Tanzania: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
07 Jan 2003
eISBN:
9781451838343
Language:
English
Keywords:
ISCR; CR; Tanzania; enterprise; Tanzania shilling; real exchange rate; export performance of Tanzania; exchange rate liberalization; Tanzania's currency; Exports; Competition; Global competitiveness; substitution effect
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This Selected Issues paper reviews developments in Tanzania in the main fiscal indicators and related structural reforms to explain the success in fiscal management. The paper contains a brief overview of the structure of the public sector. Main developments in revenue and expenditure are covered. The paper concludes that the rationalization of expenditure programs and the progressive shift from domestic to foreign financing were at the core of Tanzanian macroeconomic stabilization in the second half of the 1990s, contributing to a sharp reduction in inflation.

Abstract

This Selected Issues paper reviews developments in Tanzania in the main fiscal indicators and related structural reforms to explain the success in fiscal management. The paper contains a brief overview of the structure of the public sector. Main developments in revenue and expenditure are covered. The paper concludes that the rationalization of expenditure programs and the progressive shift from domestic to foreign financing were at the core of Tanzanian macroeconomic stabilization in the second half of the 1990s, contributing to a sharp reduction in inflation.

III. External Competitiveness and Export Performance of Tanzania28

A. Introduction

65. Fostering competitiveness is important if Tanzania wants to pursue an export-led growth strategy. Trade is considered an engine of economic growth, and recent experiences from many countries, most prominently in East Asia, have provided strong evidence of a positive link between export growth and economic growth. In particular, the manufactured exports sector is usually on the frontier in introducing new technology into an economy. In this context, performance of manufactured exports could serve as an indicator for the trends in the external competitiveness of a country. This section analyzes developments in external competitiveness and the export performance of Tanzania over the last decade. It begins by examining the changes in the real effective exchange rate (REER) since 1990 and assessing competitiveness based on a purchasing power parity (PPP) framework. However, the PPP-based real exchange rate has many weaknesses as an indicator of competitiveness over time, including its ignoring of developments in the economic fundamentals of Tanzania. Therefore, this section also estimates deviations of the real exchange rate from its equilibrium level, which is calculated from an econometric model that accounts for changes in the economic fundamentals. External competitiveness has many facets, and not all of these facets can be captured by the real exchange rate. Other factors, like the cost of doing business, quality of infrastructure, and tax structure are also important aspects of competitiveness This section also presents an analysis of changes in these qualitative aspects of external competitiveness. This section primarily focuses on Tanzania; however, as Tanzania is actively pursuing regional integration policies, we also analyze, whenever possible, the relative competitiveness and export performance of Tanzania within the East African Community (EAC) and with South Africa.

66. This section is organized as follows. Using various multilateral and bilateral real exchange rates, subsection B assesses whether Tanzania’s real effective exchange rate remained at a competitive level during thel990s. Subsection C evaluates the misalignment in the real exchange rate based on results from an equilibrium real exchange rate model that accounts for changes in the economic fundamentals of Tanzania. Then, subsection D presents an analysis of qualitative aspects of competitiveness, such as the cost of doing business. Subsection E contains an evaluation of Tanzania’s export performance in the 1990s and examines whether this performance supports the findings from the competitiveness analysis. The last subsection summarizes our conclusions.

B. PPP-Based Real Exchange Rate and Competitiveness

67. Before applying the real effective exchange rate based on the purchasing power parity (PPP) framework as an indicator of Tanzania’s external competitiveness, several points about the appropriate use of such indicators have to be clarified. First, in order to compare competitiveness across countries or over time within a country, the choice of a suitable base (i.e., equilibrium) period is important. We have selected 1990 as the base year for our calculation of REER for all three members of the EAC and South Africa The reasons for selecting 1990 as a base year for Tanzania include the lower black market premium, compared with levels observed in 1980s, a relatively stable real exchange rate in the 1990-95 period despite substantial exchange rate liberalization, and the strong growth in exports in the first half of 1990s, revealing external competitiveness.29 Moreover, as all three EAC member countries were implementing structural reforms in the late 1980s and early 1990s, it is appropriate to review the evolution of export performance and competitiveness of these economies only after 1990, when the policy regime in these economies became more comparable Second, in order to reach a meaningful assessment of competitiveness based on the real effective exchange rate, many technical issues associated with these indices need to be addressed, including the choice of partner country weights, reliability of the price or cost indices, and relevance of the price indices. We have calculated various multilateral and bilateral real exchange rates and REER indices based on different prices (e.g., consumer prices and wholesale prices) and partners to check whether the conclusions regarding Tanzania’s external competitiveness within the EAC hold up for various real exchange rate measures.

68. Starting with a pegged system in 1990, Tanzania gradually liberalized the exchange rate. Foreign exchange bureaus were authorized in 1992 to buy and sell foreign exchange at freely negotiated rates. In 1993, a weekly foreign exchange auction system was introduced, and the official exchange rate was guided by the average rate from these auctions. Consequently, the exchange rate premium in the parallel market gradually declined to below 10 percent of the official rate in 1993 from its peak of about 400 percent in 1986. A market-determined exchange rate was adopted when an interbank foreign exchange market replaced the auction system in 1994.

