United Republic of Tanzania
Fourth Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility and Request for Waiver of Performance Criteria—Staff Report; Staff Statement; Press Release on the Executive Board Discussion; and Statement
Author: International Monetary Fund
Publication Date:
11 Aug 2005
eISBN:
9781451838459
ISBN:
9781451838459
Language:
English
Keywords:
ISCR; CR; staff appraisal; end-April performance criteria; government; June; statement; debt relief; debt service; government approval; authorities' goal; fiscal year; Credit
Download PDF (925.8 KB)

This paper discusses United Republic of Tanzania’s Fourth Review Under the Poverty Reduction and Growth Facility and Request for Waiver of Performance Criteria. A principal challenge for monetary policy continues to be liquidity management in the face of high foreign aid inflows. A comprehensive Financial Sector Reform Implementation Action Plan has been completed. Under the plan, efforts to remove key structural impediments to broaden access to financial services will be accelerated, including measures to facilitate increased medium- and longer-term lending, and streamline the pension sector.

Abstract

This paper discusses United Republic of Tanzania’s Fourth Review Under the Poverty Reduction and Growth Facility and Request for Waiver of Performance Criteria. A principal challenge for monetary policy continues to be liquidity management in the face of high foreign aid inflows. A comprehensive Financial Sector Reform Implementation Action Plan has been completed. Under the plan, efforts to remove key structural impediments to broaden access to financial services will be accelerated, including measures to facilitate increased medium- and longer-term lending, and streamline the pension sector.

I. Background

1. Tanzania has made major strides over the past decade (Figure 1). Per capita growth has accelerated to nearly 5 percent, inflation has declined to around 4 percent, official assistance has increased along with donor confidence, foreign reserves have risen to comfortable levels, the debt burden has fallen, expenditures in priority areas have increased, and poverty is declining. Institutional capacity has also improved, albeit from a weak base, including stronger structures for domestic revenue collection and expenditure management.

Figure 1.
Figure 1.

Reform Efforts Are Bearing Fruit

Citation: IMF Staff Country Reports 2005, 291; 10.5089/9781451838459.002.A001

Sources: Tanzanian authorities and staff estimates.

2. Tanzania nevertheless has a long road ahead to overcome poverty (Figure 2). Per capita income remains low, aid dependence is high, trade volume is comparatively low, and the financial sector—though growing rapidly—still plays only a limited role in the economy. The cost of doing business remains high, and basic infrastructure remains poor. Tanzania will need to sustain sound economic policies and reforms for many years to achieve lasting inroads against poverty.

Figure 2.
Figure 2.

But The Path Ahead Remains Long

Citation: IMF Staff Country Reports 2005, 291; 10.5089/9781451838459.002.A001

Sources: Tanzanian authorities, World Economic Outlook, International Financial Statistics, World Bank, World Development Indicators, and African Indicators.

II. Recent Economic Developments and Performance Under the Program

3. Macroeconomic performance was better than projected (Table 2). Real economic growth in CY 2004 reached 6.7 percent, compared with projected growth of 6.3 percent and 5.7 percent in 2003. Growth was broad-based, with agriculture (nearly half of GDP) receiving a boost from a return to normal weather and better access to inputs. Inflation (through May 2005) remained low at around 4 percent, with lower food prices offsetting higher fuel costs.

Table 1.

Tanzania: Proposed Schedule of Disbursements Under the Poverty Reduction and Growth Facility Arrangement, 2003-06

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Source: Fund staff
Table 2.

Tanzania: Selected Economic and Financial Indicators, 2003/04-2007/08

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Sources: Tanzanian authorities; and Fund staff estimates and projections.

Data are on calendar year basis. 2001/02 data are for calendar year 2001.

Weighted-average yield of 35, 91-, 182-, and 364-day treasury bills.

Excluding new debt issued to recapitalize government-owned banks.

Including change in stock.

4. Fiscal performance during 2004/05 was also somewhat stronger than envisioned with net domestic budget financing estimated at 0.6 percent of GDP, well below the program target of 1.3 percent of GDP (partly reflecting the higher nominal GDP outturn) (Table 3). Revenues rose 22 percent, slightly more than programmed, driven by ongoing implementation of the Tanzania Revenue Authority’s (TRA) reform program as well as growth in some high revenue impact sectors.1 Expenditures rose by some 29 percent, broadly as programmed, mostly for priority sectors. Foreign financing marginally exceeded the program projection.

