Statement by Hector Torres, Alternate Executive Director for Bolivia and Alonso Segura, Assistant to Executive Director September 27, 2004

This paper discusses Bolivia’s Fourth Review Under the Stand-By Arrangement (SBA) and Request for Waiver of Nonobservance of Performance Criteria (PC). Economic activity in Bolivia is picking up, led by exports. Real GDP growth is projected to reach 3.8 percent in 2004. Inflation has increased but remains in low single digits. The current account surplus increased, although recent capital outflows more than offset the improvement. The 2004 program is broadly on track. Fiscal quantitative performance criteria (PCs) at end–June were also observed.

Abstract

This paper discusses Bolivia’s Fourth Review Under the Stand-By Arrangement (SBA) and Request for Waiver of Nonobservance of Performance Criteria (PC). Economic activity in Bolivia is picking up, led by exports. Real GDP growth is projected to reach 3.8 percent in 2004. Inflation has increased but remains in low single digits. The current account surplus increased, although recent capital outflows more than offset the improvement. The 2004 program is broadly on track. Fiscal quantitative performance criteria (PCs) at end–June were also observed.

Key points

  • Performance under the program has been satisfactory. While two PCs, NIR and NDA, for which we request waivers, were missed in June, both are back on track.

  • Fiscal consolidation is proceeding strongly. A fiscal adjustment of 2% of GDP is expected for 2004, with further revenue and expenditure reforms in the pipeline to guarantee the continuation of the process into the future. Continued support of the donor community is essential.

  • The banking system has regained stability, while corporate restructuring has regained momentum.. Measures to strengthen both are being implemented.

  • A successful National Referendum on key issues regarding the hydrocarbons sector has allowed an ongoing ample discussion on a new framework for the exploitation of hydrocarbon resources. Government efforts are geared towards consensus building with the goal of achieving an investment-promoting framework.

  • The new PRSP based on a national dialogue is proceeding as scheduled, and a request for a PRGF arrangement should be made early next year.

Background and Overview

1. Once again we thank the staff for a balanced assessment on the current situation in Bolivia, reflecting hard work and devotion on the part of the team, which we highly appreciate. Whereas the political and social situation has improved in the last months, aided by the high popularity of the President, the government’s success in the oil referendum, and the sensible policies the government pursues, it is true that gaining and maintaining consensus within a highly fragmented political arena and social spectrum has proven to be very difficult. Nonetheless, improvements have been attained on different fronts. Despite unavoidable disagreements between the Executive and Legislative branches, the government has been reasonably successful in passing important legislation, street protests have significantly declined, fiscal consolidation is gaining decisive footing, after some turbulent weeks in the second quarter of the year the financial sector has, once again, proven resiliency, and the strategy for the development of the oil sector is being widely discussed. The situation is, nevertheless, still fragile.

2. Compliance with the program has been strong. GDP growth, which has been stronger than expected, could be above 3.8% in 2004 and is likely to reach higher rates in 2005; exports have been booming due to favorable terms of trade but also due to significant volume growth; inflation remains under control and the exchange rate has remained stable. In this context, all but two quantitative performance criteria for June, NIR and NDA, for which we request waivers, were met. These two were missed due to a bout of instability in the financial sector that led to some withdrawal of deposits, and also due to delays in external disbursements. In both cases, these indicators have later recovered and are currently in line with the program. Ownership of the economic agenda on the part of the authorities remains strong, and despite no structural conditionality required for this review, decisive advances have been made in complying with those due for the fifth review, some of them which we will comment on later. As stated in previous Buffs, the current Stand-By Arrangement with the Fund is a key anchor for agents’ expectations, and has proven to be an effective vehicle for the Fund to provide advice to the authorities in the design and implementation of its policies, which has allowed to strike a balance between the need to ensure short-term stabilization and that of crafting the medium-term policies necessary to foster sustainable growth and poverty reduction.

Fiscal Policy

3. Strong fiscal consolidation is being attained, in line with the ambitious goals set in the program. The overall fiscal deficit for 2004 is projected at 6% of GDP, a reduction of 2% with respect to the previous year, which in the context of strong social pressures is a significant achievement. The medium-term path envisions this consolidating trend to continue in the following years, a further half to three quarters of a point in 2005 to start with, as the authorities are conscious of the risks if debt is not gradually reduced. Revenues, expenditures, and the composition of financing are all being addressed in order to promote structural changes in the fiscal accounts, that lead to a more efficient and sustainable public sector.

4. On the revenue side, the measures implemented this year and in late 2003, together with strong GDP and exports growth mainly of gas, are expected to result in higher than expected revenue collection in the order of 0.7% of GDP relative to the program, and a 2% of GDP overall increase in revenues with respect to last year. The new Tax Code (0.3% of GDP), a revised Tax Bill (0.3% of GDP), the tax regularization scheme (0.8% of GDP), the transitory two-year financial transactions tax (FTT) (0.5% of GDP), have all been instrumental in this effort. This revenue performance has allowed for an increase in pro-poor and capital expenditures, despite maintaining overall expenditures grossly constant as a share of GDP, with current expenditures falling by about half a percentage point. The wage bill is being reduced by 0.2% of GDP, with wage restraint being a key element. Poverty reduction outlays are being prioritized and would increase by a significant 0.7% of GDP. New investment projects, mainly roads to communicate Bolivia with neighbor countries have been deemed as a priority, given the landlocked nature of the country. However, the authorities have emphasized that these projects will have to be accommodated within the expenditure framework tentatively agreed with the Fund for 2005, which implies reprioritization of projects as well as subjecting to the caps on non-concessional borrowing to avoid exacerbating the debt pressures that are binding.