69. The real effective exchange rate appreciated in Tanzania in the second half of the 1990s. The REER based on trade-weighted consumer prices reveals a large real appreciation of the currency since 1996 (Figure III.1). This index is calculated from the Information Notice System (INS) database of the LMF and covers 23 major trading partners.30 Table III.1 presents the weights for the REER index. Figure III.1 also displays various components of the REER: the nominal effective exchange rate, relative consumer prices, and an index of the nominal exchange rate between the Tanzania shilling and the U.S. dollar. While the nominal effective exchange rate remained stable, higher inflation in Tanzania than in its trading partners in the mid-1990s led to a real appreciation of about 50 percent between end-1995 and end-2000 (Table III.2). Thereafter, the real effective exchange rate has been depreciating primarily owing to a weakened currency, which declined by about 16 percent against the U.S. dollar during the last 18 months through June 2002.

Figure III.1.
Figure III.1.

Tanzania: Real and Nominal Effective Exchange Rates, December 1990-June 2002

(Index, 1990-100)

Citation: IMF Staff Country Reports 2003, 002; 10.5089/9781451838343.002.A003

Source: IMF, Information Notice System (INS).
Table III.1.

Trade Weights for Real Effective Exchange Rate (REER) of Tanzania

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Source: IMF, Information Notice System (INS).
Table III.2.

Real Effective Exchange Rates (REERs) and their Components for Tanzania and Other Regional Economies

(Percent change)

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Source: IMF: information Notice System (INS).Notes: NEER is the nominal effective exchange rate, while NER is an index of nominal exchange rate of local currency with respect to U.S. dollar.

70. Alternative measures of REER show similar patterns of real appreciation in the second half of the 1990s. The literature shows that both the wholesale price index (WPI) and import price index of trading partners are more appropriate price indices than the consumer price index to evaluate competitiveness, as these prices indices include fewer or no nontradable commodities (Hinkle and Montiel, 1999). Thus, we have also calculated three alternative REERs based on the wholesale and import prices of five major trading partners using only export weights.31 Because the set of trading partners and weights are different from the INS database, we have also calculated REERs based on the CPIs. All three REERs display similar patterns over the 1990s (Figure III.2). After a stable real effective exchange rate for 1990-95, a large real appreciation is clearly evident from all three indices during 1996-98. However, the REERs based on the wholesale and import prices display much larger losses for Tanzania’s competitiveness than does the REER based on consumer prices, as total appreciation in the REER based on import prices is 50 percent during 1996-98 compared with only a 35 percent appreciation in the CPI-based real effective exchange rate.

Figure III.2.
Figure III.2.

Tanzania: Export-weighted Real Effective Exchange Rates, 1990:1-2002:11

(Index, 1990-100)

Citation: IMF Staff Country Reports 2003, 002; 10.5089/9781451838343.002.A003

Source: IMF, Information Financial Statistics, and Direction of Trade Statistics. IMF staff calculation.

71. As Tanzania is mainly an exporter of primary products (e.g., agriculture crops and minerals), export prices are likely to be determined in the world market and in major currencies. In this situation, bilateral real exchange rates with respect to major currencies can also inform us about the competitiveness of the export sector We have calculated bilateral real exchange rates for the three major currencies (U.S. dollar, U.K. pound sterling, and Deutsche mark) to see whether there are any significant differences in these real exchange rates (Figure III.3). All three bilateral real exchange rate indices are highly correlated and have similar patterns, except for the recent two years. The various indicators discussed above reveal largely similar patterns of competitiveness for Tanzania in the 1990s. Whereas the bilateral real exchange rate in the first half of the 1990s remained stable and thus suggested no loss in competitiveness, Tanzania’s external competitiveness appears to have declined in the second half of the 1990s with respect to all three major currencies. The use of a floating exchange rate regime did not help to avoid a real appreciation of the currency of about 50 percent between 1996 and 2000.

Figure III.3.
Figure III.3.

Tanzania: Bilateral Real Exchange Rates for Major Currencies, 1990:1-2002:11

(Index, 1990=100)

Citation: IMF Staff Country Reports 2003, 002; 10.5089/9781451838343.002.A003

Source: IMF, Information Financial Statistics, IMF staff calculation.

72. Tanzania’s competitiveness relative to the other members of the EAC (Kenya and Uganda) and South Africa substantially worsened in the second half of 1990s (Table III.2) The REERs for these countries also show that Tanzania’s currency appreciated in real terms, compared with the currencies of Uganda, Kenya, and South Africa (Figure III.4). Although broad trends for the real exchange rate are similar in Kenya and Tanzania, the loss in competitiveness is much smaller in Kenya. Over the whole decade, the total real appreciation was about 45 percent in Tanzania but only about 20 percent in Kenya. Uganda and South Africa, on the other hand, experienced a real depreciation in the 1990s and thus made substantial gains in their external competitiveness. The developments in relative competitiveness can be more clearly displayed by using the bilateral real exchange rates of these countries (Figure III.5). This comparison of competitiveness indicates that, unless the trend of the last few years in the REER is reversed, Tanzanian exporters will be at a disadvantage within the EAC and domestic producers will face significant pressure from South African imports because of the appreciated currency.

Figure III.4.
Figure III.4.

Regional Real Effective Exchange Rates. 1990-2002:11

(Index, 1990-100)

Citation: IMF Staff Country Reports 2003, 002; 10.5089/9781451838343.002.A003

Source: IMF, Information Notice System (TNS).
Figure III.5.
Figure III.5.

Tanzania: Bilateral Real Exchange Rates with Regional Competitors, 1990:1-2002:11

(Index, 1990=100)

Citation: IMF Staff Country Reports 2003, 002; 10.5089/9781451838343.002.A003

Source: IMF. Information Notice System and IMF staff calculations.

