Sierra Leone
Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
28 Dec 2004
eISBN:
9781451834475
Language:
English
Keywords:
ISCR; CR; government; Sierra Leonean authorities; debt service; government operation
Download PDF (1.5 MB)

This Selected Issues paper examines recent economic developments in Sierra Leone. The paper highlights that the economic recovery in Sierra Leone has benefited especially from the extensive rehabilitation and humanitarian activities in liberated areas. Real GDP growth rose by 4 percent in 2000 and accelerated further in 2001 and 2002. The paper lays out some conceptual issues for the analysis of government debt sustainability, and discusses key issues related to long-term fiscal sustainability. The challenges ahead for rehabilitating Sierra Leone’s mining sector are also examined.

Abstract

This Selected Issues paper examines recent economic developments in Sierra Leone. The paper highlights that the economic recovery in Sierra Leone has benefited especially from the extensive rehabilitation and humanitarian activities in liberated areas. Real GDP growth rose by 4 percent in 2000 and accelerated further in 2001 and 2002. The paper lays out some conceptual issues for the analysis of government debt sustainability, and discusses key issues related to long-term fiscal sustainability. The challenges ahead for rehabilitating Sierra Leone’s mining sector are also examined.

I. Recent Economic Developments1

A. Background

1. Sierra Leone remains a poor country despite its rich resource base. Following a protracted war, which began in 1991 when the Revolutionary United Front started campaigning against the government and ended with the signing of the July 1999 peace accord in Lomé, Togo, poverty has become more pervasive. With a real per capita GDP of about US$130 in 2003, Sierra Leone is well below the average for sub-Saharan African countries.2 Furthermore, it ranks last among the 147 countries on the 2004 United Nations’ human development index.

2. The IMF and the World Bank Group’s International Development Association (IDA) agreed in March 2002 to support a comprehensive debt reduction package for Sierra Leone under the enhanced Heavily Indebted Poor Countries (HIPC) Initiative. Under the decisions made by the IMF and IDA, assistance committed by IDA—US$122 million in net present value (NPV) terms—will be delivered over a 20-year period and will cover, on average, 89 percent of debt-service obligations falling due to IDA. Debt relief provided by the IMF—US$123 million in NPV terms—will be delivered over the next 10 years. A three-year arrangement under the IMF’s Poverty Reduction and Growth Facility (PRGF) was approved in September 2001 in the amount of SDR 130.84 million (126 percent of quota) and was subsequently extended to March 26, 2005.

B. Output and Inflation

3. Real growth has been rapid in recent years. Improved security and the reestablishment of government control and authority throughout the country have boosted confidence. The economic recovery has benefited especially from the extensive rehabilitation and humanitarian activities in liberated areas. Real GDP growth rose by 4 percent in 2000 and accelerated further in 2001 and 2002 to 18 and 27½ percent, respectively.3 The strong growth was driven mainly by service sector activities (transport, communication, and real estate), construction, and, to a lesser degree, agriculture (crop production, forestry, and fishery). Real GDP for 2003 rose by 9 percent and was broadly based (Table I.1; and Figure I.1 and Figure I.3).

Table I.1.

Sierra Leone: Selected Economic and Financial Indicators, 1999-2003

article image
Sources: Sierra Leonean authorities; and IMF staff estimates and projections.

Data reflect revisions in the national accounts.

Changes as a percentage of beginning-of-period money stock (including foreign currency deposits).

Domestic revenue minus total expenditure and net lending, excluding interest payments, and externally financed capital expenditure and disarmament, demobilization, and reintegration (DDR) program.

As a percentage of exports of goods and services; after Naples (2001) and Cologne flow reschedulings (2002-04), and delivery of possible HIPC Initiative assistance.

Figure I.1.
Figure I.1.

Sierra Leone: Annual Contribution to Real GDP Growth by Sector, 1999-2003

(In percent)

Citation: IMF Staff Country Reports 2004, 420; 10.5089/9781451834475.002.A001

Sources: Statistics Sierra Leone; and IMF staff estimates.
Figure I.2.
Figure I.2.

Sierra Leone: Financial Soundness Indicators of the Banking System, 2000-03

(In percent)

Citation: IMF Staff Country Reports 2004, 420; 10.5089/9781451834475.002.A001

Figure I.3.
Figure I.3.
Figure I.3.

Sierra Leone: Selected Economic Indicators

Citation: IMF Staff Country Reports 2004, 420; 10.5089/9781451834475.002.A001

4. Agricultural production in Sierra Leone accounts for about 40 percent of GDP and grew on average by about 9 percent during 2000-03. Before the civil war, the agricultural sector generated 52 percent of GDP and employed more than 60 percent of the working population, with coffee and cocoa being the principal export crops and rice being the main food crop. The slow peace process during the first two postconflict years (2000-01) delayed the resettlement of displaced farmers to their original homes and, therefore, the agricultural recovery. Improvements in the security situation during 2002-03 and the resettlement of refugees and internally displaced people in rural areas, facilitated a sharp recovery in agricultural output and rural economic activity. Harvests of rice, cassava, sweet potatoes, and vegetables were rated good in several rural areas (especially Bo, Kenema, Port Loko, Bombali, and Kambia districts).4 Stimulated by the increase in the world market prices for coffee and cocoa, the shipment of both commodities increased by 1,164 percent and 84 percent in 2002, respectively, although negligible amounts had been purchased in the previous years. In 2003, the output of rice was up to 78 percent of its prewar level, and cocoa production grew by 134 percent as a result of the continued impetus provided to farmers by the significant rise in cocoa prices in the international market.5 The government has pledged to boost agricultural production and achieve food security in Sierra Leone by 2007.

5. Industrial production accounted for 22 percent of GDP during 2000-03. As business confidence increased, the production of goods and services also increased. Key manufacturing industries were able to expand production in spite of technical problems associated with aging plant and machinery. A more reliable electricity supply to industries contributed to the expansion in capacity utilization. Growth was particularly strong in light manufacturing, which benefited from the increased imported inputs. In 2003, however, some manufacturing industries registered downturns on account of frequent breakdowns of plant and machinery, and increased consumption of better-quality imported substitutes. As for the mining sector, the production of diamonds, as measured by shipments through the Government Gold and Diamond Office, increased by 57 percent in 2002 and by 44 percent in 2003. The increase was due to intensified mining activities as well as the implementation of the United Nations Certification Scheme.6

6. Service activities have contributed substantially to GDP growth since the end of the war. During 2001-02, services expanded by about 60 percent in 2001 and 30 percent in 2002, albeit from low levels in previous years. Developments in transportation and communication (increased registration of taxis and busses, introduction of cellular phones) have supported the strong expansion in services.

