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

This paper examines Madagascar’s Sixth Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF). Madagascar’s performance under the program in 2004 has been broadly satisfactory, particularly in light of the difficult economic environment that prevailed during the first half of the year. All quantitative performance criteria at end-September and the structural performance criterion at end-December have been met. Further steps are needed to strengthen monetary policy implementation. Implementation of public enterprise reform, which has been uneven, also needs to be accelerated.

Abstract

This paper examines Madagascar’s Sixth Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF). Madagascar’s performance under the program in 2004 has been broadly satisfactory, particularly in light of the difficult economic environment that prevailed during the first half of the year. All quantitative performance criteria at end-September and the structural performance criterion at end-December have been met. Further steps are needed to strengthen monetary policy implementation. Implementation of public enterprise reform, which has been uneven, also needs to be accelerated.

Madagascar’s economic performance under the program has continued to be strong. Despite a number of shocks, including 2 cyclones that hit the island in the early part of this year, and rising oil and rice prices, the authorities’ determined implementation of their economic program has enabled them to meet all the quantitative performance criteria set for end-September, as well as the structural performance criterion and benchmarks set for end-December 2004. As I noted during the last Board meeting on Madagascar, the broad improvement in economic and financial performance over the program period, despite adverse exogenous shocks, can be attributed to the strong ownership of the program by the authorities, their commitment to the reform process, and the strong support of the international community for their efforts.

Recent Developments and Performance Under the Program

The economy is estimated to have grown by 5.3 percent in real terms, in 2004, indicating the increased resiliency of the economy to shocks, as a result of the reforms undertaken in the past years. Inflation was higher than programmed. As I explained in my last statement (BUFF/ED/04/179, 10/15/04), it was due to a number of factors, including, rising oil and rice prices, (which constitute 25 percent of the CPI basket), the impact of the cyclones on agricultural output, and the large depreciation of the Malagasy franc. In the face of strong inflationary pressures, the authorities have tightened monetary and credit policies.

In the fiscal sector, the deficit for 2004 has remained broadly within the program target. On the revenue side, reflecting the strong measures taken at customs, tax revenue is above target. This improved performance at customs is the result of the strong reform measures undertaken earlier. These included the rotation of more than 30 percent customs agents in the past six months, intensification of ex post controls and a strengthening of the fight against fraud, among others. Table 2 in the staff report shows that both tax revenue and total revenue for 2004 (in Malagasy francs) are above program targets, although as a percentage of GDP, the objective of 11.2 percent was not achieved, due to the upward revision of nominal GDP.

On the expenditure side, during the last quarter, expenditures were higher than had been projected. Underbudgetting of certain expenditures and other outlays, under emergency spending procedures, were the cause of the larger than budgeted expenditure. Nevertheless, total expenditure remained below program projections due to lower-than-anticipated foreign-financed expenditure. My authorities have taken steps to correct those weaknesses, and to strengthen expenditure control, including the control of the military wage bill.

Monetary policy has remained tight in the last quarter. However, the growth of broad money has remained strong, reflecting in part, demand from the private sector as a result of the pickup in economic activity in several sectors, and that of the privately owned oil companies following the liberalization of the sector. The authorities are monitoring carefully developments on the inflation front and the exchange rate market, and will take additional measures if needed.

In the structural area, the authorities have continued their reform efforts. The new anti-corruption bureau has started operations, and coordination with other agencies have been strengthened. As regards the sugar sector, contracts were signed with two private operators to manage the sugar company, SIRAMA. However, disagreements over staffing issues with one of the companies could not be resolved, and the government cancelled the contract with that company and awarded it to the other company. The authorities expect the privatization process to strengthen. As regards the utility company, JIRAMA, a private management company has been selected and has started operation. However, work is still ongoing on the development of the medium term strategy for that sector.

Policies for 2005

Although the present program expires next month, my Malagasy authorities would like to continue their close relationship with the Fund, in the context of a successor program. In the meantime, they have agreed with the staff on broad economic policies and objectives for 2005 that are consistent with the PRSP and the medium term objectives. Macroeconomic and structural policies will continue to be geared at fostering broad-based and sustained growth, with the deceleration of inflation to be an important objective in 2005.