73. Our conclusion that Tanzania’s external competitiveness, as measured by the real effective exchange rate, eroded in the second half of the 1990s, however, should be taken with some caveats. It is based on the assumption that changes in the real exchange rate from the base period are only temporary, and, therefore, that any deviation of the REER from its level in the base period should be considered a misalignment. However, as noted above, the selection of the base (or equilibrium) period-1990 in our case-is a subjective judgment, and another base period could lead to different conclusions about the competitiveness. Moreover, this approach ignores the changes in the economic fundamentals that affect the equilibrium real exchange rate of an economy over time. For example, an equally plausible interpretation could be that the higher value of the REER since 1996 is a reflection of changes in the fundamentals of the Tanzanian economy (e.g., increased productivity, improved economic policy, better external environment, etc.) and, thus, does not necessarily mean an erosion in competitiveness. In the next subsection, to account for changes in the fundamentals of the economy, we estimate the equilibrium real exchange rate for Tanzania and calculate the misalignment by using the fundamentals approach instead of assuming a fixed base period as an equilibrium point.

C. Equilibrium Real Exchange Rate and Competitiveness

74. According to the fundamentals approach to the equilibrium real exchange rate, the underlying equilibrium real exchange rate is not fixed over time but is variable, based on the changes in an economy’s fundamentals, such as terms of trade, productivity, and the policy stance.32 Modeling the equilibrium real exchange rate (ERER) generally aims at determining the level of the real exchange rate that is consistent with both internal equilibrium (i.e., equilibrium in goods and labor markets) and external equilibrium (i.e., a sustainable current account). Thus, the ERER is correlated with a set of exogenous and policy variables -macroeconomic fundamentals - and can be specified as the following:

ERERt=α0+α(Ft)+εt.⁢                            (1)

Here F is a vector of variables that have been identified in the empirical literature as determinants of the equilibrium exchange rate. This vector includes the terms of trade (To 7), factor productivity of Tanzania relative to its partners (RFP), policy stance such as government consumption (GQ and trade openness (OPEN), and foreign capital flows—proxied by official development assistance (AID). Thus, the model in equation (1) can be further specified for Tanzania as below:

ERERt=α0+βlTOTt+β2RFPt+β3GCt+β4OPEN+β5AIDt+εt.⁢          (2)

75. Data constraints have led us to make some compromises in implementing the preceding analytical framework. First, we only use the external real exchange rate; this is measured as a ratio of domestic CPI to trade-weighted foreign prices, because data on the internal real exchange rate (i.e., relative prices of nontradable commodities to tradable commodities) is not available for Tanzania. For foreign prices, we use alternatively trading partners’ consumer prices and wholesale prices. Second, owing to a lack of data on relative factor productivity, we use the relative growth rate of real GDP per worker (RGDP), measured in PPP dollars, as a proxy. Third, in the absence of data on public sector demand for nontradables and a measure of the stance of trade policy for a longer period, we use proxies for these policy variables: government consumption expenditures as a share of GDP, which are likely to be more intensive in nontradables, and trade openness, as measured by total trade share in GDP. The latter proxy measure is based on the argument that a more liberal trade regime leads to greater specialization in production and, hence, to a higher trade ratio. Our sample contains 32 annual observations covering the 1970-2001 period.

76. We have tested for the time-series properties of all variables prior to estimation of the long-run equilibrium real exchange rate. We have applied the augmented Dickey-Fuller (ADF) test to check the existence of unit roots. The results in Table III.3 regarding the ADF test show that all variables in the ERER models are nonstationary in levels but these variables become stationary in the first difference.33 The existence of a unit root in levels allows for the direct estimation of equation (2) using the cointegration regression. The results of the long-run equilibrium real exchange rate model based on the cointegration regression are reported in Table III.3 and discussed below. As the empirical models (except model 5) are estimated in log form, the coefficients represent elasticities of real exchange rate with respected to the economic fundamentals.

Table III.3.

Fundamentals of Long-Run Real Exchange Rate in Tanzania

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Notes: Whereas model 1 is the same as used by Nyoni (1998), models 2-4 include additional variables and disaggregated aid variable Model 5, which has been used by Altingi-Ego (2000) for Uganda, is different as it includes openness, government consumption, and aid variables without logarithmic transformation. The augmented Dickey-Fuller (ADF) test results indicate that all variables in our models have unit roots in levels but become stationary in first difference. For the ADF test, the MacKinnon critical values for rejection of the null hypothesis of a “unit root” are as follows: -3.65, -2.95, and -2.61 at the 1 percent, 5 percent and 10 percent levels, respectively The ADF test results for the level and first difference of the variables are reported below:

a)Total trade as share of GDP - log(OPEN):(-1.85, -6.54)b)Government consumption as share of GDP- log(GCGDP)(-1.88, -4.82)c)Total ODA as share of GDP - log(ODAGDP)(-2.31, -5.81)d)Terms of trade index for goods - log(TOTG)(-1.40, -5.85)e)Growth in real GDP per worker relative to major partners - log(RGDP)(-0.47, -4.38)f)External grants as share of GDP - log(GRANTGDP)(-2.38, -4.48)g)Loans as share of GDP - log(LOANGDP)(-2.37, -9.30)h)REER based on CPls(-2.03, -3.00)i)REER based on WPIs(-2.15, -3.25)

77. Although, in theory, the terms of trade have an ambiguous impact on ERER, an improvement in ToT in Tanzania, defined as the ratio of its export prices to import prices in the world market, appreciates the currency in real terms. The theoretical ambiguity is caused by the fact that an improvement in ToT will not only have a positive income effect, which increases the demand for nontradable goods and, hence, their prices, but also a substitution effect that increases the demand for imports. Thus, the overall impact of a change in ToT on the real exchange rate depends on the relative sizes of the income and substitution effects. However, in the case of Tanzania, the income effect is likely to be stronger because imports are a smaller share of total GDP and because the terms of trade have been deteriorating for a long period the significant positive coefficient on the terms of trade variable substantiates the view that the income effect dominates the substitution effect in Tanzania. Although the estimated coefficient on ToT is positive, it is relatively small, suggesting that the equilibrium real exchange rate is not very responsive to changes in the terms of trade. For example, according to most of the models in Table III.3, a 10 percent deterioration (improvement) in ToT would cause only about a 1.5 percent real depreciation (appreciation) of the currency.