7. Domestic investment and savings during 2000-03 were low, and significantly below the averages for sub-Saharan Africa.7 During 2000-03, gross domestic investment represented, on average, about 10 percent of GDP. Public investment, which was largely donor-financed, and private investment (especially in the service sectors of tourism, transportation, and communication) each represented, on average, about 5 percent of GDP. Gross domestic savings were negative during 2000-03 (on average -9 percent of GDP), with public and private savings accounting for about -4 percent and -5 percent of GDP, respectively. The weak domestic savings and investment balance must be seen in light of the damage caused to institutions and infrastructure during the war in the 1990s. The negative public savings stem from the country’s weak fiscal position, whereas the negative private savings reflect, for the most part, the extent of poverty.8

8. Inflation stabilized following the end of the conflict, but inflationary pressures reemerged in 2003.9 After the signing of the peace accord in July 1999, annual average inflation fell sharply from nearly 34 percent in December 1999 to -1 percent in December 2000, as the supply situation improved, macroeconomic policies were tightened, and the exchange rate appreciated in real terms in 2000. Inflation remained low in 2001 and 2002. Several developments accounted for this decline, including further improvements in the supply situation, particularly for imports, increased trade competition, a substantial reduction in import duties, a reduction in domestic petroleum product prices, and the relatively stable exchange rate. However, inflation accelerated in 2003 as a result of higher fuel prices and their effect on transportation costs, the expansion in broad money, and the continued depreciation of the leone against the U.S. dollar and other international currencies.

C. Fiscal Developments

9. Fiscal performance was uneven during 2000-03. Reflecting weak revenue performance and high expenditures, the overall deficit (excluding grants) remained large. The fiscal deficit was financed largely from external sources (between 6 and 8 percent of GDP), comprising economic recovery and rehabilitation credits and loans from IDA and the African Development Bank (AfDB). In addition, domestic financing of the budget has been large (Table I.1; and Figure I.3).

10. Revenues were higher than budgeted. However, as a percentage of GDP they have remained low, with little progress in raising the revenue share. Increased revenue collections reflect rising customs duty receipts, greater reliance on presumptive income taxes, and, to a lesser extent, improved tax administration, including a sustained drive to collect tax arrears. The revenue performance also reflects a substantial rise in commercial activities in the manufacturing, construction, trade, and service sectors. Nontax revenues from the mining sector rose as more mining licenses were issued and improved mechanisms for certifying diamonds for export were put in place. The establishment of the National Revenue Authority in 2003 also contributed to revenue collections.

11. There have been improvements in expenditure control. Fiscal discipline was strengthened by the implementation of computerized systems to monitor and control expenditures and to control payroll and pensions. However, significant differences remain between planned and actual expenditures. For example, Sierra Leone has limited administrative ability to implement capital projects. Substantial amounts of multilateral and bilateral project financing had been committed but were not fully used because of security and capacity constraints. In respect of goods and services, there was strong pressure on the government to increase outlays, especially for the deployment of police and the provision of other services. In 2003, fees, subsidies, and financial assistance to educational institutions and the Ministry of Health and Sanitation contributed to an increase in expenditure.

12. Shortfalls in external budgetary support led to greater than programmed recourse to domestic financing of the budget. Frequent delays in the disbursement of external budgetary assistance (excluding project-related assistance) complicated fiscal management and led to higher domestic financing. During 2001, some of the delays were related to required audits of prior aid use. In the case of budgetary assistance from the EU, a dispute about audits done for 1998 and 1999, together with delays in fielding an audit for aid disbursed in 2000, led to the postponement of further aid disbursements. The shortfall in foreign financing during 2003 arose in part because of an administrative delay in conducting an audit that constituted part of EU grant conditionality. Another cause of the shortfall was a delay in a loan disbursement from the AfDF. The Board of the AfDF approved the second Economic Rehabilitation and Recovery Loan for Sierra Leone in December 2003, and disbursement was made in April 2004. As a result of rising domestic borrowing, domestic interest outlays were much higher than programmed.

13. The government had difficulty in managing the wage bill. Strong fiscal pressures in 2000 to increase outlays reflected demands for higher allowances for civil servants, an increase in the wage bill to pay former soldiers put back on the payroll, and outlays on defense and security. In response, the government raised expenditure ceilings, which were financed by higher-than-programmed revenue and external budgetary support. In 2001, a substantial overrun on the wage bill occurred (0.7 percent of GDP) mainly because of higher-than-budgeted wage and salary payments to teachers.10 The planned wage bill was exceeded in 2002, reflecting continuing difficulties in managing teachers’ payroll and the settlement of a strike by health workers (which raised nurses’ and doctors’ pay well above budgeted levels).11 To bring teachers’ salaries under control, the government introduced a number of measures in 2003 that strengthened financial accountability for teachers’ payments and streamlined administrative procedures. The wage bill in 2003 only slightly exceeded the programmed level, reflecting, in part, the unprogrammed clearance of wage arrears.

D. Monetary Sector

14. Broad money growth accelerated during 2000-01 as a result of rising economic activity and remonetization of the economy. Monetary conditions were dominated by fiscal developments. The money supply rose as a result of the large increase in net bank credit to the government. Faced with a significant increase in their deposit base and limited growth in private sector credit in 2001, commercial banks competed to augment their share of government securities. As a result, and owing to low inflation, nominal yields on treasury bills and government bonds generally declined. The treasury bill rate fell from 20 percent in December 2000 to a low of 8.6 percent in February 2001 before rising to 14.7 percent in December 2001 (Table I.1; and Figure I.3). The spread between bank loan and deposit rates, having narrowed only marginally in response to the decline in treasury bill and bond yields, remained wide (20-30 percent).

