Liberia: Staff Report for the 2006 Article IV Consultation and Staff-Monitored Program

Liberia’s 2006 Article IV Consultation reports that the economy continues its modest recovery, driven by donor-related expenditure and the resumption of activity in rural areas. The government has endorsed the Governance and Economic Management Assistance Program that aims to strengthen economic governance and financial management and rebuild Liberia’s key economic institutions. Reestablishment of confidence in these institutions is crucial to maintaining stability, securing sustained external support, and encouraging private investment.

Abstract

Liberia’s 2006 Article IV Consultation reports that the economy continues its modest recovery, driven by donor-related expenditure and the resumption of activity in rural areas. The government has endorsed the Governance and Economic Management Assistance Program that aims to strengthen economic governance and financial management and rebuild Liberia’s key economic institutions. Reestablishment of confidence in these institutions is crucial to maintaining stability, securing sustained external support, and encouraging private investment.

I. Introduction

1. Liberia faces daunting reconstruction challenges following about fifteen years of intermittent civil war through 2003.1 The country’s physical infrastructure has been largely destroyed, government institutions lack the basic capacity for economic management, and the country’s once considerable human capital has been significantly eroded. Poverty in Liberia is also pervasive, particularly in rural areas; real GDP per capita (in 2005 prices) is estimated to have declined by almost 90 percent from US$1,269 in 1980 to US$163 in 2005. Unemployment reportedly remains at over 80 percent, and a similar percentage of the population subsists on less than US$1 a day, with no access to basic health, education, and other social services.

2. Little progress was made in implementing key reforms during the National Transitional Government of Liberia’s (NTGL) term in office from late-2003 to mid-January 2006. Consequently, only limited progress was made in improving Liberia’s relations with the international community. UN sanctions on timber and diamond exports, imposed in mid-2003, were extended further in late 2005. Liberia’s cooperation with the Fund showed a modest improvement; while monthly token payments to the Fund were made regularly, policy implementation deteriorated.2 During the last Article IV consultation discussions in April 2005, Directors urged the authorities to formulate concrete action plans to address weaknesses in financial management and economic governance. Despite advice and support from Liberia’s international partners in these areas, the momentum of reform weakened in the course of 2005.

3. In light of growing concerns, the NTGL and Liberia’s key international partners agreed in September 2005 on a long-term international assistance program to strengthen governance and financial management. The key features of the Governance and Economic Management Assistance Program (GEMAP) are: (i) improving financial management and accountability in all key budgetary institutions and the Central Bank of Liberia (CBL), inter alia by deploying international experts with binding co-signature authority alongside Liberian counterparts; (ii) strengthening the judicial system, and combating corruption; (iii) providing technical assistance to rebuild local capacity in economic management; and (iv) joint oversight over the implementation of the program by a steering committee chaired by the Head of State, and comprising key ministers and local donor representatives. The GEMAP is expected to become fully operational by mid-2006, following the full deployment of international experts at key institutions, and could remain in place until Liberia reaches the completion point under the enhanced HIPC Initiative.3

4. The new President, Mrs. Ellen Johnson-Sirleaf, a former senior UNDP official, was inaugurated on January 16, 2006.4,5 She expressed a strong desire to work with the international community to rebuild Liberia’s shattered economy and endorsed the GEMAP. As a first step to implementing a credible reform program that can be supported by the international community, the government has worked closely with the international partners to identify key objectives and deliverables for the first 150 days of the administration (the remainder of the 2005/06 fiscal year).

II. Recent Economic Developments

A. Recent Economic Developments

5. The economy continued to recover in 2005, largely driven by donor activities. Real GDP is estimated to have grown by 5.3 percent in 2005, following a modest growth of 2.6 percent in 2004. This reflected the gradual improvement of security in rural areas, and restoration of activity in those sectors benefiting from donor assistance (mainly the service sector).6 Overall, economic activity in 2005 is estimated to have returned to about 75 percent of the prewar level.

Liberia: Recent Economic Developments

(2001-06)

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Sources: Liberian authorities; and Fund staff estimates and projections.
uA01fig01

Contributions to Real GDP Growth by Sector

(In percent)

Citation: IMF Staff Country Reports 2006, 166; 10.5089/9781451822885.002.A001

Sources: Liberian authorities; and Fund staff estimates.

6. Price and exchange rate developments reflect the return of relative stability to Liberia. Recently, however, there have been signs of a rise in inflation, in part reflecting higher donor expenditure. The Liberian dollar has been trading in a range of 55–60 Liberian dollars per U.S. dollar for the last 12 months.

uA01fig02

Exchange Rate and CPI

Citation: IMF Staff Country Reports 2006, 166; 10.5089/9781451822885.002.A001

Sources: Liberian authorities; and Fund staff estimates

7. The external trade deficit has increased sharply during the postconflict period to about 30 percent of GDP (Table 2). Exports have remained depressed, mainly on account of the continued UN ban on timber and diamond exports and a gradual decline in rubber production resulting from the neglect of rubber plantations. However, a high level of imports has been sustained, driven by humanitarian aid, donor assistance, and the large presence of UNMIL officials and peacekeepers in the country. International reserves have remained at a very low level, reflecting in part the continued financial weakness of the CBL.

Table 1.

Liberia: Selected Economic and Financial Indicators, 2002-06

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

Technical adjustments are made to the CPI for 2004 and 2005 in light of the replacement of some items subject to CPI survey in mid-2004.

Defined as Liberian currrency outside banks plus demand, time, and savings deposits in Liberian and U.S. dollars.

Table 2.

Liberia: Balance of Payments, 2002-10

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

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

Apart from token payments to international financial institutions, Liberia is not servicing is external debt.