78. Policy fundamentals also influence the equilibrium real exchange rate. Our proxy for an open trade regime has a large negative estimated elasticity with respect to the real exchange rate, in line with the theoretical prediction that trade-liberalizing reforms depreciate the currency (Hinkle and Montiel, 1999). As reported in Table III.3, a 10 percent increase in the total trade-to-GDP ratio will depreciate the equilibrium real exchange rate by about 15 percent. Compared with a previous study of Tanzania (Nyoni, 1998), our estimate from a similar model is much larger, partly because our study also includes a more volatile period for the real exchange rate and openness variables (namely, 1994-2001). The alternative model (model 5), which is comparable to a recent study for Uganda (Atingi-Ego and Sebudde, 2000), suggests a similar impact of openness on the equilibrium real exchange rate34 The estimated elasticity of the ERER with respect to government consumption, a proxy for public sector demand for nontradables, is positive and significant. This result is consistent with previous empirical studies. For example, a 10 percent increase in government consumption expenditures - about 1 percentage point of GDP, based on the levels in 2001-will be consistent with about 5-6 percent appreciation of the equilibrium real exchange rate. Thus, as these expenditures are likely to increase in the context of implementing the poverty reduction strategy in Tanzania, there will be an upward pressure on the equilibrium real exchange rate.

79. The relative productivity variable influences the ERER in two ways. First, on the domestic level, the Balassa-Samuel son effect predicts that a higher productivity growth in the tradables sector than in the nontradables sector leads to an increase in the ERER by lowering the relative prices of tradables. Second, at an international level, higher productivity growth of a country relative to its partners causes higher demand for nontradables and thus appreciates its ERER. Empirical evidence from Tanzania supports this hypothesis, as the estimated elasticity is about 0.4. However, this result is based on relatively weak data for the real GDP, which is measured in purchasing power dollars. Our results suggests that, as the Tanzanian economy is likely to grow at a faster pace than its trading partners owing to both a likely catching up and the recent effort to increase investments, the equilibrium real exchange rate will appreciate further.

80. As Tanzania has little access to borrowing from international capital markets, its current account depends heavily on official flows, primarily official development assistance (ODA). In general, an increase in capital inflows (and aid) appreciates the real exchange rate by increasing the demand for nontradable commodities. The greater is the appreciation pressure on the real exchange rate, the higher is the marginal propensity to spend aid on nontradable commodities and the larger is the aid share in total economy. Tanzania exhibits high aid dependence by any standard (e.g., an aid-to-GDP ratio that averaged 10 percent in recent years). This aid dependency has raised concerns about external sector competitiveness, even though a significant portion of foreign aid goes to project-related imports.

81. Our empirical results do not provide support for the theoretical prediction that an increase in foreign aid appreciates the currency and, hence, weakens competitiveness. Contrary to the theory, model (1) in Table III.3 shows that a 10 percent increase in the official development assistance-to-GDP ratio will depreciate the equilibrium real exchange rate by about 4.3 percent.35 However, we believe that this model not only has some important economic fundamentals missing but also inaccurately assumes that all types of aid have a similar impact on the equilibrium real exchange rate. For example, when other fundamentals of the real exchange rate are included in the model (e.g., model 2, with the addition of terms of trade), the negative impact of aid on the real exchange rate declines substantially.36 More important, when we use a different formulation of model 2 (i.e., model 5), the impact of foreign official assistance disappears as the estimated coefficient becomes statistically insignificant.37

82. Models 3-4 test the hypothesis that various types of official foreign assistance have differential effects on the equilibrium real exchange rate. Whereas grants are more likely to be consumed, especially if untied, loans are usually linked to specific investment projects. Consequently, grants are likely to appreciate the currency through increased demand for nontradable goods, but loans may strengthen the supply response of the nontradable sector, thereby depreciating the real exchange rate. Moreover, loan inflows are likely to have a more differential impact on the real exchange rate than grants because large borrowing, even if it is concessional, for a highly indebted country like Tanzania will worsen debt sustainability and weaken the currency. Empirical evidence for Tanzania strongly favors the view that grants and loans have a differential impact on the equilibrium real exchange rate. For example, model 4 shows that, when overall foreign aid is replaced with its components (grants and loans), the results regarding aid impact change substantially. When separated from the loans, the grant variable does not have a statistically significant impact on the equilibrium real exchange rate. Foreign loans, however, still have a large negative coefficient, which suggests that a 1 percent increase in the foreign borrowing-to-GDP ratio will depreciate the real exchange rate by about 0.5 percent. We believe that this negative correlation between the real exchange rate and external borrowing is partly caused by structural adjustments, which are not accommodated in our models. For example, Tanzania borrowed heavily under the structural adjustment programs of the late 1980s and early 1990s; at the same lime, the exchange rate premium in the parallel market declined from about 400 percent in 1986 to below 10 percent in 1993 because of economic reforms. We believe further research is needed to account for these structural changes in an equilibrium real exchange rate model. In sum, we find no evidence that an increase in official foreign assistance has caused any erosion in external competitiveness.