15. Monetary policy during 2002-03 accommodated the expansionary fiscal stance and allowed the private sector credit to continue to grow at a rapid pace. The rapid increase in broad money can be attributed to the faster-than-programmed expansion in bank domestic assets. Private sector credit started to grow rapidly in 2002 and increased by nearly 65 percent in 2003. The sectors accounting for this increase were commerce and finance, manufacturing, construction, and services, signifying a pickup in economic activity in these sectors from low post-conflict levels. The banking system’s net credit to the government also increased substantially. The yield on treasury bills at end-2003 was 20.2 percent compared with 15 percent a year earlier.

16. The banking sector of Sierra Leone remains very small and highly liquid. At the end of 2003, broad money was equivalent to about 20 percent of GDP. The major financial institutions comprise six commercial banks—three local, of which one is 100 percent state-owned, and three foreign. The banking system’s assets increased by 91 percent during December 2000-03, a rise fueled, on the liability side, by a rapid growth of banking system deposits (108 percent). On a risk-weighted basis, banks’ capitalization increased to 40 percent in 2003 from 25 percent in 2000 (Figure I.2).12 Reported capitalization figures reflect the high level of government securities in banks’ balance sheets. The commercial banks’ ratio of nonperforming loans to total bank loans continued to decline to slightly below 10 percent in December 2003 from 38 percent at end-2000; the decline has been attributed, in part, to the repayment of government arrears to enterprises, but also to the rapid increase in credits to the private sector (64 percent in December 2003 from end-year 2002). The overall ratio of liquid assets to deposits grew from 67 percent in 2000 to 71 percent in 2003. In an environment of rapidly expanding banking activities and high real interest rates, the commercial banks have been able to remain profitable, as measured by their return to equity (33 percent in December 2003).

E. External Sector

17. The external current account deficit (excluding official transfers) has remained large since the end of the conflict in July 1999. This reflects the sharp increase in commercial and humanitarian relief imports, as well as the country’s limited export capacity (still operating below potential). The current account deficit in 2000 was financed by foreign grants and concessional loans, and the capital account balance improved markedly as a result of larger official inflows (Table I.1; and Figure I.3).

18. Exports started to recover in 2001. The implementation of the UN-sponsored diamond export certification scheme helped raise the level of officially recorded diamond exports to US$26.3 million in 2001 from US$10.1 million in 2000. Nonetheless, the 2001 level was a small fraction of total diamond exports.13

19. Proceeds from officially exported diamonds increased by 59 percent in 2002, reaching the highest level since 1985. The impressive performance in the export of diamonds can be attributed to the increased mining activities and improved incentives and logistics for mine wardens and also to the more effective implementation of the certificate of origin scheme. In addition, strong recovery in coffee and cocoa production led to a substantial increase in these exports.

20. On the import side, the increased availability of foreign exchange to importers improved business confidence, and greater economic activity contributed to rising imports. The surge in imports in part reflected UN and NGO operations, while the increases in the value of machinery and transport equipment are explained by increased investment. Private capital inflows, including from NGOs and the UNAMSIL, helped to finance imports.

21. Sierra Leone’s external current account deficit in 2003 rose to about 14 percent of GDP, reflecting increased imports related to reconstruction activities and the higher cost of fuel. Foreign trade during 2003 rose by 23 percent from a year earlier, as manifested in the significant increases in both import payments (owing to a general rise in commercial activity) and export receipts (owing to a further boost in mining and agricultural output). Officially recorded diamond exports have benefited from the international adoption of the Kimberley Process Certification Scheme; as a result, proceeds from the export of diamonds increased by 83 percent in 2003. Agricultural exports also expanded strongly but continued to account for only a small share of total exports. Export earnings from agricultural commodities increased by 71 percent, mainly because of a market rise in cocoa exports. The total import bill showed an increase of about 16 percent over 2002. Import growth was mainly driven by payments for petroleum products, machinery, transport equipment, and manufactured goods for reconstruction activity. The increase in petroleum imports reflected higher volumes to meet rising domestic consumption as well as an increase in world market prices for petroleum products.

22. Sierra Leone’s foreign exchange market operations have improved. The introduction of the foreign exchange auction in early February 2000 has reduced the parallel exchange market operations and lowered the spread between official and parallel market exchange rates, from an average of 34 percent in 1999 to 10 percent in 2000.14 This development was associated with a sharp appreciation of the leone against the U.S. dollar (by 32 percent in real terms) in 2000 as the economy started to stabilize. However, with the increasing demand for foreign exchange, combined with uncertainty associated with the disbursements of external program assistance, the real effective exchange rate of the leone depreciated by 14 percent during 2001-03.

23. Gross official reserves of the Bank of Sierra Leone have been under pressure. The import cover peaked at 2.5 months in 2002, but declined to 1.5 months by end-2003 because some program receipts expected in 2003 were not disbursed.

24. Since reaching its decision point under the enhanced HIPC Initiative in March 2002, Sierra Leone has received substantial assurances of HIPC assistance from creditors. Most multilateral creditors (IMF, World Bank, African Development Bank, and European Commission/European Investment Bank) and Paris Club creditors are providing interim assistance to Sierra Leone. Bilateral creditors have also provided debt relief, but on terms that fall short of that provided by the Paris Club creditors.15 Despite the authorities’ efforts, Sierra Leone has made relatively little progress in settling its commercial arrears, and some commercial creditors have resorted to litigation.

II. Fiscal Sustainability in Sierra Leone16

1. During the 1990s, Sierra Leone’s macroeconomic performance was undermined by the prolonged civil conflict and political instability. These are reflected in negative real growth and high inflation, together with large volatility in both (Table II.1)

Table II.1.

Sierra Leone: Public Sector Debt Sustainability Framework, Baseline Scenario, 2001-22

(In percent of GDP, unless otherwise indicated)

article image
Sources: Country authorities; and Fund staff estimates and projections.

Public sector comprises the central government or nonfinancial public sector. External debt is reported inclusive of unconditional HIPC debt relief.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues includes grants.

Debt service is defined as the sum of interest and amortization of medium- and long-term debt.

Historical averages and standard deviations are generally bsed on data for 1993-2002.