8. Despite a strong recovery in both revenue and expenditure, fiscal management deteriorated markedly toward the end of the NTGL’s period in office (Table 3). Revenue collection increased by about 3½ percent of GDP in 2004 following the end of the conflict, and this strong recovery continued in the first half of 2005, allowing a similar expansion in total spending. However, collections slowed down significantly towards end-2005, largely reflecting a breakdown of controls in customs and the delay in implementing measures to strengthen revenue administration. At the same time, expenditure decisions were taken in a non-transparent manner, circumventing the Cash Management Committee (CMCo) which had been set up to avoid further accumulation of arrears. Excessive allotments granted for some ministries by the Bureau of the Budget and the indiscriminate issuance of vouchers by line ministries undermined a balanced cash-based budget, and sizeable domestic arrears were incurred. At end-January 2006, domestic arrears accumulated under the NTGL (excluding those to the CBL, and commercial banks) amounted to US$20 million, about 25 percent of the annual budget. In addition, the implemented budget deviated significantly from its original structure, reflecting the latitude given to the head of state to authorize such changes.

Table 3.

Liberia: Summary of Central Government Operations, 2002-06

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

Includes military outlays.

At end-2003, government had a net cash deposit of US$4.7million.

9. The CBL succeeded in accommodating the increased demand for local currency while largely avoiding pressures on prices and the exchange rate (Table 4). This was achieved despite a considerable increase in the supply of local currency; the year-on-year growth in the Liberian dollar currency in circulation accelerated significantly during 2005, from about 18 percent in May to nearly 30 percent in late 2005; and the Liberian dollar component of broad money growth also remained high at 26 percent in December 2005, far exceeding nominal GDP growth.

Table 4.

Liberia: Monetary Survey, 2002-2006

(In millions of Liberian dollars, end of period; unless otherwise indicated)

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Sources: Liberian authorities; and Fund staff estimates.

Derived from commercial banks’ balance sheets (Liberian dollar denominated).

Liberian dollar currency outside banks and commercial banks reserves (Liberian dollar denominated) held at central bank.

One bank has been excluded from the deposit since May 2003.

Excluding U.S. dollar in circulation

uA01fig03

Liberian Dollar Component of Money Supply in 2005

(year-on-year changes, in percent)

Citation: IMF Staff Country Reports 2006, 166; 10.5089/9781451822885.002.A001

Source: Central Bank of Liberia

10. The banking sector continues to be weak. Commercial banks remain fragile due to low profitability and poor asset quality. The CBL incurred a cash shortage on account of substantial unserviced claims on the government, and continued to draw on its international reserves to finance current outlays, resulting in a slower accumulation of foreign reserves than had been expected.

11. Governance concerns arose under the NTGL as new concessions and contracts, mainly in natural resource sectors, were granted in a nontransparent manner and on terms unfavorable to the Government. In addition, in 2004–05, EU-sponsored audits of the main revenue-generating agencies and an ECOWAS audit of travel expenses revealed pervasive mismanagement of public funds prior to and during the NTGL’s term of office.

12. For 2006, the economy is expected to continue to recover, based on strong donor inflows and a revival of rural activities, following the reestablishment of security and return of refugees to their communities. Real GDP is projected to grow by about 8 percent, led by agriculture and services. Notwithstanding the large donor presence, inflation is expected to remain modest, being contained to single digits. With a gradual decline in rubber exports and further increase in donor-funded imports, the trade deficit is projected to widen further.

III. Discussion of Economic Policies

13. The discussions took place against a background of rising expectations for the new government in the context of deep-rooted problems inherited from the past. The new government has inherited largely dysfunctional public institutions and pervasive governance problems, as well as challenges related to rebuilding Liberia’s destroyed physical and social infrastructure. Expectations among the population for visible progress are mounting while donors are insisting on significant and irreversible progress in rebuilding key government institutions and raising economic growth.

A. Recent Reform Efforts

14. Immediately following its inauguration, the new government implemented several key steps to begin addressing long-standing problems. These included: (i) the enforcement of pre-shipment inspections for imports and exports;7 (ii) more prudent budget allotments for line ministries; (iii) the reestablishment of the CMCo to contain expenditures within available cash revenues; and (iv) the initiation of a review of all concessions and contracts signed by the NTGL. The CBL, while still running a cash deficit, is also taking steps to strengthen its budgetary management.

15. The new government also formulated a comprehensive program for its first 150 days in office, in collaboration with donors.8 Regarding economic policy, the government specifically aims to: (i) establish sound financial management and budgeting, (ii) increase revenue and control expenditure, and (iii) implement the GEMAP.

B. Medium-Term Outlook and Policies

16. The authorities indicated that macroeconomic policy over the medium term will be designed to support the government’s reconstruction efforts, and create a stable macroeconomic environment that will facilitate private sector development. To this end, the government will pursue balanced budgets on a cash basis for some time, reflecting domestic and external financing constraints, supported by a monetary policy geared to containing inflation.

17. The government stressed that a key element of its strategy in the short- and medium-term would be to achieve significant progress in rebuilding key institutions, as envisaged under the GEMAP (Box 1). This includes putting in place a functioning budgetary process, including planning, execution, internal controls, and regular reporting, as well as strengthening the main revenue-generating agencies so that they can fulfill their role in a fully transparent and accountable fashion.

18. The authorities agreed that reestablishment of confidence in Liberia’s key economic institutions and improving the business climate would be crucial to securing sustained external support and attracting private investment, but also stressed that Liberia’s reconstruction would require sustained external financial and technical assistance. To this end, the authorities have fully endorsed the GEMAP, with a view to establishing a sustained track record of economic management. Such a track record would be a prerequisite for Liberia to make progress toward normalizing relations with international financial institutions and eventually addressing its debt overhang.

19. The authorities and the staff agreed that the main fiscal challenges are to strengthen revenue collection and improve expenditure control so as to channel available resources to poverty-reducing activities, while ensuring sufficient transparency and accountability. In light of external and domestic financing constraints, the authorities agreed that the budget should remain balanced for some time. There is also a need to make the main revenue-generating agencies fully transparent and accountable, and channel their collections fully to the budget, as envisaged under the GEMAP.

20. In the monetary sector, the key actions in the period ahead include strengthening the CBL and the banking system, and introducing additional monetary policy instruments to enable a more active policy over the medium term for maintaining low inflation. Further efforts will be required to address the weak financial position of the CBL and to restructure fragile commercial banks. To expand the scope for an active monetary policy, the staff suggested that the CBL consider the development of additional instruments as the expected increase in the demand for local currency gradually widens the scope for monetary policy in the as-yet highly dollarized economy.9

21. The authorities pointed to Liberia’s large external debt overhang as a key constraint to securing financing for their reconstruction efforts, and attracting potential foreign investment. The staff stressed that the establishment of a strong track record of implementing reforms and prudent policies would be key to making progress toward the resolution of the debt overhang.