83. Based on cointegration regressions, the real exchange rate of the Tanzania shilling was slightly overvalued at end-2001 but is gradually moving toward its equilibrium level. In order to extract the long-term trend component of the fundamentals for calculating an equilibrium real exchange rate, we have smoothed the data series by using a Hodrick-Prescott smoothing filter38 The estimated equilibrium real exchange rate shows that the currency was significantly overvalued during 1997-99 (Figure III.6). However, since 2000, the fundamentals of real exchange rates have been improving, and, thus, the equilibrium real exchange rate has been rising. Consequently, the gap between the real effective exchange rate and the equilibrium real exchange rate has been narrowing. By 2001, the currency was overvalued in real terms by about 9-12 percent, compared with the 40 percent real overvaluation in 1998.39 These estimates suggest that Tanzania’s competitiveness has been improving in recent years. Contrary to the assessment of a real exchange rate based on the PPP approach in the previous subsection, which indicated an overvaluation of about 45 percent in 2001, the fundamentals approach suggests a relatively small (about 10 percent) overvaluation of the currency in real terms in 2001. The latter evidence is in line with our view that economic reforms have been improving the efficiency of the Tanzanian economy and thereby gradually offsetting the erosion in competitiveness in 1996-98. This view is also supported by the evidence on other aspects of competitiveness.

Figure III.6.
Figure III.6.

Tanzania: Comparison of Actual REER and Long-Run Equilibrium Real Exchange Rate.

Citation: IMF Staff Country Reports 2003, 002; 10.5089/9781451838343.002.A003

Source: IMF. Information Notice System and IMF staff calculations.

84. We complement our analysis of the equilibrium exchange rate with other aspects of external competitiveness. First, we can analyze the relative cost of doing business within the EAC region. For small open economies, cost-based measures of competitiveness are a useful guide to the profitability of producing goods and services. As we do not have consistent and comparable overall business cost and unit labor cost indices for the EAC members, we compare and evaluate various aspects of doing business: utility costs, infrastructure, tax system, and institutional structure. Second, we can use the actual performance of Tanzanian exports during the 1990s to draw conclusions about the developments in its competitiveness. The growth of exports relative to Tanzania’s regional competitors and the performance of sectors more sensitive to changes in the REER (e.g., manufactured exports) can be used as supplementary evidence for judging the changes in external competitiveness. The next two subsections focus on qualitative measures of competitiveness and Tanzania’s export performance to supplement our analysis of external competitiveness.

D. Qualitative Measures of Competitiveness

85. The discussion of qualitative aspects of Tanzania’s external competitiveness is based on diverse sources of information. Tanzania embarked on a program of structural adjustment in the late 1980s and has since undertaken many measures to enhance efficiency and productivity in the economy. Similarly, Uganda started its economic reform program in 1986 when a reform-minded government took office. However, Kenya was always a relatively more market-oriented economy. Moreover, the recent efforts to form a free trade area and customs union among the three countries further induce us to do a comparative analysis of their external competitiveness. Furthermore, we want to analyze whether economic reform has improved efficiency and productivity, and whether such gains in efficiency could offset the drag of the real appreciation of the Tanzania shilling on the export sector.

86. All three countries have been exporting primary commodities, with coffee, tea, cotton, and fish being the main exports. Moreover, most of the manufactured exports from Kenya and Tanzania are agriculture related. A study by the U.S. agency for International Development (USAID) provides a comparative analysis of the cost of production for major crops (Odhiambo and others, 1996). We focus only on the costs of two major agriculture exports: coffee and textiles/cotton (Table III.4). The labor cost for producing coffee was very similar in all three countries in 1992/93, but the cost in U.S. dollars of supplying clear coffee was much higher in Tanzania than in the other two countries, mainly because of a lower crop yield. Tanzanian’s cost for one kilogram of clean coffee was US$ 2.2, compared with USS1.1 and US$ 0.8 for Uganda and Kenya, respectively. Similar patterns in the cost of producing a square meter of fabric were present in these countries. Despite relatively cheaper cotton lint and lower wages for skilled labor, Tanzania had the highest cost of producing textiles, about 40 percent more than the cost in Kenya. This comparative analysis indicates that Tanzania was less competitive in coffee and textiles in the early 1990s. Unfortunately, we do not have more recent data on the cost of production for clean coffee and textiles to assess changes in competitiveness as a result of the economic reforms. However, data on coffee yield for 2000/01 suggest that Tanzania has made significant progress in improving the efficiency of agriculture sector production (Table III.4).

Table III.4.

Comparative Competitiveness of EAC Countries for Selected Crops

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Sources: Odhiambo and others (1996). Coffee yield in 2000/01 is from the Food and Agriculture Organization database.

Data are for year 1992/93.

Data year varies for the three countries between 1993 and 1994.

Tax cost is measured as percent of cost of production.

87. Costs of major utilities and taxes on certain inputs have been higher in Tanzania (Table III.5) Tanzanian businesses had to pay twice as much for electricity than those in Kenya in 1994 and were paying even higher average electricity tariffs in 2000. Recently, the cost of industrial fuel in Tanzania has been significantly higher than in Kenya, although both countries had about the same costs in 1994. Fuel cost is the highest in Uganda, partly because of the higher transportation cost resulting from its landlocked geographic position. Higher petroleum taxes in Tanzania have led to higher fuel costs. Tanzania has also higher telecommunication costs and a much higher cost of registering new businesses than Kenya. The authorities are aware of these problems, which were also discussed at the recent investor roundtable, and have taken some steps to improve the business environment (e.g., lowering electricity tariffs for businesses in April 2002 and reducing taxes on some industrial fuels in the 2002/03 budget). Finally, although exports are zero rated for the value-added tax, Tanzania has a slightly higher VAT rate than other members of the EAC.