Table 3.

Tanzania: Central Government Operations, 2003/04-2007/08 1/

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Sources: Ministry of Finance and Fund staff projections.

Fiscal year: July-June.

Basket funds are sector-specific accounts established by the government for channeling donor support to fund specific activities in different sectors.

Unidentified financing (+)/expenditure (-). Includes expenditure carryover from the previous fiscal year.

Defined as a ratio (in percent) of gross grant and loan inflows to the sum of total expenditures and amortization payments.

Defined as a ratio (in percent) of current expenditures to a sum of program grants and loans (including basket funding).

Including contigent liabilities, largely consisting of non-guaranteed parastatal debt.

5. Tanzania’s estimated 2004/05 current account deficit was somewhat smaller than envisaged, partly due to stronger growth of traditional exports (Tables 2 and 6). Good weather, the recovery of some commodity prices, and better access to inputs contributed to this outcome. It is noteworthy that the recovery in traditional exports has been driven more by increased production than prices (Figure 3). Nontraditional exports continued their robust performance, mainly gold, but also manufactures. Imports, particularly capital and intermediate goods, expanded as expected.2 The current account deficit was financed by foreign assistance as well as higher FDI, which amounted to more than 4 percent of GDP.3 Net inflows resulted in an increase in official gross reserves to US$2.1 billion, equivalent to about 6 months of imports.

Table 4.

Tanzania: Summary Accounts of the Bank of Tanzania, December 2004 - June 2006

(In billions of shillings, unless otherwise indicated; end of period)

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Sources: Bank of Tanzania; and Fund staff estimates and projections.

Calculated as reserve requirement times banks’ deposits minus half of bank cash in vault.

Table 5.

Tanzania: Monetary Survey, December 2004 - June 2006

(In billions of shillings, unless otherwise indicated; end of period)

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Sources: Bank of Tanzania; and Fund staff estimates and projections.
Table 6.

Tanzania: Balance of Payments, 2003/04-2007/08

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

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Sources: Tanzanian authorities; and Fund staff estimates and projections.

Arrears are on non-Paris Club official and commercial debt subject to rescheduling and currently under negotiation. Projection assumes these will clear once agreements are reached.

Program and Project assistance (BOP coverage) as percentage of GDP.

Figure 3.
Figure 3.

Tanzania Traditional Exports: 1990-2005

(1990=100)

Citation: IMF Staff Country Reports 2005, 291; 10.5089/9781451838459.002.A001

6. The nominal exchange rate of the shilling to the U.S. dollar has remained mostly flat since the third review, but depreciated somewhat in real effective terms (Figure 4). The staff continues to believe the exchange rate is aligned with fundamentals and is not hampering competitiveness.

Figure 4.
Figure 4.

Challenges of Liquidity Management

Citation: IMF Staff Country Reports 2005, 291; 10.5089/9781451838459.002.A001

Sources: Tanzanian authorities, Information Notice System, and staff estimates.1/ Weighted sum of changes in the interest rate and the effective exchange rate relative to base period.

7. The government continued negotiations with bilateral creditors for HIPC comparable debt relief. Dialogue is moving ahead with the United Arab Emirates, Hungary, Iran, and Libya. The U.K. has committed to pay 10 percent of Tanzania’s debt service obligations to IDA and ADB.

8. Monetary policy has evolved in line with program goals (Tables 4 and 5), amid continued challenges to liquidity management (Figure 4). Despite liquidity pressure emanating from high donor inflows, the BoT met the end-March 2005 reserve money target through sales of government paper, foreign exchange, and other measures. Reflecting the increased open market operations, interest rates paid on treasury bills rose during much of 2004/05.4 The end-March performance criterion on net international reserves was also observed. M3 growth has accelerated at a faster than expected pace, owing to higher-than-expected deposit growth. Credit to the private sector has continued its robust expansion at about 35 percent, concentrated in the high growth sectors of the economy. Financial soundness indicators show that the banking sector remains strong (Box 1).