Medium-Term Prospects for Liberian Economy

To illustrate the positive effects of economic reforms, the staff prepared two medium-term scenarios. The basic assumption underlying both scenarios is that the government will be pursuing prudent macroeconomic policies, but the two scenarios differ in the assumed pace of structural reforms, the scale of aid inflows, and the timing of the lifting of UN sanctions.

The “baseline scenario” assumes that strong implementation of reforms under the GEMAP will trigger significant financial and technical support from donors. In addition, the early establishment of an environment conducive to private investment and the lifting of UN sanctions on timber and diamond exports in 2007 could potentially attract large FDI flows. A strong recovery in real output growth in forestry and minerals is assumed to support higher real GDP growth of about 8 percent annually during 2006-10.

uA01fig04

Real GDP -- Past and Projections

(1980=100, 1980-2030)

Citation: IMF Staff Country Reports 2006, 166; 10.5089/9781451822885.002.A001

The “lower-case scenario” is premised on a slower pace of reform and lower level of donor support, which would allow only modest growth, insufficient to create significant new employment opportunities, or raise living standards. Real GDP would grow by about 4 percent annually as existing capacity is gradually brought back into production. As a consequence, the real GDP per capita would be lower by 15 percent by 2010 than under the baseline scenario. Compared with the baseline scenario, FDI flows are assumed to be lower by 2–3 percent of GDP, and inflation would also be lower, reflecting less demand pressure due to lower donor inflows.

Liberia: Medium-Term Scenarios, 2005-10

(In percent of GDP, unless otherwise indicated)

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

In this scenario, UN sanctions on timber are assumed to be lifted by mid-2007.

A steady rise is assumed for donor inflows at about half the rate of nominal GDP growth, based on the country’s extensive reconstruction needs and assumed strong policy performance that would likely elicit continued strong donor support.

In this scenario, UN sanctions on timber are assumed to be lifted by mid-2009.

This scenario, based on weaker policy performance, assumes donor inflows equal to two-thirds of those in the baseline.

C. Fiscal Issues

22. The government needs to contain its expenditure within available resources under the current difficult financing environment, while persisting with efforts to strengthen revenue collection. Current efforts to strengthen public revenues are expected to raise the ratio relative to GDP to around 15–16 percent in the coming years. This increase in revenues, together with possible donor assistance, should be channeled toward poverty reducing expenditures.

23. In light of the crucial importance of reestablishing a functioning and transparent budget process, the discussions focused on the long-standing weaknesses of financial management and the measures to strengthen fiscal policies in the short term. Immediate actions are needed to enhance revenue collection and strengthen expenditure control, consistent with previous technical assistance recommendations. For the remainder of the 2005/06 fiscal year,10 the government agreed to a balanced cash budget that prioritizes expenditures in order to maintain its core functions and to ensure the clearance of recent civil service pay arrears.

24. On the revenue side, the authorities are fully committed to implementing key revenue-enhancing measures. They agreed with the need to strengthen the Large Taxpayer Unit (LTU), through creating an audit unit within the LTU, in order to further enhance revenue collection efficiency. From a medium-term perspective, the authorities have requested technical assistance from the Fund on tax policy reforms to broaden Liberia’s revenue base and to reduce gradually its dependence on trade taxation.

25. The staff also stressed the importance of ensuring equitable treatment of tax payers and enhancing transparency. To this end, the authorities agreed to: (i) discontinue the current practice of allowing settlement of tax obligations through the delivery of goods or services; (ii) establish a program to address overdue tax/duty obligations; and (iii) review and rationalize the extensive list of duty exemptions. Furthermore, as envisaged under the GEMAP, transparency in resource flows from revenue-generating agencies is to be enhanced with the placement of external experts as financial controllers at these agencies.

26. On the expenditure side, the staff emphasized the importance of strengthening commitment control, as well as proper cash management, to avoid the emergence of domestic arrears (Box 2). The authorities agreed with this view, and committed to fully implement a comprehensive commitment control system by end-June 2006.

Expenditure Management System in Liberia

To establish discipline in expenditure management in the context of limited local capacity, the NTGL first centralized all its accounts at the CBL, and then established a cash management system (under the CMCo), and took preliminary steps to implement an interim commitment control system in mid-2004, based on Fund technical assistance.

However, these systems failed to work as intended during the last two years, primarily owing to the lack of cooperation within the NTGL, and insufficient checks and balances within the system. Specifically, the following deficiencies were observed:

  • (1) Indiscriminate allotments for line ministries by the Bureau of the Budget (BoB) without consultation with the Ministry of Finance (MoF) about actual revenue collection.

  • (2) Commitments made by line ministries in excess of their allotments. Purchasing orders were deemed official commitments without the approval of the Bureau of General Auditing (BGA) at the MoF.

  • (3) Spending decisions made outside the CMCo.

The new government has committed to address these problems and take decisive actions to strengthen expenditure control, as envisaged under the GEMAP. Specifically, the following steps have been taken under the new government:

  • (1) The BoB shall make allotments in consultation with the MoF. The BoB is scheduled to be merged into the MoF by July 2006.

  • (2) The government will make a public announcement that it will certify commitments and validate all purchase orders with the BGA stamp in order to avoid over-commitments by line ministries.

  • (3) External experts are in place at the CMCo and the CBL with co-signatory authority to make sure no disbursements are made on the margin of the CMCo. The CMCo documents are also being publicized on the MoF’s web site.

27. The authorities agreed with the staff that any additional resources should be spent for poverty reducing expenditures. The staff noted that progress with the reform effort is likely to attract grants, also in the form of budgetary support, once the budget process has been sufficiently strengthened. Together with higher revenue, these resources should be channeled toward basic infrastructure and social services in the context of the poverty reduction strategy that will be developed through a consultative process. The authorities indicated an intention to prepare an interim Poverty Reduction Strategy Paper (I-PRSP) by end-September 2006.