Table III.5.

Selected Costs of Doing Business in EAC Countries

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

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Sources: For 1994, Odmarnbo and others (1996). For 2000, data collected from various sources (e.g., meeting with business community in Tanzania, and the 2000 RED report for Uganda). Telephone costs are from the 2001 UNCTAD report for Mozambique. Entry regulation data from the World Bank.

88. The business community’s perception of Tanzania’s relative economic performance and prospects has been improving in recent years, as is evident from the analysis carried out in the recent reports on Africa’s competitiveness (World Economic Forum, 1998 and 2000/01). Albeit somewhat subjective, this approach is comprehensive as it covers many aspects of competitiveness, including infrastructure, labor, and the performance of institutions. This assessment utilizes both published data and business survey responses to compare the performance of 22 major African economies. The overall performance of Tanzania was below average in 1997, as it was placed at the 16th position out of a total of 22 African countries (Table III.6).40 However, Tanzania’s ranking on the overall competitiveness index improved in 2000/01 report, suggesting that continued good economic policies and reforms have improved Tanzania’s perception by the business community. For example, Tanzania was ranked lower than Kenya and Uganda in 1997 but was ranked better than these countries on the competitiveness index in 2000/01.

Table III.6.

Competitiveness of Tanzania Relative to African Countries

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Source: World Economic Forum (1998 and 2001).

Overall competitiveness is an average of six indices: openness, government, finance, labor, infrastructure, and institutions. The “improvement” and “optimism” indices demonstrate business communities’ altitudes toward the reforms and growth; they are constructed from nearly 30 “direction of change” questions in the business survey.

89. Tanzania scores even better on two other performance indices: the backward-looking improvement index and the forward-looking optimism index. The improvement index indicates changes in the business community’s assessment of various policies and costs of doing business in the year of survey relative to five years earlier; the optimism index shows expected changes in these areas for two years in the future. The improvement index clearly shows that Tanzania, which was ranked third in the 1997 survey and is listed at the top in the 2000 survey, has made tremendous progress in providing a business environment conducive to economic growth (Table III.6). Uganda has performed equally well, but Kenya was ranked much lower on the improvement index At the same time, the business community in Tanzania is more optimistic about the government’s efforts to further improve the business environment in the coming years, as Tanzania was ranked second among 24 African nations on the optimism index in 2000/01. These perception indices clearly indicate that economic reforms in Tanzania have improved the business environment and enhanced economic efficiency. However, the overall ranking is still weak, indicating substantial room for further improvements.

90. The survey responses for the Africa Competitiveness Report and the recent investor roundtable discussions indicate that Tanzania has substantial work ahead to make its business sector more competitive in the region. The exchange rate policy was considered supportive of the export sector, but access to credit for this sector was rated poor. On the government indicator, Tanzania has a relatively lighter burden of government regulations, but, despite many years of reform, its tax system is still considered an obstacle for business growth. Tanzania’s banking system is perceived to be open, but it is considered as not serving adequately the credit demands of businesses, especially smaller firms. Although Tanzania’s ranking on infrastructure is similar to other EAC members, the costs of transportation, electricity, and telecommunications are considered a major hindrance for competitiveness.

91. On the labor side, although Tanzania has a relatively less disruptive work environment, the hiring practices are deemed to be inflexible, and the education system is judged to be weak. Finally, on the institutional front, Tanzania’s performance was ranked much better than Kenya’s and Uganda’s despite some concerns about the frequent changes in government policies regarding the business sector and the complex, as well as costly, procedures for starling new businesses.

E. Tanzania’s Export Performance in the 1990s

92. The export sector performance was mixed in the 1990s. Whereas total exports of goods grew substantially in the first half of the 1990s, they then declined persistently in 1997-99, following the real appreciation of the currency during 1996-98 (Figure III.7). Since 2000, aggregate exports have been recovering, mainly due to increased gold exports. However, if we adjust for the growth in gold exports, which grew from US$ 3 million in 1998 to US$ 254 million in 2001, the rest of the export sector does not show much improvement.41 The average annual growth of exports (U.S. dollar value) was about 13 percent for the period 1991-95 but exports declined by about 3 percent annually over 1996-99 - a time when the real exchange rate sharply appreciated and agriculture production was affected by adverse climatic conditions related to the El Nino phenomenon (Table III.7). The average annual growth rate of exports for the whole decade was only 5.6 percent, compared with export growth of 8.1 percent for developing countries and 7.8 percent for Kenya. As Tanzania’s terms of trade remained relatively stable during the second half of the 1990s, persistent decline of nongold exports after 1996 cannot be explained by developments in the terms of trade. One of the factors for the poor performance of exports in the 1997-99 period was a significant real overvaluation of the currency, which has been discussed in previous subsections.

Figure III.7.
Figure III.7.

Tanzania: Exports and Imports Indices (Based on U.S. dollar values) and Real Effective Exchange Rate (REER), 1990-2001

(Index, 1990-100)

Citation: IMF Staff Country Reports 2003, 002; 10.5089/9781451838343.002.A003

Source: IMF, Information Financial Statistics, Tanzanian authorities, and IMF staff calculation.
Table III.7.

Exports Growth

(Annual average rate, in percent)

article image
Source: IMF: Direction of Trade Statistics, unless otherwise indicated.