2. During this period, the government’s fiscal performance was also generally weak. Overall fiscal deficits averaged 7.5 percent of GDP (Figure II.1), while primary deficits were somewhat smaller. The fiscal positions came about because of weak revenue efforts (domestic revenues as a percentage of GDP averaged only slightly higher than 10 percent). Although total noninterest expenditures during this period (at about 18 percent of GDP) were in line with those of other HIPC countries, and somewhat lower than for sub-Saharan Africa as a whole17, the government could not finance them without resorting to foreign borrowing (historically, domestic debt has been short term and a rather small portion of the overall debt stock).18

Figure II.1
Figure II.1

Sierra Leone: Indicators of Fiscal Performance, 1993-2002

(Percent of GDP)

Citation: IMF Staff Country Reports 2004, 420; 10.5089/9781451834475.002.A001

Sources: Sierra Leonean authorities, and staff estimates and projections.

3. Macroeconomic performance has improved since 2001. Real growth has picked up since the economy returned to normalcy in 2001. By strengthening fiscal and monetary policies the government has brought inflation down to more manageable levels. As a result, primary and overall fiscal balances have improved, while the debt-to-GDP ratio has fallen partly as a result of external debt relief granted under the HIPC Initiative.

4. Historically the government budget has depended heavily on foreign grant financing, with foreign grants comprising between 30-70 percent of budget financing. In recent years, the share has averaged about 50 percent. This heavy dependence on foreign financing, together with uncertainty about the disbursements of grants, has complicated fiscal management.

5. Fiscal pressures are likely to continue in the medium term. As the government’s focus shifts from post conflict stabilization toward medium-term development and poverty alleviation, in the context of its poverty reduction strategy, it needs to prioritize many demands on the basis of domestic and external resources.

6. In what follows, Section A lays out some conceptual issues for the analysis of government debt sustainability, while sections B and C discuss key issues related to long term fiscal sustainability. Section D concludes.

A. Some Conceptual Issues

7. Given the nature of government’s operations, sustainability has to be considered in an intertemporal framework. In general terms, sustainability means that the government can satisfy the net present value of future budget constraints without significant corrections to its revenues or expenditure to avoid insolvency or illiquidity.19

8. When the present value of current and future primary expenditures does not exceed the present value of current and future streams of income, net of any initial indebtedness, the government is solvent. That is,

Σi=0∞Et+iΠj=1i(1+rt+j)≤Σi=0∞Yt+iΠj=1i(1+rt+j)−(1+rt)Dt−1,(1)

where Et is the primary expenditure (total expenditure minus interest payment) at period t, Yt is the government income (GDP for a country), Dt-1 is the end-of-period debt stock at t-1, and rt is the nominal interest rate. When liquid assets and available financing are sufficient to meet all maturing liabilities, regardless of whether the solvency condition is satisfied, the government is said to be liquid.

9. On the basis of the above general definition, the government’s debts can be considered sustainable when the government can repay its current debt stock with future primary surpluses:

Dt=Σi=0∞PBt+iΠj=0i(1+rt+j)=Σi=0∞Zt+iΠj=0i(1+rt+j)−Σi=0∞Et+iΠj=0i(1+rt+j),(2)

where PBt is the primary balance and Zt is government revenue (including foreign grants).

10. Equation (2) can be modified to distinguish between domestic and external debt:

Dt=DDt+ɛtDEt=Σi=0∞((1−λt+i)Πj=0i(1+rt+j)+λt+iɛtΠj=0i(1+qt+i)Πj=0i(1+rt+i*))PBt+i,(3)

where DDt is the beginning-period stock of government domestic debt denominated in local currency at period t, DEt is the beginning-period stock of government external debt in term of foreign currency units, st is the nominal exchange rate (Leone per foreign currency), At is the share of external borrowing needed to finance primary deficits, qt is the rate of appreciation of the nominal exchange rate, and r*t is the nominal interest rate charged on external debt.

11. Equation (3) indicates that the key variables for determining fiscal debt sustainability are government revenue, primary expenditure, debt stock (domestic and external), the cost of borrowing (that is, domestic and foreign nominal interest rates), and nominal exchange rate. Higher output and inflation will influence fiscal sustainability not only through changes in the denominator (ratios to GDP) but also through their effect on key variables determining the government’s fiscal position (such as tax revenues, inflation, and the exchange rate).

B. The Baseline Scenario

12. The baseline scenario assumes sustained high output growth together with low inflation.20 Real output is projected to grow between 6-7 percent a year in the projected period, with inflation dropping to low single digits. Given their substantial roles in the economy, agriculture and mining, as well as investment in these sectors, would be the key driving forces of growth.

13. The primary balance is projected to strengthen. This strengthening is brought about both by a stronger domestic revenue effort, measured in terms of percent of GDP, and by the augmentation of the revenue base. Through the addition of revenues from the mineral sector, which is projected to expand considerably during the next 5-7 years as new mining projects are brought to production (Box 1). Although the introduction of the common external tariff for the Economic Community of West African States (ECOWAS) could result in a small revenue loss (possibly ½ a percentage point of GDP), the broadening of the tax base, in the context of a value-added tax system, to services and other products not currently taxed would benefit the government. Furthermore, the government should increase its effort to collect income taxes, as well as increasing the share of personal taxes collected (currently only about 1½ percent of GDP in tax revenue is derived from personal income taxes).

14. An improved revenue effort will be required to compensate for the projected decline in foreign grants, from 40 percent of total revenues and grants in 2003 to below 10 percent by the year 2022. However, additional resources not currently projected could become available in the context of the PRSP and the MDGs. If they did not, a larger share of current expenditures would need to be covered by domestic revenues, which represents an important shift from the prevailing high dependency on foreign donor support.

Sierra Leone: Mineral Sector Revenues

The medium-term fiscal revenue projections incorporate forecasts of the revenue streams from major mineral projects (including kimberlite, rutile, bauxite, and gold). Sierra Leone has few relatively large mining projects and IMF staff has projected revenues separately for each one.

Although reasonable forecasts have been used for price, cost, and production developments, they are subject to downside risks (for example, price forecasts underpinning the projections may turn out to be too optimistic, production could be postponed, development and operational costs could turn out to be higher than initially projected, and the fiscal regime could change) as well as upside risks (for example, the realized price, cost, and production figures could be more favorable than initially projected; and new mineral deposits could be discovered). To avoid overstating the medium-term projections, a 15 percent discount factor has been applied to the baseline projections to account for potential downside risks.