9. Key structural reforms have continued to progress favorably, particularly in the fiscal and financial sectors. Specific progress in tax administration includes amendment of the Tanzania Investment Act to limit the applicability of fiscal stability clauses, a further increase in coverage in the Large Taxpayer Department (LTD), and completion of the quality assurance review of the Customs and Excise Department (all structural benchmarks), as well as integration of the Value-Added Tax (VAT) and income tax departments, intensification of audits, and further progress in customs modernization. In the area of expenditure management, measures were implemented to further improve procurement and to mitigate the large year-end check float, which has complicated liquidity management (MEFP, paras. 5 and 8).

10. Financial sector reforms have proceeded broadly as expected, except that amendments to the BoT Act and the Banking and Financial Institutions Act (BFIA) were not submitted to parliament by end-April (structural performance criteria).5 The structural performance criterion on government approval and announcement of the preferred bidder for the National Microfinance Bank (NMB)6 was observed, as was the benchmark on submission to government of The Financial Sector Reform Implementation Action Plan (MEFP, para. 38) albeit with slight delay to incorporate additional stakeholder comments. The framework for the Development Finance Guarantee Facility (DFGF) has been largely finalized, in line with earlier commitments (MEFP, para. 42). The government has approved the Strategic Plan for the Implementation of the Land Laws, and new microfinance regulations have been approved. The government is also continuing its efforts to strengthen its anti-money laundering regime.

Tanzania—Financial Sector Developments

Available information shows that the financial sector as a whole is sound with lending concentrated mainly in high growth sectors of the economy. The last two years have witnessed remarkable progress in financial sector development, albeit from a low base. Financial soundness measures indicate that the system is liquid, well-capitalized, profitable, has good asset quality, and is resistant to shocks. In terms of these indicators, Tanzania also compares favorably to other countries in the region. However, Tanzania’s M3 and bank credit to the private sector remain modest relative to other Sub-Saharan African countries.

Tanzania — Financial Soundness Indicators: 2002-2004

(in percent, end of year)

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Source: Bank of Tanzania

Five largest borrowers to total banking sector capital.

11. In other areas of structural reform, the government has prepared a plan for clearer delineation of public and private functions in crop boards. The local government development levy has been abolished and fees on agricultural products capped at 5 percent, and business license fees were eliminated for small businesses. The Law Reform Commission has prepared amendments to anti-corruption legislation intended to strengthen prosecution and incorporate commitments under international treaties (MEFP, para. 47). Draft anticorruption strategies have been completed for all local government authorities and submitted for government approval (end-June structural benchmark). Progress in the energy sector, however, has been mixed. Better rainfall has improved the outlook for hydropower, but TANESCO’s cash flow has come under strain due to delays in commissioning additional gas turbines.

III. Report on the Discussions

12. The discussions centered mainly on the 2005/06 framework, particularly (i) the budget, in the context of the authorities’ goals for growth, employment, and poverty reduction; (ii) liquidity management in the presence of high aid inflows; (iii) progress on tax and expenditure reforms; and (iv) structural reforms to further strengthen the financial sector and business environment.

A. Macroeconomic Outlook and Poverty Reduction Strategy

13. The macroeconomic framework targets real growth of 6.9 percent (in CY 2005) and inflation of about 4.0 percent. Growth will be driven by a continued expansion of agriculture, agroprocessing, manufacturing, construction, and trade.

14. The main goals of the PRGF program remain to accelerate growth and reduce poverty. In this context, the authorities have begun implementing their new five-year PRSP—MKUKUTA in Kiswahili— which adopts an outcome-based approach focusing on growth and reduction of income poverty, improved quality of life and social well-being, and good governance and accountability (MEFP, para. 18). MKUKUTA, which utilizes a macroeconomic framework broadly consistent with the PRGF,7 focuses on a number of reforms to stimulate private sector activity, including better infrastructure, enhanced domestic savings, better access to financial services, stronger governance, and reducing administrative burdens on the private sector. The authorities have revised the timing and modalities of the budget guidelines to strengthen the link between budget preparation and the three broad outcomes targeted in the MKUKUTA. The next stage will be to carry this revised allocation process into the medium-term expenditure framework (MTEF).8

15. The authorities at the highest level expressed their resolve to maintain steady, prudent policies up to and beyond the October 2005 presidential and parliamentary elections. More generally, they reiterated their view that continued macroeconomic stability and steady implementation of ambitious structural reforms to improve the environment for productive private sector activity are key to improving the lives of all Tanzanians. The authorities also expressed the desire for ongoing Fund involvement in Tanzania to provide policy advice, technical assistance, and signaling to development partners.

