Statement by Damian Ondo Mañe, Executive Director for Republic of Madagascar

Madagascar showed strong economic growth and low inflation under the Poverty Reduction and Growth Facility (PRGF) Arrangement. Executive Directors commended these developments, and stressed the need to restore fiscal discipline, improve governance, strengthen the business climate to encourage private investment, and accelerate structural reforms. They welcomed the plan to privatize and rehabilitate the telecom, cotton, sugar, and utility companies, and agreed that Madagascar has successfully completed the fourth review under the PRGF program, and approved waiver, additional interim assistance, and an extension of the arrangement.

Abstract

Madagascar showed strong economic growth and low inflation under the Poverty Reduction and Growth Facility (PRGF) Arrangement. Executive Directors commended these developments, and stressed the need to restore fiscal discipline, improve governance, strengthen the business climate to encourage private investment, and accelerate structural reforms. They welcomed the plan to privatize and rehabilitate the telecom, cotton, sugar, and utility companies, and agreed that Madagascar has successfully completed the fourth review under the PRGF program, and approved waiver, additional interim assistance, and an extension of the arrangement.

Madagascar’s economy is responding well to the comprehensive set of measures that were implemented in late 2002 and early 2003, following the political crisis of 2002. As Directors may recall this crisis brought about a major disruption in the economy, characterized by a very sharp drop in real GDP and aggravated the hardships of the population. To address this situation, the government established, with the assistance of the Fund, World Bank, other multilateral institutions and bilateral donors, a recovery and reconstruction plan. The measures taken were consistent with the PRGF program and aligned with the PRSP, and were aimed, among others, at stabilizing the economy, strengthening the business climate and governance, encouraging private sector investment, and diversifying the export base. An important component of the plan was also the provision of emergency assistance to the most vulnerable groups of the population. The recovery plan was successful in meeting most of the objectives that were set.

The Malagasy authorities have built on the progress made in 2003, and have strengthened their efforts in many areas, in particular in the fiscal sector where the authorities are implementing the FAD technical mission recommendations. As described in the authorities’ Memorandum on Economic and Financial Policies for 2004, a wide range of measures consistent with the PRSP are being taken.

Performance in 2003

Macroeconomic performance in 2003 continued to improve compared to the previous year, on the basis of the comprehensive measures undertaken. All the performance criteria for end-June 2003 were observed. Real GDP in 2003 is estimated to have increased by nearly 10 percent, compared with a program objective of 6 percent, with annual average inflation declining by 1.4 percent, compared to an increase of 8 percent in the program. Employment, in particular in the Export Processing Zone increased significantly, while activities in the other sectors of the economy, including the agricultural sector, were buoyant. Good progress was also made in improving access to education with the construction of additional classrooms, the recruitment of teachers, and the provision of basic supplies to primary school children. Access to basic health care was also expanded.

In the fiscal area, the authorities’ objectives, for 2003, were: the improvement of government revenue to allow for increased social spending, and the promotion of economic recovery, while keeping the deficit at a level consistent with the program. In this regard, a wide range of measures were taken and included targeted revenue increases as well as reforms of tax and customs administration, and the strengthening of expenditure and treasury management. To help the economic recovery, following the major shock that occurred, the authorities reduced marginal income tax rates for individuals and companies, and the tariffs on a number of inputs for the agricultural and construction sectors. These measures were supplemented in mid-2003 by further temporary tax and tariff exemptions for the import of capital goods and selected commodities. The fiscal impact of these additional exemptions is estimated at about one quarter of one percent of GDP for 2003. On the expenditure side, there was an increase in extrabudgetary outlays in the area of education, security, public enterprise reform and additional domestic interest obligations, but overall expenditure was kept within program target. Government revenue, however, is estimated at 10.3 percent of GDP, instead of 10.6 percent, as programmed. As a result, the overall fiscal deficit (on a commitment basis, excluding grants) was 7.9 percent of GDP. Although, this deficit improved compared to 2001, it was higher than the program target of 7.6 percent of GDP.

The objective of monetary policy in 2003 was to reduce inflation while ensuring adequate scope for the expansion of credit to the economy, which is essential to the recovery. The stance of monetary policy was such that it helped to bring inflation under control. However, credit to the economy remained subdued in the first half of the year as businesses confidence took time to recover, and expanded in the second half of 2003 as credit to the government and crop financing picked up. The introduction of the new currency, the ariary which is equivalent to FMG 5, is proceeding smoothly

In the external sector, although there was broad improvement, the current account deficit target was higher than programmed, as exports increased by less than projected, as it is taking longer for the factories in the Export Processing Zone to return to full production. Import, in particular of capital goods, also increased significantly. The level of international reserves was lower than programmed. The authorities maintained their flexible exchange rate policy, and reflecting in large part the strengthening of the euro, the effective exchange rate depreciated in 2003.

The authorities implemented a number of structural reform measures in 2003. In particular, measures were introduced to enhance private sector confidence and development. The anticorruption commission was established. Steps were taken to strengthen tax and customs administrations and to combat fraud. The Property Act was amended to allow foreigners to own land. A comprehensive program of privatization was put in place, but met with delays due to technical problems and issues related to shareholder rights. The authorities remain committed to the privatization program and are working closely with the different partners to complete the process.

Program for 2004

The program for 2004 will continue the reform agenda. The authorities will implement policies that will ensure sustainable economic growth and the reduction in poverty, consistent with the PRSP. In this regard, the policies being implemented are expected to achieve real GDP growth of 6 percent, contain inflation at about 5 percent, and raise the level of international reserves to the equivalent of 3.8 months of imports. Efforts to improve the fiscal outlook and accelerate structural reforms will be intensified.