In the discounted scenario, mineral revenues are projected to comprise 0.4 percent of GDP in 2004. This figure is projected to increase to 1 percent of GDP by 2008 and to increase by 1 percent more in the subsequent years.

15. To facilitate fiscal sustainability in the long run, the government needs to reduce expenditures, other than interest payments (Table II.1). It should achieve reductions in part through cost cutting, rationalization of government operations, and other reforms to contain costs and improve efficiency. Furthermore, the government needs to prioritize outlays according to the country’s developmental and poverty-related needs (the poverty reduction strategy should provide key guidance on this). The share of investment expenditure needs to be increased to promote high output growth.

16. The long-run debt-to-GDP and debt-to-revenue ratios are projected to fall (Figure II.3.). The baseline scenario is illustrated. As a result of fiscal consolidation and improved fiscal management, the staff projects declines in the debt-to-GDP and in the debt-to-revenue ratios while the ratio of debt service to revenue is projected to remain broadly stable in the long run. In part, these outcomes are assisted by debt forgiveness under the HIPC Initiative, which will lower the net present value of external public debt. Moreover, lower domestic borrowing (as a percentage of GDP) helps alleviate the rising cost of borrowing from domestic sources, a key medium-term risk to fiscal sustainability in Sierra Leone (the share of domestic debt to total debt stock is projected to fall from 41 percent in 2003 to 18 percent in 2022). The share of foreign currency debt is projected to rise towards the end of projected period.

Figure II.2
Figure II.2

Sierra Leone: Domestic Source of Government Financing, 1993-2002

(In percent)

Citation: IMF Staff Country Reports 2004, 420; 10.5089/9781451834475.002.A001

Sources: Sierra Leonean authorities, and staff estimates and projections.
Figure II.3.
Figure II.3.

Sierra Leone: Indicators of Public Debt Under Alternative Scenarios, 2003-22 1/

(In percent)

Citation: IMF Staff Country Reports 2004, 420; 10.5089/9781451834475.002.A001

Source: Staff projections and simulations.1/ Historical scenario is based on averages during 1993-2002.2/ Revenue includes rants but excludes domestic debt service.

C. Sensitivity Analysis

17. The overall macroeconomic environment in which the government is operating will affect the fiscal outcome and, by extension, fiscal sustainability. That is, changes in real growth and inflation, as well as in the external environment, would need to be offset by fiscal adjustments to preserve long-term fiscal sustainability. Private sector consumption and saving decisions affect interest rates and the cost and level of private investment activity and, eventually, economic growth and the government’s revenue collections and ability to spend on various public programs. Foreign investments in the country are equally important for supporting domestic activities and export growth. Expectations and public confidence in the government’s ability to implement appropriate economic policies influence private sector decisions and, hence, need to be fostered.

18. We therefore conduct a series of tests, with other things being equal, to see how sensitive the above conclusions are if there were a domestic or external shock. The test results suggest that, in the face of significant macroeconomic shocks, the fiscal debt could not be sustained in the long run.

19. Improved macroeconomic performance and fiscal balance are essential for fiscal sustainability (Figure II.3). Using historical averages for output growth and the primary balance, we find that unless such improvements occur, the debt will be unsustainable in the long run. Although the unsustainability reflects the country’s volatile past, it also suggests that Sierra Leone needs to maintain high output growth and broadly balance its primary position in the medium term; otherwise, the public debt is likely to remain unsustainable. The need for further fiscal consolidation is reinforced by the results of the “no reform” scenario, in which where the fiscal primary balance is maintained constant at its 2002 level.

20. A temporary negative output shock leads to an unsustainable fiscal adjustment and rapidly rising debt-to-GDP and debt service ratios (Figure II.4).21 This is because total expenditures, as a percent of GDP, would increase significantly if nominal GDP is declining and lead to a larger primary deficit and borrowing. A temporary worsening of the primary balance, which could be caused, for example, by delays in external grants, will not necessarily affect the government’s long-term fiscal position permanently, provided that the authorities adjust the medium-term fiscal portfolio to make the debt sustainable. A transitory real exchange rate shock could permanently lower the debt-to-GDP and debt-to-revenue ratios (Figure II.5).22 The effect of such a shock would be felt as the domestic currency value of foreign currency debt changed.

Figure II.4.
Figure II.4.

Sierra Leone: Indicators of Public Debt Under Alternative Scenarios, 2003-22 1/

(In percent)

Citation: IMF Staff Country Reports 2004, 420; 10.5089/9781451834475.002.A001

Source: Staff projections and simulations.1/ Historical scenario is based on averages during 1993-2002.2/ Revenue includes rants but excludes domestic debt service.
Figure II.5
Figure II.5

Sierra Leone: Indicators of Public Debt Under Alternative Scenarios, 2003-22 1/

(In percent)

Citation: IMF Staff Country Reports 2004, 420; 10.5089/9781451834475.002.A001

Source: Staff projections and simulations.1/ Historical scenario is based on averages during 1993-2002.2/ Revenue includes rants but excludes domestic debt service.

21. Liquidity risk could arise from a higher rollover of short-term domestic debt. In Sierra Leone, virtually all domestic public debt is short-term.23 Since no long-term domestic debt instruments (beyond the maturity of one year) are available, the government will have to finance all future borrowing by issuing short-term debt. In the long run, this will result in a situation where virtually all domestic debt would be short term. Given the size of the domestic debt stock, equal to about 41 percent of GDP at end-2003, the debt carries a significant rollover risk.24 With a view to addressing the high rollover and liquidity risks, the government should promote domestic debt markets that would enable it to issue longer-term debt securities to finance its fiscal deficit.

22. Privatization of state-owned enterprises could promote fiscal sustainability. Revenues from the sale of state assets could be used to finance poverty-related expenditures or lower the stock of domestic debt.

D. Conclusions

23. Sierra Leone needs to achieve fiscal sustainability through a mixture of revenue and expenditure measures that will allow it to balance its primary fiscal position. The process will be much assisted by the assumed external debt forgiveness in the context of the HIPC Initiative, which lowers the share of external debt and, hence, provides room for additional domestic borrowing. There are, however, significant risks to this scenario arising from negative shocks to real growth and the primary deficit. The authorities also need to address rollover and associated liquidity risks caused by the short maturity of domestic debt. They can do so by extending the maturity of domestic debt.