93. Since 1990, Tanzania has made progress in diversifying its exports’ composition and destination and, thus, has reduced its vulnerability to external shocks generated from primary commodities (Figure III.8). At the beginning of the 1990s, Tanzania was mainly an exporter of a few traditional agricultural commodities, when coffee and cotton accounted for about 40 percent of total exports. With the liberalization of the marketing and exporting of agricultural commodities, Tanzania’s traditional exports more than doubled between 1991 and 1996 (an annual growth rate of 16), partly due to the emergence of new cash crops (e.g., cashew nuts). After 1996, when traditional and manufactured exports were declining, exports of minerals and fish products grew substantially, increasing from about US$ 107 million in 1997 to about USS400 million in 2001 (an average growth rate of 33 percent per year). The geographical pattern of exports also changed during the 1990s, with a substantial increase in the share of exports to Africa and other developing countries. For example, exports to Kenya rose from 1 percent in 1990 to about 5 percent of the total exports in 2001.

Figure III.8.
Figure III.8.

Tanzania: Changes in Composition of Goods Exports, 1090-2001

Citation: IMF Staff Country Reports 2003, 002; 10.5089/9781451838343.002.A003

Source: Tanzaruan authorities.

94. Notwithstanding the good overall performance, the share of manufactured exports has been declining in Tanzania since 1997, except for a small recovery in 2000-01. As the manufacturing sector is usually more sensitive to external competitiveness, the significant decline in manufactured exports in 1997-99 suggests that the real overvaluation of the currency had adversely affected the sector (Figure III.7). While manufactured exports were about 16 percent of total exports during 1994-96, the share of these exports declined to about 6 percent during 1998-99. The trade regime in Tanzania is designed to provide incentives and some relative protection to the manufacturing sector through a cascaded tariff structure. Under the current structure, which has only three nonzero tariff rates (10, 15, and 25 percent), capital goods and unprocessed raw material imports have no import duty, while most of the finished consumer goods are subject to a 25 percent import tariff in order to encourage domestic manufacturing. Moreover, the government applied various restrictions (licensing, minimum dutiable values, suspended duties, etc.) on selected imports to promote domestic manufacturing sector. Despite all these measures, manufactured exports declined in the second half of the 1990s. In addition, manufactured exports accounted for only 6 percent of the manufacturing sector’s total annual output during 1998-2000, indicating that most Tanzanian firms produce for domestic consumption.

95. Several factors explain the decline in traditional and manufactured exports since 1997. First, the large real appreciation of the currency since 1995 has eroded the competitiveness of the export sector. Second, the decline in world prices for commodities (e.g., coffee and cashew nuts) has reduced export earnings. Third, a severe drought in 1998–99 caused a decline in agricultural production. Fourth, trade liberalization and increased regional integration led to a decline in the manufacturing sector, which was heavily protected prior to the 1990s. Overall, although Tanzania’s manufacturing sector is weaker than Kenya’s, the growth performance of all categories, except clothing, has been better than Kenya’s in recent years (Table III.8).

Table III.8.

Competitiveness of Tanzania’s Exports Relative to Kenya’s

article image
Source: COMTRADE database from United Nations Statistical Department (2001).

Trend growth is average annual growth weighted by individual weights of specific products within sector.

Gain (+) or loss (-) in market share is a combination of change in competitiveness, initial specialization of exports on dynamic markets and on product facing a dynamic demand in the world market, and responsiveness of exports to changes in world demand.

F. Conclusions

96. Several important conclusions can be drawn from this analysis of Tanzania’s external competitiveness. First, the real effective exchange rate indicators based on the PPP approach point to a significant worsening of Tanzania’s external competitiveness in the mid-1990s. Similarly, the estimated equilibrium real exchange indicates that the currency was significantly overvalued in real terms during 1996-2000, although some of the real overvaluation has been offset in the last two years by improvements in the economic fundamentals. However, in 2001, the real exchange rate was still about 10 percent overvalued compared to its equilibrium level. Thus, the broad trends of a real overvaluation of the currency are similar under both the PPP-based approach and the fundamentals approach. Second, despite Tanzania’s high dependency on foreign aid, our empirical results for the equilibrium real exchange rate do not provide support to the theoretical prediction that an increase in foreign aid appreciated the currency and eroded the competitiveness in Tanzania. However, we believe further research is needed to account for the structural shifts in Tanzania, a factor that is missing in our model, and to get a more definitive answer on the impact of foreign aid on competitiveness. Third, the adverse impact of the overvalued currency in 1996-2000 is evident from the decline in Tanzania’s market share in the world after 1996 and the sharp decline in manufactured exports. However, the recent increase in total and manufactured exports reveals that external competitiveness has been improving. Fourth, some of the loss in competitiveness due to the real appreciation of the currency has been offset by the authorities’ economic reforms, as is evident from the increased export diversification and improved external position. However, agricultural exports are still stagnant, partly because of depressed commodity prices, and manufactured exports are rebounding only slowly; both of these facts suggest that further reforms in these sectors are needed to improve efficiency and competitiveness. Finally, the business community in Tanzania viewed favorably the authorities’ efforts during the second half of the 1990s to promote private businesses, it also has a positive outlook, for the coming years. However, the business community also observes that Tanzania’s private sector still faces several problems that are not captured by the traditional measures of competitiveness (i.e., real exchange rate), including poor access to credit and generally high costs of doing business.

References

  • Atingi-Ego, Michael and Rachel Sebudde, 2000, “Uganda’s Equilibrium Real Exchange Rate and its Implications for Non-Traditional Export Performance,” AERC Research Report. Nairobi, Kenya: African Economic Research Consortium.