28. To improve the budgetary process, the government intends to enhance transparency and accountability. As a first step, the government plans to introduce new legislation by mid-2006 that would limit the discretion granted to the administration to change budget allocations without legislative approval. In addition, the budget will be posted on the website of the Ministry of Finance with regularly updated information on progress in implementation.

D. Monetary and Exchange Rate Issues

29. The staff continues to support the CBL’s monetary policy framework which has helped to hold inflation to about 7 percent in 2005. This framework, which was formulated with MFD technical assistance, recognizes that in the highly dollarized and very open Liberian economy, the exchange rate is the main transmission mechanism through which monetary imbalances affect prices. Moreover, the CBL lacks credible monetary indicators that capture U.S. dollar liabilities. Against this background, and in view of uncertainty about the pace of increase in the demand for local currency in rural areas, the CBL will continue to use the exchange rate as an indicator of domestic monetary conditions and gear its management of Liberian dollar liquidity to maintaining broad stability in the exchange rate.

30. The staff cautioned that trends in the demand for local currency in Liberia’s highly dollarized environment should be carefully assessed.11 In response, the CBL noted that, for 2006, a further strengthening in the demand for Liberian dollars would be expected with a further rebound in economic activity as internally displaced persons and refugees continue to return to their rural homes, and a continued recovery in other economic activity on account of the strengthening of internal security. The staff suggested that the money supply in local currency should be cautiously expanded to maintain a broadly stable exchange rate, and also stressed that scarce foreign reserves should not be used to defend the exchange rate in the event of downward pressure due to exogenous shocks. The CBL concurred with this view.

31. From a medium-term perspective, the staff encouraged the CBL to explore the scope for expanding an active monetary policy. For this purpose, the CBL noted that it planned to prepare for (i) the introduction of purchase auctions of foreign exchange, (ii) the establishment of a liquidity monitoring framework, and (iii) over the medium-term, the development of money and capital markets. The staff broadly agreed with the approach but stressed that the use of securities (either government- or central bank-issued) should only be considered once the current unsustainable public debt and the weak financial position of the CBL have been fully addressed.

32. The authorities informed the staff that a Money Management Committee had been established, but that at this stage the Committee had been primarily engaged in administrative issues. The staff welcomed the establishment of the Committee, but urged the authorities to expand its mandate to also include responsibility for the preparation of monetary operations and the implementation of monetary policy.

33. The banking system remains fragile and undercapitalized (Box 3). In light of the weakness of the banking sector, the staff encouraged the CBL to continue to monitor closely developments in the banking sector, to fully implement regulatory guidelines related to credit risk management, and to develop restructuring plans for undercapitalized banks that are fully consistent with the Bank Restructuring and Resolution Policy formulated in 2005 with MFD technical assistance. The CBL noted that a resident supervisor had been placed at one bank, and that restructuring plans had already been developed for two banks. Plans for the remaining banks were expected to be developed by end-March 2006. In addition, the authorities indicated that no new bank licenses would be granted for the time being.

Soundness of Liberia’s Banking Sector

Liberia’s commercial banking sector consists of five operating banks (with two recently licensed); at end-2005, the overall gross assets amounted to US$129.5 million, about 24 percent of nominal GDP. Liberian banks are predominantly foreign-owned. Public sector ownership is limited to one bank with a shareholding of about 20 percent.

Banking Sector Financial Soundness Indicators

(In percent)

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Adjusted by the Central Bank of Liberia based on its assessment.

Source: Central Bank of Liberia

The banking sector is highly liquid but remains fragile. The overall risk-weighted capital adequacy ratio has been negative; the nonperforming loan ratio remained high at close to 20 percent at end-2005. The income structure is also weak, with substantial reliance on non-interest income (i.e., fees and commissions), representing around 80 percent of total revenue.

34. The staff noted with concern the continued weakness in the financial position of the CBL, despite a significant retrenchment program in early 2005, and urged it to take steps to eliminate the cash deficit.12 The CBL supported this objective, but noted that that the budget for 2006 would have to accommodate commitments made by the previous management of the CBL.13,14 The CBL agreed to target a balanced current budget (excluding the capital spending and one-off costs relating to the retirement of the previous executive management) for the remainder of the year. Furthermore, to help facilitate efforts toward prudent expenditure management, and to enhance transparency, the new management of the CBL will commission a comprehensive external audit by auditors of international repute, with assistance expected to be provided by the EU.

CBL Budget

(In millions of U.S. dollars)

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Source: Central Bank of Liberia.

E. Governance Issues

35. The staff is encouraged that the GEMAP is being implemented in full collaboration with Liberia’s international partners. Regular meetings among the government and local donor representatives are being held to operationalize the GEMAP and review its implementation, while external experts have already been posted at the Ministry of Finance and the CBL, helping to ensure the full functioning of the CMCo. Other experts will be deployed at key revenue-generating agencies by mid-2006.15

36. The staff discussed with the new government their plan to strengthen governance and combat corruption. Specifically, it endorsed the government’s goal of formulating a national anti-corruption strategy, drawing on the recent anti-corruption program studies by UNDP and the U.K. Department for International Development (DFID). The new government also intends to request support from international experts for help with the investigation of serious fraud, corruption and economic crimes.

37. The staff encouraged the new government to take all steps necessary to allow for the lifting of UN sanctions on timber and diamond exports (Box 4). The new government is currently working with key external partners toward fulfilling the conditions for a lifting of the sanctions on timber exports.

United Nations (UN) Sanctions on Liberian Diamonds and Timber

In 2003, the UN Security Council imposed sanctions on Liberian diamond and timber exports.16 The sanctions resulted from the recognition that revenue from the illicit trade in diamonds and timber played a major role in fueling West African conflict.

In December 2005, the Council determined that insufficient progress had been made for lifting of sanctions and renewed the measures for a further period of six months. A panel of UN experts will assess the progress made towards meeting the conditions for lifting the measures and report to the Council in June 2006.17

The new government is planning to take the following actions:

  • Timber: Following a public announcement nullifying all existing forestry concessions in January 2006, the government plans to allocate future concessions using the Public Procurement and Concession Act of 2005 guidelines, which require competitive bidding. The authorities are also planning a system to establish control over forest resources.