III. Rehabilitating Sierra Leone’s Mining Sector—Challenges and the Way Forward25

1. Sierra Leone faces challenges both in rehabilitating large-scale mining operations and in regulating artisanal mining activity. The challenges are quite different and require different policy responses, but in general the government of Sierra Leone has already made significant progress in developing a policy framework to address them. Fiscal policies for both large- and small-scale mining, for example, are already broadly appropriate and need only to be refined and applied. In large-scale mining, a major task will be to apply the general fiscal policies, which means breaking with the previous practice of reaching special agreements with individual investors that, in some cases, deviate significantly from the general regime. Implementation of the Extractive Industries Transparency Initiative (EITI), under which all revenue flows from the mining sector are published, will also help to increase transparency and reduce governance concerns. In artisanal mining, the government’s main concern is to eliminate the incentives for smuggling. Besides improving administrative and law enforcement ability it will also need to adopt a more holistic approach that aims to create an environment where local communities and diggers and miners benefit more from the country’s mineral wealth. Increasing transparency in the domestic diamond trade will be a key step in this endeavor.

A. Background

2. Sierra Leone has a rich and diverse mineral resource base, and mining is vital to its economy. The mineral sector can be divided into three sub sectors: large-scale production of the non precious minerals rutile (titanium dioxide and a little iron) and bauxite; large-scale production of diamonds; and artisanal and small-scale production of precious minerals—mainly diamonds and to a much lesser extent, gold.

Table 1.

Export Trends in Sierra Leone

(In percent of GDP)

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The year before the war forced the closure of major mining operations.

3. Large-scale production of nonprecious minerals. Prior to the war, which began in 1991 and lasted until 2001, the Sierra Rutile Mine produced over 25 percent of the world’s rutile from one of the world’s highest-grade deposits. Work interruptions caused by the war led, in 1995, to the closure of the mine. In 1994, the last full year of production, the rutile mine generated about US$60 million in exports, corresponding to a third of that year’s exports. To reopen the mine, the government entered into an agreement with an investor in 2001; the agreement was modified in 2003. Production is expected to resume in 2005. Sierra Leone’s other major non-precious mineral is bauxite. Until the Mokanji Bauxite Mine was closed in 1995 on account of the war, it produced, together with neighboring deposits, a specialty bauxite with little organic material. Bauxite exports in 1994 totaled about US$16 million. Negotiations on the terms for rehabilitating the bauxite mine are currently under way, and, if they are concluded successfully, production could also restart in 2005.

4. Large-scale production of diamonds. Sierra Leone has two known kimberlite diamond deposits, the Koidu and Tongo Fields. Diamonds found in kimberlite deposits can be mined by large-scale corporate operations. In 1995, the government entered in 1995 into an agreement with an investor to develop the Koidu Kimberlite Project. After an investment of US$18 million, the mine was scheduled to begin operations in 1997 but was forced to close in the same year because of the war. The investment was lost. Additional shareholders were brought in, and, after another investment of US$18 million, production resumed in late 2003.

5. Artisanal production of diamonds. Since the discovery of the first alluvial diamond deposits in Sierra Leone in the 1930s, diamond operations have largely been controlled by a single company that guarded the mining fields and had the resources to employ heavy equipment.26 27 But during the 1970s and 1980s the Sierra Leone diamond industry fell prey to corruption and mismanagement, with the result that many of the country’s diamonds were exported illegally. Eventually, diamond mining was opened to artisanal, or small-scale, miners.28 Between 1992 and 2000, average official exports were less than 200,000 carats—just one-tenth of official exports in the peak years during the late 1960s—and the per carat value was significantly less than the country’s historical average. Not only was the bulk of the country’s diamonds being smuggled out, but they also became an impetus for war: the Kongo and Tongo Fields, the richest diamonds mines in the country, became primary targets for the rebel movement, the Revolutionary United Front (RUF), which relied on diamond mining as a major source of fund-raising activities. In 2000, the UN Security Council responded by imposing an embargo on the direct and indirect import of rough diamonds from Sierra Leone until a new mining, export, and monitoring regime could be developed. A certification system was put in place in October 2000, with technical assistance from Belgium’s Diamond High Council and financial assistance from the United Kingdom and the United States. In order to ensure effectiveness of the certification system, the Kimberley Process, a standardized global certification scheme, was implemented simultaneously in more than 50 countries in January 2003. This contributed to an increase in officially recorded diamond exports from 350,000 carats in 2002 to about 500,000 carats in 2003.

B. Restarting Large-Scale Mining Operations

Attracting Investment Without Eroding the Revenue Base

6. Facilitating the restart of large-scale mining operations poses a difficult challenge for the government of Sierra Leone in that it has to balance the demand for suitable incentives with the need to preserve the tax revenue potential of the mining sector. Rehabilitating the equipment needed for large-scale mining operations requires substantial investments, but investors are likely to be wary of such investments given the large losses they suffered during war years. Fiscal incentives might also be necessary to compensate for the poor state of the infrastructure and to address the remaining governance concerns. Generous tax incentives, however, imply that a smaller share of the rents generated by Sierra Leone’s mineral wealth accrues to the government.

7. The trade-off between facilitating investment and forgoing revenue should be governed by the overall fiscal regime, which in Sierra Leone has a solid foundation. A recent review of Sierra Leone’s fiscal regime for the mineral sector by the staff did not find fundamental weaknesses. The fiscal regime is regulated by the Mines and Minerals Act of 1996 and the Income Tax Act of 2000. The Mines and Minerals Act set royalties at 5 percent for precious stones, 4 percent for precious metals and 3 percent for all other minerals. In international comparisons, Sierra Leone’s royalty rate is on the low side for diamonds but probably high for other minerals. The income tax on mining companies is 30 percent, which is moderate by international standards; as to import duty, the Income Tax Act grants mining companies duty-free importation of machinery and equipment for prospecting and exploration. In sum, the fiscal regime imposes a moderate tax burden on the mining sector and is reasonably free of targeted tax incentives.