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    • Export Citation

  • Hinkle, Lawrence, and Peter Montiel, 1999, Exchange Rate Misalignment: Concepts and Measurement for Developing Countries, New York: Oxford University Press for the World Bank.

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    • Export Citation

  • Nyoni, Timothy, 1998, “Foreign Aid and Economic Performance in Tanzania,” World Development, Vol. 26, July, pp 1235–40.

  • Odhiambo, Walter, and others, 1996, “Comparative Cost of Production Analysis in East Africa: Implications for Competitiveness and Comparative Advantage,” unpublished; Washington: U.S. Agency for International Development.

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  • World Economic Forum, 1998, The Africa Competitiveness Report, 1998, Geneva, Switzerland: World Economic Forum.

  • World Economic Forum, 2001, The Africa Competitiveness Report, 2000/01, Geneva, Switzerland: World Economic Forum.

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28

Prepared by Mumtaz Hussain.

29

These factors were also present in Kenya, South Africa, and Uganda, albeit to a lesser extent. Nevertheless, the selection of 1990 as a base (i.e., equilibrium) period is a subjective choice that has implications for any conclusions about the level of competitiveness.

30

The INS methodology for REER construction is discussed by Zanello and Desruelle (1997).

31

Based on average export shares for 1990-95, we have selected Germany, the United Kingdom. Japan, Italy, and the United States. The INS system also lists the same five countries as the largest trading partners, but with slightly different weights.

32

Owing to data limitations in the case of Tanzania, we concentrate on a few major economic fundamentals of the equilibrium exchange rate.

33

The ADF test is based on the “t” statistic on the distributed lag term (α) in the following equation:ΔRERt= αRERt-1+∑f=1kβΔRERt-1+εt. The null hypothesis of unit root is rejected if (a) is significant.

34

According to model 5, a 2 percentage point increase in openness (the trade-to-GDP ratio), which is roughly equal to the 10 percent increase in log(OPEN) used in other models, will depreciate the real exchange rate by about 16 percent.

35

Based on a similar model, Nyoni (1998) estimates that a 10 percent increase in foreign aid inflow in Tanzania caused the real exchange rate to depreciate by about 5.6 percent.

36

The same is true when we add the relative growth of real GDP per worker instead of the terms of trade.

37

This model of ERER has been applied to other countries (see Atingi-Ego and Sebudde (2000)).

38

The Hodrick and Prescott (HP) smoothing method is widely used to obtain a smooth estimate of the long-term trend component of a data series. However, like many other smoothing techniques, the HP filter’s estimate of the permanent component depends on the smoothing coefficient used.

39

Using model 3, we get estimates for overvaluation between 12 percent (for the CPI-based real exchange rate index) and 9 percent (for the WPI-based real exchange rate) for 2001.

40

The 1998 report contains 23 countries, of which 22 were included in the report for 2000/01. Overall performance is based on six sets of indicators: openness (trade and exchange rate policies); government (fiscal performance, tax structure, burden for businesses of government regulation, and government efficiency); finance (saving and investment rates, banking quality, and access to financing); infrastructure (level and adequacy of infrastructure, and costs of infrastructure), labor (skill, health, and work conditions), and institutions (antitrust policy, legal system, crime, and stability of the policy regime).

41

Based on data from the Bank of Tanzania, overall exports grew by 6.9 percent annually, while nongold exports grew by only 2.9 percent per year during thel991-2001 period.

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
Tanzania: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Volume/Issue:
Volume 2003: Issue 002
Publisher:
International Monetary Fund
ISBN:
9781451838343
ISSN:
1934-7685
Pages:
137
DOI:
https://doi.org/10.5089/9781451838343.002
  • View in gallery

    Tanzania: Real and Nominal Effective Exchange Rates, December 1990-June 2002

    (Index, 1990-100)

  • View in gallery

    Tanzania: Export-weighted Real Effective Exchange Rates, 1990:1-2002:11

    (Index, 1990-100)

  • View in gallery

    Tanzania: Bilateral Real Exchange Rates for Major Currencies, 1990:1-2002:11

    (Index, 1990=100)

  • View in gallery

    Regional Real Effective Exchange Rates. 1990-2002:11

    (Index, 1990-100)

  • View in gallery

    Tanzania: Bilateral Real Exchange Rates with Regional Competitors, 1990:1-2002:11

    (Index, 1990=100)

  • View in gallery

    Tanzania: Comparison of Actual REER and Long-Run Equilibrium Real Exchange Rate.

  • View in gallery

    Tanzania: Exports and Imports Indices (Based on U.S. dollar values) and Real Effective Exchange Rate (REER), 1990-2001

    (Index, 1990-100)

  • View in gallery

    Tanzania: Changes in Composition of Goods Exports, 1090-2001

Tanzania: Real and Nominal Effective Exchange Rates, December 1990-June 2002

(Index, 1990-100)

Tanzania: Export-weighted Real Effective Exchange Rates, 1990:1-2002:11

(Index, 1990-100)

Tanzania: Bilateral Real Exchange Rates for Major Currencies, 1990:1-2002:11

(Index, 1990=100)

Regional Real Effective Exchange Rates. 1990-2002:11

(Index, 1990-100)

Tanzania: Bilateral Real Exchange Rates with Regional Competitors, 1990:1-2002:11

(Index, 1990=100)

Tanzania: Comparison of Actual REER and Long-Run Equilibrium Real Exchange Rate.

Tanzania: Exports and Imports Indices (Based on U.S. dollar values) and Real Effective Exchange Rate (REER), 1990-2001

(Index, 1990-100)

Tanzania: Changes in Composition of Goods Exports, 1090-2001