B. Fiscal Policy

16. Consequent to the authorities’ 2005/06 growth and poverty reduction goals, the budget targets further increases in expenditure, mainly for priority sectors and infrastructure, financed by increased domestic revenue mobilization and higher foreign aid. Net domestic budget financing will be contained at 1.1 percent of GDP in order to avoid crowding out the private sector.

17. Domestic revenues are projected to rise from 13.6 percent of GDP in 2004/05 to 14.3 percent of GDP, driven by a number of reforms (MEFP, para 23), in particular the full-year effect of the new Income Tax Act, the graduation of a number of tax-exempted companies into the tax net, and the ongoing reform of the TRA and customs administration. The staff and the authorities agreed that administrative controls on exemptions should be maintained.9 In that same vein, in the context of plans to establish special economic zones (SEZs), the government will focus on strengthening infrastructure and providing efficient services, including expedited customs clearing and VAT refunds, rather than new tax exemptions.

18. Expenditure is programmed at 26.8 percent of GDP, compared with 25 percent in 2004/05. Recurrent expenditure is projected to rise by 0.5 percent of GDP mainly on account of wage and salary hikes, designed to boost capacity under the Public Service Reform Program (PSRP). Development expenditures are projected to increase by 1.2 percent of GDP, mainly reflecting higher outlays on infrastructure. The staff supported the proposed expenditures, but remarked that the wage hikes should be accompanied by reforms of the allowances system, including transparency about their magnitude, and the authorities agreed to study these issues (MEFP, para. 17). About 44 percent of programmed expenditures are expected to be financed by development partners, broadly unchanged from earlier years.

19. It should be noted that expenditure levels in the budget submitted to parliament are 1.5 percent of GDP higher than the program (with net domestic financing of 2.6 percent of GDP). The staff argued that the higher net domestic financing under the budget would unduly crowd out the private sector. The authorities agreed to constrain spending to limit net domestic financing to 1.1 percent of GDP (performance criterion, MEFP, para. 25). The staff is confident that the authorities will meet this program target, given their strong track record of significant overperformance on net domestic financing and high level of commitment to meeting program targets.10 The authorities also noted they have consistently exceeded their revenue targets in past years, and are actively seeking additional donor support. If additional resources emerge, expenditures on infrastructure and goods and services will be increased, in line with the budget. The staff noted that even if such additional resources are attained, divergence between the program and the budget is detrimental to the budget process and to transparency, notwithstanding explicit discussion of this difference in the MEFP and this staff report, which are to be published.

20. The staff views the medium-term fiscal outlook as positive, albeit dependent on sustained donor support. Moreover, the authorities agreed that the revenue to GDP ratio, notwithstanding its increase by 1.5 percentage points of GDP over the past two years, remains low by regional standards. They agreed that continuing to increase the revenue to GDP ratio over the medium term, particularly through broadening the tax base and improving tax policy administration is important (Box 2). They have requested technical assistance from the Fund in a broader review of tax policy.

21. In this context, further strengthening of tax administration is envisaged for 2005/06 (MEFP, paras. 26-27). In particular, the operation of the VAT and income tax departments will be enhanced, the LTD will be further strengthened, and efforts to streamline customs administration will continue. In support of these efforts, to improve the performance of customs, the authorities will strengthen the post clearance audit section, including through increasing the number of staff (end-March 2006, structural benchmark) and will integrate the destination inspection program with custom procedures in the Dar es Salaam custom offices (end-January 2006, structural benchmark). The authorities will also complete an action plan by June 2006 for establishing a single domestic tax department.