  • Diamond: To remove the ban on diamond exports, the authorities are planning to establish an effective Certificate of Origin regime for trade in Liberian rough diamonds that is transparent and internationally verifiable with a view to joining the Kimberly process.

F. Donor Activities and Technical Assistance

38. Following the 2003 peace agreement, donor activities in Liberia have increased sharply. Donor disbursements are estimated at US$460 million during 2004–2005 and projected to continue at a similar pace in 2006 (Box 5). These donor funds are spent entirely outside the government’s budget. The authorities expressed concerns about the lack of budget support but recognized that past governance problems made it difficult for donors to provide resources in this form. The staff agreed that improved governance and greater transparency and accountability in the use of public resources were a precondition for budget support in the future.

Donor Assistance

The international community has increased its support for Liberia sharply since the 2003 peace agreement. According to data gathered by RIMCO (the coordinating committee for the donor-supported Results Focused Transitional Framework (RFTF)), donors disbursed a total of US$460 million in Liberia during 2004 and 2005, entirely outside the government’s budget, while donor pledges and commitments were considerably larger. The US and the European Commission were the largest donors. The bulk of these funds (about three-fourths) were spent in the area of social development and community revitalization, including disarmament and demobilization and resettlement and reintegration. These figures do not include the cost of UNMIL, which is put at about US$1 billion per year, although most of this amount does not enter the Liberian economy directly.

Liberia: Humanitarian and Reconstruction Funding, 2004-2005

(In millions of US dollars)

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Source: RIMCO

Taking into account undisbursed commitments and based on stated donor intentions (including those of the US, the EC, and the World Bank), donor assistance, including in support of the government’s 150 day plan, is expected to increase further in 2006, to about US$245 million. In addition, UNMIL peacekeepers and officials are projected to spend about US$58 million in Liberia in 2006.

Liberia: Donor Support, 2006

(In millions of US dollars)

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Source: Staff estimates

Includes UNDP, Japan, UK, Germany, Sweden, Denmark, Ireland.

39. The GEMAP also serves as a key framework to coordinate the activities of international donors to ensure effective and efficient technical assistance. The United States provides assistance in budget preparation, and forestry management. The EU intends to focus on economic governance, based on its above-mentioned audits as well as providing support for the financial controllers of the major state-owned enterprises. The Fund and the World Bank closely coordinate their work on expenditure management. The Fund has also taken the lead in tax and customs administration and financial sector issues, while the World Bank focuses on procurement, forestry and public enterprise reform, and community-driven development.

G. Public Debt

40. Liberia’s external debt is clearly unsustainable. According to preliminary data for end-2005, the stock of external public debt, most of which has been in arrears, amounted to US$3.7 billion in nominal terms (Table 5). At end-2005, the NPV of debt to GDP and exports ratios were 790 percent and 3,040 percent, respectively, well above the relevant debt sustainability thresholds of the LIC DSA framework (Appendix II).18

Table 5.

Liberia: External Public Debt, 2001-05 1/

(In millions of U.S. dollars)

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Source: Liberian authorities and Fund staff estimates.

Data has been revised to reflect recent information on multilateral debt and to include estimates of interest arrears and late interest charges.

41. Liberia’s records on external debt were largely lost during the period of conflict. The authorities have attempted to contact their external creditors to obtain loan documents on their external debt obligations. Responses have been incomplete, particularly regarding commercial debt as the holders of those claims are in many cases no longer the original creditors. The staff urged the authorities to make further efforts to fully reconcile their external debt data with that of creditors as this would be an essential ingredient in moving Liberia eventually to the decision point under the HIPC Initiative. The authorities indicated that they would not contract or guarantee any new public sector external debt before the debt overhang has been resolved.

42. Liberia’s debt problem is further compounded by a sizable, but uncertain, stock of domestic arrears. The authorities estimate the stock of unverified domestic arrears at about US$0.7 billion, most of which is to the CBL and commercial banks, although there are also significant arrears on salaries and pensions and to suppliers. The staff urged the authorities to complete the verification of all outstanding domestic claims, as a precursor for the development of a domestic debt resolution strategy. Several options for domestic debt resolution have been proposed by US experts, all of which call for a substantial discount from the face value of the claims.19 The staff noted that a strategy would need to be developed to normalize relations with creditors. It also stressed that, in light of the adverse implications for the domestic banking sector, restructuring strategies for both commercial banks and the CBL would need to be defined in advance.20 The authorities concurred with these views.

H. Trade Regime and Competitiveness

43. Liberia’s external competitiveness has been severely eroded by the destruction of infrastructure and loss of human capital as a result of internal conflict. Lack of reliable economic data prevents the computation of standard indicators of external competitiveness. The nominal exchange rate of the Liberian dollar vis-à-vis the US dollar has stabilized over the last two years. The authorities did not see domestic cost levels as a major obstacle to business activity. In their view, the lack of basic infrastructure (transport and telecommunications) and utilities (electricity, water, sanitation) presented a far more significant hurdle to commercial and export activities. They also recognized that an uncertain business climate brought on by an unstable political situation and erratic regulatory implementation discourages domestic or foreign investment. The staff agreed that the creation of a stable business environment, with predictable application of laws and regulations, would be crucial to fostering private sector development.21

44. Import tariffs are set at a relatively moderate level ranging from 2.5 to 25 percent.22 The staff encouraged the authorities to take stock of their tariff regime and consider the benefits of regional and international trade integration. The authorities indicated a desire to harmonize Liberia’s trade regime with that of ECOWAS; they saw a harmonization of goods classification with international standards as a first step in that direction. The authorities also expressed interest in seeking fast-track membership of the WTO.