8. In practice, however, the legislated general regime has been overridden by special agreements. In fact, on each occasion that an investor has applied for a mining lease, that investor has sought and received a special agreement incorporating specific fiscal terms for the project. As a result, the fiscal regimes for all three large-scale mining operations (rutile, kimberlite, and bauxite) are regulated by special agreements.29 Negotiating a special agreement holds two advantages for mining investors: first, the terms may be more generous than those envisioned under the general regime, and, second, special agreements typically contain fiscal stability provisions that prevent the government from unilaterally changing their terms. For the government, however, this practice undermines the general fiscal regime and opens the door to discretionary decisions, which may lead to revenue losses, inequitable treatment of investors, and governance concerns.

9. Special agreements that give investors equity stakes in mining operations have been a source of concern for stakeholders in the mining sector in the recent past. The government agreed in 2003 to a modification of the prevailing agreement with the investor in the rutile mine by signing a memorandum of understanding that granted the investor significant tax concessions in return for an equity stake.30 The government, believing the new fiscal terms were necessary to ensure that the rehabilitation of the country’s major mine would go forward asked for the equity share as a way to benefit in any favorable developments in the project. However, a number of stakeholders in the mining sector objected to government equity participation—even a non-operating interest—because they had had a bad experience with previous state-run enterprises in this sector. They also objected on the grounds that participation by the government was inconsistent with its privatization and divesture policy. In addition, such equity stakes raise complex valuation issues and may give rise to governance concerns. Responding to these concerns, the government clarified that acquiring an equity stake in the rutile mine was a one-off decision and that it would not seek further equity stakes in lieu of dues, taxes, and fees.31

Refining and applying the fiscal regime

10. The existing fiscal regime provides a good starting point for rehabilitating the mining sector, but further refinements may be needed to meet the government’s objectives. The government has made substantial progress in outlining its objectives by formulating, in consultation with stakeholders, its Core Mineral Policy. This policy states that the government’s objective is to stimulate investment in the mineral sector by promoting private sector participation, which is to be achieved through the establishment of a favorable environment, in which geo-information and regulations area adequate, the institutional capacity for the processing of investments is satisfactory, and the fiscal conditions are attractive. To make fiscal conditions attractive, the government plans to review and put in place an investor-friendly legal and institutional framework, which is to include a progressive and predictable tax regime. As a next step, the government will review the Mines and Mineral Act of 1996 and relevant income tax legislation to make it consistent with these objectives and will develop implementing regulations.

11. Any review of the existing fiscal regime will have to address the question of how relevant the general regime has been, given that every investor has negotiated a special agreement. Since Sierra Leone has recently emerged from a serious conflict period and political instability, it is probably inevitable that investors will seek special agreements with assurances of fiscal stability and the best terms possible. A revised fiscal regime will probably have to accommodate investor concerns, but ensure at the same time that the agreements are consistent with the general regime. The government should consider a number of issues.

12. Providing fiscal stability. The existing general legislation does not contain provisions assuring investors of fiscal or wider legislative stability. Including such provisions in revised legislation could increase investor confidence. Those in special agreements, which probably remain inevitable, could reference the provisions in the general legislation, thereby contributing to a more uniform treatment of investors. As a general principle, the scope of stability provisions should be limited to fiscal imposts. The provisions should also be symmetrical: the investor should receive indemnity of exemption from increases but should not benefit from decreases.

13. Limiting discretion. To prevent a situation where the fiscal terms in special agreements have little resemblance to the general fiscal regime, it would help to incorporate all fiscal provisions into the relevant fiscal legislation and to limit fiscal provisions in special agreements and in the Mines and Minerals Act to cross-referencing the fiscal legislation. The legal status of special agreements should also be clarified to ensure that these are subsidiary to relevant fiscal legislation and the Mines and Minerals Act. Finally, it might be helpful to develop model agreements, which have proved useful in the petroleum sector.

14. Clarifying the power to make agreements. The Mines and Minerals Act should be amended to provide a clear power for concluding mining agreements. The current situation gives rise to some uncertainty, which might have contributed to investor demands to give special agreements the status of law.32

15. Enhancing transparency. The revenues derived from mineral extraction should be made public to address widespread governance concerns in Sierra Leone. The government has taken an important step in this direction by expressing its interest to the World Bank in participating in the Extractive Industries Transparency Initiative (EITI). The basic principle of the EITI requires the government to publish its receipts of mineral resource revenues and the mineral companies to report their payments to the government. In principle, there is no reason to expect any differences between the reported transactions. If there are differences, they should be reconciled clearly and consistently.

C. Regularizing Artisanal Mining Activity

The challenge of eliminating the incentives for smuggling

16. The objectives in reducing smuggling and regularizing artisanal mining activity are to (i) restore government control, law and order, and government services to the artisanal mining areas;33 (ii) increase transparency in the diamond trade so that local communities, miners, and diggers can benefit more from the country’s diamond wealth; and (iii) increase tax collection. Currently, smuggling is pervasive: a recent survey of diamond mining in Sierra Leone, which relied on air patrols and on-site visits, concluded that about 55 percent of the total significant mining operations in Sierra Leone were operating illegally in 2003.34 35 The challenge is that the incentives to smuggle are inherent in artisanal mining.

17. The incentives for smuggling are inherently greater in artisanal mining than in kimberlite (large-scale) mining for two reasons36: artisanal mining typically takes place in large, insecure regions that are difficult to control, and artisanal mining is often associated with limited competition between diamond buyers because of barriers to entry and implicit contracts, giving rise to uncompetitive domestic prices and, thus, increasing the benefits of smuggling.37

18. Implicit contracts contribute to both smuggling and the lack of transparency in the domestic diamond trade. Implicit contracting typically occurs because artisanal miners have irregular earnings and therefore need financing to insure themselves against bad times.38 Since they are typically unable to borrow through the conventional banking system, their financing needs are often met by diamond dealers, who pay them in advance in return for the exclusive right to buy their diamonds. Diamond dealers, in turn, often have similar implicit contracts with exporters. Implicit contracting gives rise to smuggling through two channels:

  • Implicit contracts limit competition and allow export companies to purchase diamonds at prices below the international market price, creating incentives to smuggle.

  • Partners in implicit contracts smuggle to avoid their contractual obligations. It is lucrative for a dealer, for example, to smuggle a valuable stone outside the country and obtain a higher price for it than implied by the implicit contract with an exporter. Likewise, an exporter has incentives to bypass official sale channels to hide the true value of the stones he is exporting, which allows him to undervalue them and thereby reduce the price he pays the dealer. The latter case is likely to be more prevalent than the former, since exporters are better positioned to assess the true value of a stone and smuggle it outside the country. One side effect of such operations is that the domestic diamond trade becomes nontransparent.