22. The authorities will further strengthen public expenditure management (MEFP, paras. 28-30). In particular, the government will (i) review the organizational structure of the Ministry of Finance in light of the Public Finance Act 2001 and review the consistency of that Act with other legislation; (ii) address weaknesses related to projecting expenditure requirements; (iii) integrate local government agencies (LGAs) into the budget preparation and execution process; and (iv) act on weaknesses in procedures in internal and external audits of public expenditure.

C. Monetary Policy and Financial Sector Issues

23. The staff agreed with the BoT that an increase in the targeted path of reserve money growth during 2005/06 and the associated continued strong growth in private sector credit will not pose undue risks to inflation, given the absence of inflationary pressures, continued buoyant economic conditions, and strong private sector demand for credit. Under the proposed program, M3 growth is projected to rise to 27 percent by end-June 2006 from an estimated 24 percent through June 2005. Velocity is projected to decline, consistent with the deepening of the financial system and in line with the annual average decline of velocity over the past five years.

24. The authorities and the staff agreed that the principal challenge in implementing monetary policy continues to be liquidity management in the face of high aid inflows (Box 3). The staff has continued to emphasize heavier reliance on foreign exchange sales, noting that the real exchange rate would remain around its equilibrium level even if a moderate nominal appreciation materializes in the coming year.11 The BoT indicated it does see some additional room to increase sales of foreign exchange to complement open market operations, but nevertheless continued to express concerns about the potential loss of competitiveness. To further improve liquidity management, the authorities also plan to strengthen liquidity forecasting, including improving projections of liquidity-injecting government expenditures.

Tanzania—Revenue Performance in Perspective

The last three years have marked strong progress in tax administration reforms. The TRA is pursuing a modernization strategy that is supported by Fund TA. This includes increased coverage of the LTD, integration of the VAT and income tax departments, efforts to reduce exemptions, and increased emphasis on taxpayers’ services. In addition, the Customs and Excise Department has embarked on an ambitious program of reforms and modernization. This is being strengthened through enhanced audit capacity and further simplifications of procedures in clearing goods.

These tax administration reforms have led to significant improvement in revenue performance. The revenue-to-GDP ratio increased from about 12 percent of GDP in 2002/03 to a estimated 13.6 percent of GDP in 2004/05.

Despite these improvements, the revenue-GDP-ratio remains low by regional standards. Achieving the government’s growth and poverty reduction goals, and reducing aid dependency, will require increased domestic resource mobilization. A comparison of revenue performance in Tanzania with other countries of broadly the same level of development shows scope for further enhancing revenue.

Cross-Country Comparison of Revenue Performance (percent of GDP), 2003/04 2/

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As of 2003

Calendar year 2004 for Mozambique and Zambia

Sources: World Development Indicators (WDI), IMF country reports, and IMF staff estimates.

Liquidity Management in the Presence of High Aid Inflows

Since the mid-1990s, rapid GDP growth and deep structural reforms have helped attract substantial aid inflows, projected to reach 14.0 percent of GDP in 2005/06.

Given the natural lag in the expansion of absorptive capacity, the surge in aid inflows and the resulting increased liquidity present challenges to monetary policy. On the one hand, aid inflows allow for increased investment and poverty reducing expenditures as well as boost domestic demand. On the other hand, the resulting rise in liquidity threatens the BoT’s ability to meet its reserve money targets.

The challenge lies in effectively balancing the pressure on prices from increased liquidity versus the pressure on interest rates from the expansion of sterilization operations, and on exchange rates from increased foreign exchange sales. For a given reserve money target, increased sales of foreign exchange may adversely affect export competitiveness through an exchange rate appreciation. Conversely, the use of domestic debt sales for sterilization may (i) put upward pressure on interest rates, crowding out credit for private sector investment and (ii) strain the BoT’s balance sheet as it absorbs the interest it pays on domestic paper (and put pressure on the government’s budget as the costs of sterilization are eventually borne there).

The appropriate policy mix between these options has consequences for prices, the exchange rate and/or interest rates, and ultimately for growth and macroeconomic stability. A successful monetary response is one that avoids a jump in interest rates, an overshooting of the exchange rate or a surge in inflation.

