in (extreme) poverty. Notwithstanding the considerable economic changes that have taken place since, the survey’s findingsaccording to which poverty was a rural phenomenon and disproportionately affected women (particularly as were heads of household), the unemployed, and youngremain valid. In response to these challenges, the government adopted a relatively comprehensive framework for poverty alleviation in 1997. Based on three pillars (described below), the National Poverty Alleviation Plan (NPAP) consciously targeted rural poverty, while aiming at an improvement of the overall effectiveness of the poverty-alleviation programs. The new administration intends to focus on these experiences.

The FAIMO tradition. Since independence, governments have responded to food insecurity and associated rural poverty with labor-intensive public work programs (Frentes de Alta Intensidade de Mão de Obra, or FAIMO). These were financed by the counterparts of foreign food aid, providing payments in exchange for work. While FAIMO succeeded in securing a minimum degree of food security for the poorest segments of the population and in creating and maintaining some basic infrastructure (especially roads), the program created a considerable degree of “welfare dependency” as it failed to provide incentives for labor productivity increases. At present, about 20,000 households depend on FAIMO support.

Economic integration of the poor. In 1999, the government began reforms aimed at complementing the FAIMO program by (i) developing a participatory and municipality-based mechanism of allocating public works; (ii) enhancing the productive capacity of the poor through the professional development of their marketable skills; and (iii) building capacity within the 17 municipalities to plan, implement, and monitor projects. Requiring the regions to cofinance the projects (with 10 percent of total costs), a mechanism has been found to prioritize public infrastructure investment projects, thereby minimizing inefficient expenditures. In this context, a contract management agency (AGECABO) was created to coordinate small-scale infrastructure projects and assist workers in establishing enterprises for this purpose. The latter would bid for, and carry out, the locally owned public work projects. The program—brought together under the umbrella of the Unidade da Coordençcão dos Projetos (UCP)—started to fully operate in 2000, despite some start-up problems stemming from insufficient communication and coordination among the various parties. With a budget of US$7.3 million, largely foreign financed, the UCP looked after 80 projects in 2000. The project-based approach is complemented by social policies designed to (i) improve access to health, water, and nutrition; (ii) enhance primary and professional education; and (iii) reduce the vulnerability of the poor, thereby creating conditions that permit a reduction in FAIMO’s food security role.

uA01fig01

Public Work Programs, 1987–2000

Citation: IMF Staff Country Reports 2001, 174; 10.5089/9781451809268.002.A001

The social emergency fund. The authorities created a third antipoverty pillar with the establishment, in late 199S, of a special fund for social emergency expenditures—the Fundo Especial de Estabilização e Desenvolvimento (FEED)—from which they could draw in cases of droughts, floods, volcanic eruptions, or epidemics. FEED is to be financed with (domestic currency) privatization revenues and from a 5 percent share of the offshore Trust Fund earnings. In 1999—the only year so far, in which FEED resources have been used—“extraordinary social expenditures,” for a total amount of about 214 percent of GDP, were financed from the budget.

Table 1.

Cape Verde: Selected Economic and Financial Indicators, 1997–2003

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Sources: Cape Verdean authorities; and staff estimates and projections.

Exports and imports of goods and nonfactor services. In 1997, the Cape Verdean authorities began to record sales of fuel to ships in full; previously they had been recorded only partially. The staff has attempted to replicate this new, more accurate presentation for the years 1994–96. The staff has also moved the item to exports, rather than services, to comply with the stipulations of the 5th edition of the balance of Payments Manual.

Lending rate; in percent. The discount rate was increased to 9.5 percent in December 2000 and to 11.5 percent in April 2001.

Including the claims on the offshore Trust Fund.

Table 2.

Cape Verde: Sources and Uses of Resources, 1997–2003

(In percent of GDP)

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Sources: National Institute of Statistics (INE); and staff estimates and projections.

Assuming that 50 percent of capital expenditure, as classified by the treasury, is indeed current expenditures.

Table 3.

Cape Verde: Fiscal Operations of the Central Government, 1997–2001

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Source: Ministry of Finance; Bank of Cape Verde; and staff estimates and projections.

Since 1998, tax revenue excludes taxes collected on behalf of the municipalities and the TPC (Economic Community of West African States),

Includes the so-called comas de. ordem, which are budgeted revenues from direct provision of services by government agencies offset by the same amounts under current expenditure for each of these agencies. Recurrent expenditure excludes extraordinary social outlays.

These are enterprises’ shares of government investment costs, usually in infrastructure directly related to the activity of these enterprises.

For 1998, include the drawings expected from the concessional line of credit to cover domestic interest payments.

On a commitment basis.

For December 1999, amortization includes repayment of US$15 million drawn on the Partuguese credit line (FAC).

In 1999, Cape Verde was trying to reschedule its US$6,49 million arrears with Spain and managed to find an agreement with Brazil on its bilateral US$7.29 million obligations. While negotiations with Spain are still ongoing, Brazil cancelled 60 percent of Cape Verde’s debt and arranged a ten-year repayment schedule with the Cape Verdian authorities.

Net of current amortization.

Includes discrepancy vis-á-vis the monetary accounts; the financing gap in 2000 reflects ongoing negotiations regarding a settlement of a foreign loan.

Table 4.

Cape Verde: Monetary Survey, 1997–2001

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Sources: Bank of Cape Verde; and staff estimates and projections.

For pre–1999 dales, in calculated with the Portuguese escudo(Esc) multiplied by the fixed Esc-Euro rale established on Jan 1, 1999.

The end December 1999 figure includes CVEsc 5,524.4 million in central bank ‘rescheduling’ and the CVEsc 0.4 billion conversion with the social-security agency(TNPS).