I. Relations with the Fund

45. The staff welcomed the authorities’ efforts to improve relations with the Fund. In a clear departure from the past, the commitment to policy implementation has already been illustrated through the quick steps taken to address long-standing problems in fiscal management and economic governance. Furthermore, the prospects for maintaining the current momentum in policy reforms are encouraging in view of the agreement reached on the SMP as well as the new government’s strong desire to work with the international community as envisaged under the GEMAP. The staff acknowledged the authorities’ intention to continue monthly token payments of US$60,000 to the Fund, as well as to make regular payments to the World Bank and the AfDB.23 The staff explained that a continuation of regular payments and implementation of sound policies would form the basis for the Fund’s Executive Board to consider whether to commence the process of de-escalating the Fund’s remedial measures against Liberia.24 Moreover, the staff noted that, if sufficient financing assurances and resources for eventual debt relief become available, strong performance under the SMP could form a basis for a subsequent rights accumulation program (RAP), which in turn could lead to a comprehensive arrears clearance operation, a decision point under the HIPC initiative, and eventually to eligibility under the MDRI.25

J. Data Issues

46. Serious data deficiencies continue to hamper surveillance. The authorities acknowledged the need to prepare timely and reliable national income and balance of payments statistics. In January 2006, the authorities began compiling data for a new consumer price basket, which is expected to replace the previous basket in January 2007. The staff welcomed improvements in the quality of monetary statistics (also reflecting Fund technical assistance), but regretted little improvements in the reliability of fiscal information, attributable to the neglect of a monthly reconciliation exercise based on the account statements from the CBL. The authorities agreed to conduct the exercise on a regular basis.

IV. Program Risks and Monitoring

47. Despite the authorities’ stated commitment to economic reforms, considerable risks remain. Peace and security remain fragile, and obtaining political support from the legislature will be important to support the efforts of the new government. On the policy side, the authorities will also require technical assistance from the international community to achieve some of the key structural benchmarks, including formulating strategies on domestic debt resolution and bank restructuring, and completing the review of the concessions and contracts.

48. A committee comprising key officials will closely monitor program implementation. Also, as indicated in the authorities’ technical memorandum of understanding (TMU)(Appendix I, Attachment II), reports on program implementation will be communicated to Fund staff through the Resident Representative on a regular basis. The quantitative and structural benchmarks are specified in Tables 1 and 2 of the MEFP. The three test dates for the staff-monitored program are set at end-March, end-June, and end-September 2006.

V. Staff Appraisal

49. As a postconflict country, Liberia faces daunting reconstruction challenges. Government institutions have a weak capacity for economic management. Decisive and continued efforts are required to reduce pervasive poverty and high unemployment, and to put the country on track toward sustainable economic recovery.

50. Liberia’s recent history of policy implementation has been poor. This has reflected limited local capacity and a lack of political will to address long-standing governance problems. While the NTGL agreed to the GEMAP, it is regrettable that economic governance and fiscal management continued to deteriorate further toward the end of the NTGL’s period in office. As a consequence, the new government has inherited a severely mismanaged economy, characterized by endemic corruption and dysfunctional public institutions.

51. Rebuilding Liberia’s economy and reducing pervasive poverty requires immediate and decisive action. In particular the authorities should focus on reestablishing an effective budget process and strengthening capacity in key economic institution to improve economic governance. The new government’s endorsement of the GEMAP is welcome, and it is important that GEMAP experts are quickly put in place for the program to become fully operational.

52. The staff is encouraged that the new government has already implemented several important measures to address long-standing governance problems. Key recent actions include rigorous enforcement of pre-shipment inspections for imports and exports, more prudent budget allotments for line ministries, and reestablishment of the CMCo to contain expenditures within available cash revenues.

53. Effective implementation of the public expenditure management framework is critical to channel scarce resources to their most effective uses. In view of past problems, it is imperative that the Bureau of the Budget is brought into the Ministry of Finance, that the interim commitment control system is fully implemented so that only purchase orders with the Bureau of General Accounting’s seal are considered valid, and that legislation is enacted to limit the power of the administration to change budget priorities and allotments between line ministries without prior legislative approval. These actions will provide greater certainty to line ministries and allow the CMCo to work effectively, so as to ensure that government spending is limited to available cash and that domestic arrears are not incurred.

54. Raising the level of fiscal revenues is imperative if the government is to start meeting the most critical needs of the Liberian people. Key steps include: continuation of rigorous enforcement of pre-shipment inspections; maintaining security at the port, ensuring that all duties are paid, including on rice and petroleum; and reviewing the numerous tax and duty exemptions granted by the NTGL.

55. Liberia requires continued strong support from the international donor community. The authorities’ 150 day plan represents an important reform agenda, which aims to start irreversible change through rebuilding key government institutions, maintaining and strengthening security, and meeting some of the urgent needs of the population. Looking ahead, it will be important for the government to initiate a consultative process for the development of a poverty reduction strategy focusing on the maintenance of macroeconomic stability, the provision of basic social services, and strengthening the climate for private sector development and investment. Strengthening public expenditure management systems and governance will be essential to permit an increasing share of donor support to be channeled through the budget.

56. The staff considers that the current monetary policy framework, aiming to contain inflation by maintaining a stable exchange rate, continues to be appropriate in view of the high degree of dollarization of the domestic economy, and in the absence of other credible monetary indicators. However, the authorities should stand ready to accommodate increased demand for the Liberian dollar, and should not use scarce foreign exchange reserves to defend the exchange rate in the event of downward pressure due to exogenous shocks.

57. The staff is concerned that the CBL has been drawing on its reserves to finance its cash deficit. However, the new CBL management’s resolve to strengthen the CBL’s financial position is encouraging. This will require ensuring that staffing and capital spending costs are strictly controlled, as well as effectively implementing the recently introduced procurement guidelines that apply to all the public institutions. It is important to move as quickly as possible to a balanced budget in the CBL’s operations, both in view of the very low level of official reserves, the liquidity impact of a cash deficit, and because of the need to secure support for the eventual restructuring of the CBL.

58. The staff welcomes the new government’s resolve to address long-standing economic governance concerns, as envisaged under the GEMAP. Specifically, it is important to develop quickly a national anti-corruption strategy and a domestic debt resolution strategy in collaboration with international partners. It will also be critical to make fast progress in fulfilling the requirements for the lifting of UN sanctions, which would have a significant and positive impact on economic activity and government revenues.