The Trilemma: absorbing high inflows requires some combination of changes in inflation, interest rates and exchange rates

Given that in Tanzania: (i) inflation has been low at around 4 percent, (ii) the cost of sterilization operations has been increasing rapidly, with a negative impact on BoT profitability, (iii) Treasury Bill rates have moved up over the last couple of years, and (iv) the real exchange rate has depreciated to levels broadly in line with fundamentals the staff and the authorities agreed on a high reserve money path, consistent with estimated money demand growth. To achieve the reserve money targets, the staff urged a higher reliance on sales of foreign exchange, even if that entailed allowing for a slight nominal exchange rate appreciation. This could be achieved while continuing to smooth out large abrupt exchange rate fluctuations and avoiding any significant exchange rate overshooting.

The challenges of liquidity management underline the importance of improving the supply response and absorptive capacity of the economy. In this context, key focus areas include improving the business environment, expanding the availability of bank credit, strengthening labor productivity, and addressing infrastructural bottlenecks, particularly in the areas of transportation, utilities, and telecommunications.

25. The authorities intend to accelerate financial sector reforms during 2005/06. Despite rapid growth in recent years, Tanzania’s financial sector remains small, and large portions of the economy work with little formal credit. The financial sector reform plan addresses structural impediments in nine areas, and includes a detailed matrix of reforms and identified donor support (MEFP, para. 38). In addition to the amendments to the BoT Act and the BFIA (MEFP, para. 39), near-term actions will include completion of the NMB privatization, restructuring remaining state-owned banks, and development of a legal and regulatory framework and investment guidelines for pension funds (end-June 2006, structural benchmark) to boost availability of funds for longer-term productive investments.

26. The authorities are pursuing efforts to improve the availability of medium-term credit to key sectors of the economy (MEFP, paras. 42-46). In addition to the DFGF discussed earlier, the government intends to establish a Development Finance Institution (DFI) that would channel donor funds and perhaps government seed money for development-oriented lending. Though the DFI’s mode of operation is still under development, the authorities responded to staff concerns about potential government contingent liabilities by indicating that the DFI would not take any new deposits from the public (other than its credit customers) nor raise any other funds under government guarantee, and would operate under a strong governance structure. The authorities agreed that government exposure under the DFI and the DFGF will be strictly limited (continuous structural performance criterion), and that the instruments establishing the DFGF and the DFI will require annual independent operational audits—in addition to standard independent audits of financial statements—to verify that the funds are being employed as intended (structural benchmark). The government also hopes to facilitate creation of a privately owned and managed long-term financing facility (LTFF), with no government guarantees (continuous structural performance criterion), that would channel funds to be on-lent to commercial banks on a long-term basis.

D. External Sector Policies and Prospects

27. The current account deficit is expected to widen somewhat in 2005/06 to 12.4 percent of GDP, driven by an increase in the trade deficit. Imports of intermediate and capital goods are expected to increase, due to accelerating economic growth, infrastructure projects, government subsidies for fertilizer transport, and high oil prices. Export growth is expected to be solid, with mining and manufacturing exports remaining strong and traditional exports benefiting from an easing of structural bottlenecks such as road improvements and facilitated access to inputs, as well as favorable commodity prices. Non-traditional export growth will abate over the medium term as no new gold mines are foreseen. Ongoing structural reforms continue to aim at lowering impediments to exports.

28. The trade deficit will be largely covered by increased aid inflows, which are expected to reach 14 percent of GDP in 2005/06. Increased net inflows to the balance of payments are projected to result in an overall international reserves position of around 5.7 months of imports. The BoT is committed to limit its interventions in the foreign exchange market to facilitate liquidity management and smoothing any short-run excessive fluctuations in the exchange rate.

29. The government will continue efforts to negotiate debt relief agreements with the few remaining creditors under HIPC comparable terms (Table 8). An updated debt sustainability analysis (Appendix V) shows that Tanzania’s external debt position is sustainable, with moderate risk. On trade, the East African Community (EAC) aims to reduce conflicting regulations within and outside the regional trade blocks. Over the medium term, the authorities aim to increase intra-regional trade and economic integration.

Table 7.

Tanzania: Disbursements of Program Assistance, 2003/04 - 2005/06 1/

(In millions of U.S. dollars)

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Sources: Tanzanian authorities; and donors.

Fiscal year: July-June.

Poverty reduction budget support.

Including loan baskets.