In the fiscal sector, while important progress has been made in restoring fiscal discipline and improving governance, this progress has to be consolidated and strengthened. Measures envisaged for 2004 go in this direction, and will focus, among others, on enhancing transparency and efficiency in public resource management, improving governance and raising the level of revenue. With the economy recovering, the authorities will focus more efforts on raising government revenue, and in this regard, the measures envisaged for 2004, are expected to raise the tax-to-GDP ratio from 10 percent in 2003, to 11.2 percent in 2004.

The authorities are taking steps that will continue the process of broadening the revenue base and maintaining the integrity of the VAT. The VAT is being extended to cover a number of previously exempted goods and services, and taxes on tobacco and cigarettes are being increased. The efforts to strengthen tax and customs administrations, as well as collection of tax arrears will be pursued. The authorities have also taken steps to simplify and streamline the tax system. In particular, the number of trade taxes and tariff rates are being reduced. These measures are also expected to contribute to enhance the openness of the economy and to reduce fraud. The Budget for 2004 includes measures aimed at reversing the increase in tax exemptions, and introduces a comprehensive overhaul of the tax system based on the recommendations of the Fund technical assistance mission.

On the expenditure side, the tight control over outlays will be maintained. However, the budget includes increases in poverty-related expenditure, as well as increases in capital expenditure, which is externally financed for the most part. The wage bill will be reduced to 5.1 percent of GDP in 2004, as no wage increase will be granted, although there is allowance for new recruitments in the areas of health, education, justice and security, and for the program of early retirement. The authorities also intend to clear all payments arrears outstanding at end-2003, and pay arrears of the SIRAMA and TELMA to sugar planters and creditors respectively. Procedures have been put in place to prevent the occurrence of new arrears. The authorities will also intensify their efforts to improve treasury accounting, simplify budget execution system, and strengthen the monitoring of budget implementation.

Monetary policy will be consistent with the inflation and growth objectives. In this regard, the authorities will monitor closely liquidity developments in the banking sector, and will also facilitate the development of a money market which should improve the effectiveness of monetary policy. The resumption of strong economic growth and the strengthening of the investment climate are expected to be conducive to demand for credit by the private sector. With the government not having recourse to net bank credit, the authorities have programmed broad money to increase by 12 percent during the year, which should be adequate to meet the needs of the economy while remaining consistent with the inflation objective. The availability of credit to small- and medium-sized enterprises is being improved through amendment to the Property Act to allow the use of property as collateral. The legal framework for microfinance activities is being finalized and operations are expected soon. Although the banks are well capitalized, nonperforming loans have been increasing, mainly as a consequence of the 2002 crisis. The authorities expect these nonperforming loans to decrease as the recovery takes hold, but they are, nevertheless, strengthening banking supervision and developing systems of early warning with assistance from the Fund. Moreover, the audit of reserves management and foreign exchange activities has begun, as recommended by the safeguards assessment report.

In the external sector, the prudent macroeconomic policies being implemented and the ongoing structural reforms will contribute to maintaining Madagascar’s external competitiveness. The return of the EPZ factories to full production should also improve the export picture which, however, will be adversely affected by the drop in vanilla exports. On the import side, the public and private investment program and the lowering of a number of tariffs are expected to cause import to show a substantial increase, so that the external current account deficit(excluding transfers) is projected at about 7.6 percent of GDP. Reflecting a higher level of external financial assistance, the level of international reserves should increase to the equivalent of 3.8 months of imports. Moreover, in the context of its regional integration policy, and the launching of the customs unions of the COMESA, Madagascar is taking measures to harmonize its customs rules and procedures with those of the other countries of the COMESA.

As regards the debt profile, it remains broadly similar to that projected at the decision point. Madagascar has also finalized bilateral rescheduling agreements with most Paris Club and several non-Paris Club creditors. Contacts have also been made with all official creditors for the reconciliation of outstanding debt in preparation for reaching the completion point.

The comprehensive program of structural reforms will be pursued in 2004. In the fiscal sector, measures are being taken to further improve the operations of the tax and customs departments. In the public enterprise sector, the authorities are pursuing the efforts to complete the agenda of reforms for the several public enterprises for which reforms are underway.

Cyclone Gafilo

My authorities are fully committed to the reform process and to accelerate the reform agenda where possible. However, as has been the case in the past, the country remains subject to exogenous shocks, and especially to the vagaries of the weather. Last week Madagascar was hit twice by a violent hurricane which has caused large loss of lives and extensive damage to the agricultural sector and the infrastructure. The authorities are in the process of assessing the damages and the costs of reconstruction. They will consult with the staff, if any change needs to be made to the program’s objectives, and will work with staff on the assessment of any additional support that may be required. However, in view of the extensive damage caused by the cyclone, as outlined in the staff supplement, and based on preliminary assessment, my Malagasy authorities are requesting an augmentation of access under the current PRGF arrangement in an amount equivalent to 10 percent of quota. I would, therefore, like to request Directors for their full support of the proposed decision, including the augmentation of access, to enable the Malagasy authorities to pursue their strong reform agenda. My authorities are thankful for the assistance that they have already received, and they hope that the international community will continue to stand by their side in these difficult times.

Conclusion

Despite the many challenges they faced, my Malagasy authorities are of the view that the overall performance of the economy improved significantly in 2003, and that progress has been made in the reform agenda. The poverty-reduction program has been well implemented and is having a positive impact on the population. Under the 2004 program, the authorities’ efforts will be intensified, as the macroeconomic situation has broadly stabilized. There is no doubt that the recent cyclone will have an impact on my authorities’ efforts, but they remain fully committed to pursue steadfastly the reform agenda. They are thankful to the international community for the excellent assistance that has been provided to them, and which they are putting to good use.