19. The lack of transparency in the domestic diamond trade is in itself a source of concern. Nontransparent pricing allows exporters to underpay dealers and, by extension miners and diggers. The bulk of the rents generated by Sierra Leone’s diamond wealth thus accrues to a small circle of people, and most of it probably leaves the country when the diamonds are smuggled to and sold in foreign diamond centers like Antwerpen, Belgium. According to some estimates, local expenditures associated with the annual production 39 (inputs) are not more than 10 percent -15 percent of the diamond output value. In an extreme case, dealers, miners, and diggers capture none of the rents, and around 80 percent of the diamond value accrues in rents to domestic exporters and foreign diamond traders.40

Empowering local mining communities

20. The general fiscal regime for artisanal mining is broadly appropriate since the implementation of reforms in the early 1990s, including a low export tax (3 percent) to encourage the regularization of the diamond trade through official channels and a liberal foreign exchange regime. No other turnover or profit taxes are levied other than a standard income tax. With the cost of smuggling generally estimated at 2-3 percent of revenues, taxes in Sierra Leone are not a major impediment to legal exports.

21. However, the government is unable to enforce the fiscal regime or, more generally, property rights and mining regulations in the diamond regions. The United Nations Mission in Sierra Leone found in a recent mining survey that the government—in particular, the Ministry of Mineral Resources and the police, need more training to be able to address illicit mining and smuggling activities satisfactorily.41 The government, with assistance from the World Bank, is currently installing a mining cadastre based on GIS and GPS that will help define property rights and thereby provide the basis for the enforcement of mineral rights. Secure property rights and a better prepared government agencies will go a long way toward bringing the mining sector back under the government’s control and restoring law and order.

22. Enabling local communities to benefit more from mining operations in their region will require, however, an approach that goes beyond the enforcement of laws and regulations. Currently, local communities receive 0.75 percentage points from the 3 percent export tax, which is enhanced by some local taxes (for example, a residence tax) on mining activity. the government and the mining industry acknowledge that local communities do not receive a proportionate share of diamond revenues. The government is addressing this inequity, in part, by establishing of the Diamond Area Community Development Fund, which provides a mechanism to channel a portion of the total diamond revenues to local communities. These additional funds also increase the incentives for local communities to help regularize illegal mining activity.

23. The government could:

  • Empower local miners and diggers through various means, including by:

  • leveling the playing field through training to improve their ability to evaluate products;

  • providing information on available production and marketing facilities;

  • helping artisanal miners establish a business for the rental or lease of equipment so they can fund their mining operations;

  • providing extension services to artisanal miners;

  • promoting the formation of associations for small-scale miners; and.

  • addressing bottlenecks in the banking system so that foreign currency transferred for diamond trade transactions is available immediately, which would minimize recourse to the parallel market for foreign exchange and increase incentives to use the banking system.

24. Many of these measures are designed to enhance transparency in the diamond sector, thereby weakening the rationale for smuggling and ensuring that miners and diggers receive fair prices. Another ongoing effort entails organizing miners into cooperatives, training them, and providing funding to mechanize some operations. The government has already committed itself to these and other measures in its Core Mineral Policy.

25. An important step in the implementation of these measures is the Peace Diamond Alliance, which was launched in August 2003. Its purpose is to demonstrate, in Kono District, that an alluvial diamond industry can

  • have a transparent, fair, and safe local market;

  • maximize benefits to local miners, diggers, and their communities;

  • track diamonds from the ground to export;

  • minimize corruption; and

  • mobilize local surveillance and monitoring of mines.

  • The alliance brings together international, national, and local stakeholders.42 It is managed by an executive committee, comprising representatives from the mining industry, the government, and local communities. The executive committee serves as a local forum for the discussion of diamond management issues. Alliance members may provide funding for a credit scheme for miners; buy diamonds that are certified by the alliance to be sold as fair trade diamonds; miners and diggers on the value of their production; and develop diamond resource-use maps.

STATISTICAL APPENDIX

Sierra Leone: Basic Data

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Sources: Sierra Leonean authorities; and IMF staff estimates and projections.

Data reflect revisions in the national accounts.

Changes as a percentage of beginning-of-period money stock (including foreign currency deposits).

Domestic revenue minus total expenditure and net lending, excluding interest payments, and externally financed capital expenditure and disarmament, demobilization, and reintegration (DDR) program.

As a percentage of exports of goods and services; after Naples (2001) and Cologne flow reschedulings (2002–04), and delivery of possible HIPC Initiative assistance.

Table 1.

Sierra Leone: Production of Major Agricultural Commodities, 1998–2003

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Sources: Domestic production data from the Ministry of Agriculture, Forestry, and the Environment (Planning, Evaluation, Monitoring, and Statistics Division (PEMSD)). From 1991/92, import data from the Bank of Sierra Leone.

Paddy converted to rice equivalent based on 5 percent seed, 15 percent postharvest loss, and 65 percent milling recovery rate

Table 2.

Sierra Leone: Domestic Fish Catch, 1998–2003

(In thousands of metric tons)

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Source: Ministry of Fisheries and Marine Resources, Sierra Leone.
Table 3.

Sierra Leone: Mineral Production, 1998–2003

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Sources: BSL Bulletin, Bank of Sierra Leone; and data provided by the Sierra Leonean authorities.

Figures for exports under Alluvial Diamond Mining Scheme represent both gems and diamonds from 1990/91.

Figures represent official sales of the Government Gold and Diamond Office (GGDO).

The production of bauxite and rutile, as well as ilmenite (a by-product of rutile), ceased in January 1995 with the seizure of mine sites by forces hostile to the government.

Amount of gold purchased by the Bank of Sierra Leone’s gold buying unit, which suspended operations in November 1989, recommenced operations in October 1992, and ceased operations in June 1994.

Table 4.

Sierra Leone: Production of Manufacturing Establishments, 1998–2003

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Sources: BSL Bulletin, Bank of Sierra Leone; and data provided by the Sierra Leonean authorities.
Table 5.

Sierra Leone: Petroleum Prices and Utility Tariffs, 2001–03

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Source: Data provided by the Sierra Leonean authorities.