59. There is a critical need to build on the first encouraging steps to reconstruct a core statistical database to enable effective economic policy making. The authorities should seek further technical assistance from external partners in this area, especially on the national accounts, consumer price index, and balance of payments, as well as basic data on social indicators. To help reconstruct the statistical database, the Fund is planning to extend further technical assistance in the areas of fiscal and monetary operations.

60. The staff is encouraged by the government’s enthusiasm and determination to implement a policy of zero tolerance for corruption and to strengthen the effectiveness of public institutions. However, past experience has shown the difficulty of implementing new measures in an environment of highly constrained resources and capacities. The staff therefore urges the authorities to ensure that each government agency cooperates fully in bringing to fruition these systemic improvements. Effort also needs to be made to utilize the available technical assistance effectively so that capacity is developed in ministries to transform current plans in these areas into reality.

61. The SMP is centered on ambitious macroeconomic and structural benchmarks. This program also provides a window of opportunity to make progress toward the eventual resolution of Liberia’s debt overhang. Satisfactory implementation of the SMP would provide a basis for the Fund to consider the de-escalation of the remedial measures that the Fund has imposed on Liberia. Moreover, if sufficient indications of support from donors are forthcoming, strong performance under the SMP could form a basis for a subsequent program, which in turn could lead to the eventual resolution of Liberia’s debt overhang.

62. It is proposed to hold the next Article IV consultation on the standard 12-month cycle.

Table 6.

Liberia: Core Set of Financial Soundness Indicators, 2003-2005

(In percent, unless otherwise indicated)

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Source: Central Bank of Liberia.

Adjusted by the CBL.

APPENDIX I

Monrovia, April 12, 2006

Mr. Rodrigo de Rato

Managing Director

International Monetary Fund

Washington, D.C. 20431

USA

Dear Mr. de Rato,

As you know, the Liberian economy has suffered significant setbacks during the past fifteen years on account of civil conflicts, and economic mismanagement by successive governments. The task of reconstructing the Liberian economy is immense, but we believe that we will succeed in this important undertaking.

A key element of the government’s strategy is to demonstrate a decisive departure from historical practices in order to maintain public support for the difficult challenges that lie ahead. In support of this, the Liberian government is committed to implementing an economic and financial program to be monitored by IMF staff for the period through September 2006, with a view to commencing the task of rebuilding key public institutions, restoring credible financial management, and accelerating structural reforms. Such a program should facilitate our dialogue with multilateral and bilateral donors and the eventual de-escalation of the remedial measures previously imposed by the IMF on Liberia. We also hope that the successful execution of the program would pave the way toward a subsequent Fund-supported arrangement and eventually lead to the resolution of Liberia’s debt overhang.

The policies and measures set forth in the attached memorandum (Attachment I) reflect the understandings reached with the IMF staff during the February 2006 Article IV mission, which we believe can achieve the objectives of the program. We will, however, take any additional measures that may become necessary for this purpose. We will remain in close consultation with IMF staff on the adoption of such measures, and in advance of any revisions to the policies contained in the MEFP. The government will provide the IMF staff with all information that it requests to assess the implementation of the staff-monitored program. A Technical Memorandum of Understanding defining the indicative targets of the staff-monitored program and the data to be reported is also attached (Attachment II).

Sincerely yours,

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Attachments:

Memorandum on Economic and Financial Policies

Technical Memorandum of Understanding

Summary on the Governance and Economic Management Assistance Program (GEMAP)

ATTACHMENT I Liberia Memorandum on Economic and Financial Policies

The Government’s Economic Program for the period February – September 2006

I. Introduction

1. Following the signing of the peace agreement in Accra, the National Transitional Government of Liberia (NTGL) took office in October 2003. In parallel, the UN established a peace-keeping mission in Liberia (UNMIL), and security in the country gradually improved. Economic management, however, did not improve due to the lack of cooperation within the NTGL. Presidential elections in October and November 2005 took place in a relatively secure environment. Mrs. Ellen Johnson-Sirleaf, who won the run-off election on November 8, was inaugurated as President of Liberia on January 16, 2006. The new government inherited a severely mismanaged economy, characterized by endemic corruption and dysfunctional public institutions. The new government is formulating a “150-day plan” of priority short-term reforms and deliverables. The plan is fully consistent with the Governance and Economic Management Assistance Program (GEMAP)1, and underpins the economic program for the period February-September 2006 described in this Memorandum on Economic and Financial Policies (MEFP) that will be monitored by the staff of the IMF. The key features of the GEMAP are described in Attachment III.

II. Current Economic Situation

2. Liberia’s recent history has left deep marks on the population and economy. Poverty is pervasive; real GDP per capita (in 2005 prices) is estimated to have declined by almost 90 percent from US$1,269 in 1980 to US$163 in 2005; unemployment is estimated to be over 80 percent; a large share of the population was displaced by conflict; the most recent household survey, conducted by the United Nations Development Program (UNDP) in 2000, indicated that 76 percent of the population was living on less than US$1 per day; malnutrition and disease, including tuberculosis, cholera, malaria, and yellow fever are prevalent; and about one-fourth of infants die before reaching the age of 5. Liberia’s HIV/AIDS prevalence rate is estimated at about 10–12 percent. The destruction of both physical infrastructure (roads, railways, electricity and water, and telecommunications) and human capital (through armed conflict, emigration, lack of access to education, and poor health) have serious consequences for Liberia’s growth potential. In addition, efforts to formulate and implement consistent macroeconomic policy is severely hampered by the lack of management capacity in government institutions and accurate and timely data.

3. Economic developments in 2003-2005 closely mirror political events; driven by domestic instability and a UN ban on exports of timber and diamonds2, real GDP declined by about 31 percent in 2003. Real output growth is estimated to have been 2.6 percent and 5.3 percent respectively in the subsequent two years in line with the gradual improvement in security in rural areas, and restoration of activity in those sectors benefiting from donor assistance (mainly the service sector). The volatility in prices and the exchange rate declined following the cessation of hostilities in mid-2003. Recently, however there have been signs of a rise in prices, in part reflecting higher donor expenditure. The exchange rate vis-à-vis the U.S. dollar has returned to preconflict levels (following a depreciation of about 23 percent in 2002), and is currently trading in a range of 55–57 Liberian dollars per U.S. dollar.