Reflecting the significant transformation that the economy has undergone in the recent past towards a market economy, the investment made, in particular, in the agricultural and tourism sectors, as well as the strong construction activities, real GDP is projected to reach 6.4 percent in 2005. End-of-period inflation is expected to be brought down to about 5.5 percent, by December 2005, on the basis of the tight fiscal and monetary policies being pursued, and the expected decline in rice prices, and more stable or declining oil prices.

Fiscal policy will aim at reducing the deficit as well as contributing to the efforts to reduce inflationary pressures. The authorities are putting in place the measures to strengthen budgetary execution and control which will help to prevent the slippages that occurred last year. They intend to strengthen these efforts with the recruitment of an international expert. On the revenue side, the authorities will take additional measures to raise revenue, and continue their efforts to strengthen tax and customs administrations. The authorities will also postpone their decision to reduce the VAT from 20 percent to 18 percent until September, and they are working closely with the World Bank to improve the taxation of the mining sector. On the basis of these efforts, the authorities expect tax revenue to increase to 11.6 percent of GDP in 2005, and the overall fiscal deficit (including grants) is to be reduced to 1.6 percent of GDP.

As noted above, the reduction of inflation will be an important objective of policies in 2005. In this context, the central bank will pursue a tight monetary policy, while ensuring that adequate credit goes to the private sector to support economic activity. This should also be helped by the projected decline in the government’s financing needs from the banking system. The authorities will continue their efforts to improve the effectiveness of monetary policy with technical assistance from MFD, in particular in the development of stronger forecasting instruments to better manage liquidity and foreign exchange cash flow. It will also, among others, improve coordination between the treasury and the central bank, develop the money market, and strengthen banking supervision.

As regards the exchange rate, the measures taken in the middle of last year, following the sharp depreciation of the Malagasy franc, have helped to stabilize the exchange rate and the market is functioning smoothly. The central bank will continue to allow the exchange rate to be market determined, and will intervene only to dampen sharp swings in the exchange rate and to meet the central bank’s objective of net foreign assets accumulation.

The external accounts position will remain difficult, although the authorities expect a small improvement in the current account balance for 2005. The uncertainties come from the weak vanilla price and the termination of the Multi Fiber Agreement (MFA), as well as the scheduled expiration of the third-party apparel provision of the AGOA in early 2007. For their part, the authorities will continue their efforts aimed at export diversification. The difficult external outlook will also impact the debt situation, and could increase the NPV of debt to exports. To meet the development needs, the authorities will continue to rely on external financing at concessional terms, and strengthen debt-management capacity. However, as noted by staff, my authorities hope that the pressure for loan financing could be eased provided Madagascar benefits from the grants from the U.S. Millennium Challenge Account.

On structural reforms, the authorities will continue with the privatization program and the reforms in the fiscal area. They will also implement measures to improve the competitiveness of the economy and diversify the export base. Recent developments have shown that there is a critical need to strengthen capacity in the area of economic policy formulation and implementation. In this regard, the authorities are preparing a time-bound capacity-building plan for several government institutions. Once the plan is finalized, the authorities intend to request assistance in the different areas from their development partners, including the Fund. My authorities view this assistance as critical to strengthen capacity and improve policy implementation.

In conclusion, my Malagasy authorities are broadly satisfied with performance under the PRGF arrangement, and the objectives achieved. Last October, Madagascar also reached the completion point under the HIPC Initiative, for which my authorities have asked me to express their thanks and appreciation to the Board. My Malagasy authorities would also like to express their deep appreciation to their development partners for their strong and continued assistance to Madagascar. My authorities fully recognize that, despite the progress made, important challenges remain, and the progress made has to be consolidated. They will pursue steadfastly their reform efforts, and are hopeful that the international community will continue their strong support for these efforts. They would also like to continue the close relationship with the Fund, in the context of a successor PRGF arrangement, after the expiration of the present one in March 2005. They look forward to an early Fund mission in Antananarivo for discussions on such a program.