5. On a longer term perspective, from 2005 onwards, the authorities are aware of the need to continue the fiscal consolidation efforts. This implies, according to numbers broadly agreed between the staff and the authorities, that new measures for an equivalent to 11/4 percent of GDP for 2005 need to be identified, which calls for efforts on multiple fronts. On the revenue side, a tax reform aimed at implementing a more progressive and efficient tax system is being prepared, for which an FAD mission was requested, and visited La Paz in July-August. Among the main pillars of such reform are the phase-out of the transaction tax (IT) by means of merging it to the VAT, with an increase in the later rate, as well as the introduction of a personal income tax (PIT) to replace the current RC-IVA which allows for the VAT on consumer goods to be credited against taxes on wages and interest payments, a mechanism that is widespread known as being subject to abuse and fraud. As a result of this reform, temporary and distortionary taxes would also be progressively phased-out (including the temporary FTT), and moderate gains in revenue collection would be expected. With regards to the temporary freeze on fuel prices, while this measure may have been considered technically a backward step, it was necessary in order to avoid social adverse reactions. Price increases are expected to resume by year-end, as a more flexible price mechanism is enforced again; however, it may not be prudent to move into a fully “automatic” price-adjustment mechanism.

6. On expenditures, decisive actions are being taken to improve the quality of expenditures in the medium-term, particularly those aimed at poverty reduction, as well as identifying priorities to enable the reduction in overall spending gradually through 2007. To this end, the high-level commission of members from the civil society has already finalized a report which contains specific recommendations and targets to such end. Last Monday, its preliminary results were presented to the donor community and the final report is expected by the end of the month (end-September PC). Beyond this, we have requested a new FAD mission to help us focus on public expenditure management and decentralization. We expect that such mission will arrive in La Paz next month. In sum, we aim at substantially improving Bolivia’s budget administration and expenditure management with inputs provided not only by the aforementioned high-level commission, but also by the IDB and the World Bank through the Public Expenditure Review (PER), and through the HIPC assessment and action plan.

7. Grants continue to be essential to the success of the fiscal program and the authorities are grateful to the donor community for their continuous support to Bolivia. A Consultative Group meeting is being prepared for the end of this year or early 2005, in order to gather the concessional resources and grants needed to support such fiscal program. In addition, the limits on overall non-concessional financing will be maintained and tailored to the debt situation of the country, in order to avoid exacerbating debt dynamics. Whereas a more detailed DSA analysis is envisioned for the near future, the staff’s projections show a sustainable medium-term path, supported by fiscal consolidation efforts, a continuation of concessional financing, and increased hydrocarbons production either through an LNG or alternative projects, some of them which have already implied increased production and exports.

Structural Reforms and Framework for Hydrocarbons

8. Actions to strengthen the banking and corporate sectors continue. An advisory committee, headed by the Superintendent is exploring ways to strengthen both, the independence of the Superintendence of Banks, as well as the banking system. Regarding the bank, which is majority-owned by NAFIBO, the write-off of the shareholders capital according to the due dilligence process, has already taken place, and initial actions are being taken for the re-privatization of the institution. As indicated by the staff, corporate restructuring has regained momentum with the appointment of a new Superintendent and a significant number of pilot cases being identified.

9. The conduct of monetary policy is carefully geared towards preserving adequate liquidity conditions and monitor inflation developments, as proved by the timely increases and later decreases of reference interest rates by the Central Bank (BCB). The prudent policies followed by the BCB have constituted a key anchor to expectations, successfully controlling the bouts of deposit bank runs of the last year. As a consequence, after an important loss of reserves in the first two quarters of the year, NIR are back on track, and bank deposits have partially recovered. The increased dynamism of placements of government paper is proof of the regained confidence, and the policy of extending their maturity is a sensible strategy to extend the yield curve. Increased placements in local currency mitigate debt management risks and also serve as a means to gradually reduce dollarization. As indicated by the staff, other market friendly measures are being considered, in order to bolster BCB’s NIR position, while introducing flexibility into an exchange rate arrangement that has served Bolivia well so far.

10. Development of the hydrocarbons sector is key to Bolivia’s future and to attain a sustainable reduction in poverty levels. Being aware of this, the authorities are doing their utmost efforts to put in place a framework for the exploitation of their vast hydrocarbons reserves, that while being market friendly, also garners the essential social consensus to allow the private sector to operate. In this delicate balancing act, pushing for a referendum proved to be an accurate decision by the authorities, since it has led to reduced social tensions and has empowered the executive branch with the popular backing to propose a new framework. A draft of the new hydrocarbons law is being discussed now, not only at the political level in Congress, but with private actors as well. The advice of multilateral institutions is being carefully considered. While there remains some contentious issues, it is important to underline the consensus building process under way. The authorities’ ultimate goal is to arrive at a framework that promotes private investments, with the proper checks and balances in place to ensure a fair share of the benefits for the Bolivian people.

The Road Ahead

11. The authorities will be finalizing by year-end, a medium-term policy framework, anchored into a new Poverty Reduction Strategy Paper (PRSP) that should serve as the basis to request a new three-year PRGF program. My authorities plan to bring such a request to the Board early next year, to serve as a continuation of the expiring Stand-By arrangement.