4. Fiscal management deteriorated markedly toward the end of the NTGL’s period in office. Revenue collection stagnated towards end-2005, largely reflecting a breakdown of controls in customs, while expenditure decisions were taken in a non-transparent manner, circumventing the Cash Management Committee (CMCo) which had been established earlier. Excessive allotments granted for some ministries by the Bureau of the Budget and the indiscriminate issuance of vouchers by line ministries undermined a balanced cash-based budget. As a result, sizeable domestic arrears were accumulated. At end-January 2006, domestic arrears accumulated under the NTGL (excluding those to the Central Bank of Liberia (CBL) and commercial banks) amounted to US$20 million, about 25 percent of the annual budget.

5. Governance concerns arose as new concessions and contracts, mainly in the mineral sectors, were granted in a nontransparent manner and on unfavorable terms. In addition, in 2004–05, EU-sponsored audits of the main revenue-generating agencies and an ECOWAS audit on travel expenses also revealed pervasive mismanagement of public funds prior to and during the transitional government’s term of office.

6. The banking sector continues to be weak. Commercial banks remain fragile due to low profitability and poor asset quality. Nevertheless, operating banks are liquid, reflecting an increase in donor-related deposits and the low demand for loans from the private sector in the fragile economic environment. The CBL, incurring an income shortfall on account of substantial unserviced claims on the government, has drawn on its international reserves to finance outlays, resulting in a slower accumulation of foreign reserves than had been expected.

7. The external environment remains difficult, even though donor assistance has increased to levels substantially higher than during the pre-conflict era. While imports almost doubled in 2004, and remained at that level in 2005, exports have remained at low levels on account of the UN ban on the export of timber and diamonds. The overall balance of payments deficit rose further in 2004 and 2005, financed largely by a further accumulation of external payments arrears. Liberia’s external debt has been in arrears for more than two decades, and is unsustainable; at end-2005, the ratio of debt to exports was estimated at about 3,040 percent, while the ratio of debt to GDP amounted to about 790 percent.

III. The Governments Economic Program: February – September 2006

8. Following about fifteen years of intermittent civil war, Liberia faces daunting challenges to put in place a policy framework that will support economic recovery, and begin to address the pervasive poverty. To meet these challenges, the government established the Liberia Reconstruction and Development Committee (LRDC) to implement a broad development strategy under four pillars: (i) economic revitalization; (ii) infrastructure and basic services; (iii) governance and the rule of law; and (iv) security. A key element of the government’s strategy in the short run will be to achieve significant progress in rebuilding key government institutions. It will aim to: (i) re-establish a functioning budgetary process (planning, execution, internal and external controls, and regular reporting); (ii) rebuild the main revenue-generating agencies so that they can fulfill their role in a fully transparent and accountable fashion; and (iii) make the operations of the CBL and the banking system fully market-based and transparent. To this end, the government has already implemented a number of important measures to improve public finance management and enhance transparency, including: (i) fully enforcing pre-shipment inspections by the pre-shipment verification company, BIVAC; (ii) ensuring prudent allotments by the Bureau of the Budget for line ministries in collaboration with the Ministry of Finance; (iii) reestablishing the CMCo to contain spending commitments within available cash revenues; and (iv) developing a plan for reviewing all concessions and contracts signed by the NTGL, and placing a moratorium on awarding new concessions until a transparent bidding process has been established.

9. The government’s program assumes effective implementation of the GEMAP, prudent macroeconomic policies, the gradual revitalization of exports once UN sanctions are lifted, and post-war reconstruction. Real GDP is projected to grow by around 7–8 percent in 2006. Average annual inflation is projected to remain modest at around 8 percent, anchored on a stable exchange rate. The trade deficit is projected to widen further as the growth of donor-financed imports rise by more than exports. Official reserves, are projected to increase modestly, with the cover of non-donor financed imports rising from 0.5 months at end-2005 to 0.8 months at end-2006. Given Liberia’s resource constraints and low level of income, restoration of physical infrastructure and achieving sustained high economic growth will require substantial external support for an extended period.

10. The government will also initiate the development of a poverty reduction strategy aimed at restoring basic social services, and addressing the “Monrovia-bias” that fueled the civil conflict. In this context, the government will prepare an interim Poverty Reduction Strategy Paper (I-PRSP) by end-September 2006.

A. Fiscal Policy

11. The challenge for the government is to convince Liberians and Liberia’s development partners that the country’s scarce resources are being used efficiently to rebuild the economy and to start addressing pressing social needs. To this end the government will focus on the rebuilding of fiscal institutions to enhance revenue collection, and to strengthen public expenditure management. Recognizing Liberia’s significant public debt burden, the government will pursue a balanced budget for the foreseeable future; deficit spending will only occur to the extent that external donor support on grant terms becomes available (see Table 1).

Table 1.

Liberia: Quantitative Indicators (flow basis)

(In millions of US$)

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The fiscal balance, on a cash basis, is defined as the difference between (a) total central government revenue (excluding grants); and (b) total current expenditure plus investment expenditure (excluding spending through budget support and foreign-financed investment).

12. The government will implement a broad range of reforms to enhance the efficiency of revenue collection and broaden the tax base (see Table 2). These reforms include enforcing pre-shipment inspections for imports and exports and strengthening the Large Taxpayer Unit. In addition, the government will establish a program to address overdue tax/duty obligations. Furthermore, as envisaged under the GEMAP, transparency of resource flows from revenue-generating agencies is expected to be considerably enhanced with assistance from the external experts at five revenue generating agencies (namely the National Port Authority (NPA), Roberts International Airport (RIA), the Liberia Petroleum Refining Corporation (LPRC), the Forestry Development Agency (FDA), and the Bureau of Maritime Affairs (BMA)).3 The government will integrate the Bureau of the Budget and the Bureau of Maritime Affairs into the Ministry of Finance by end-June 2006. With technical assistance on tax policy from the IMF, the government will also aim to shift gradually revenue from the current trade-based structure to domestic activities.

Table 2.

SMP for 2006—Structural Benchmarks

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