We thank staff for the well-written and concise report on the 2006 Article IV consultation, supported by relevant background studies, and for the well-balanced FSSA update. Additional documents, to be issued shortly, include AML/CFT and data ROSCs, and a detailed assessment of observance of the Basel Core Principles. Our Tunisian authorities are grateful for the effective Fund support received over the years and appreciate staff work and policy advice as well as Directors’ contribution to the continuous strengthening of the relations between the Fund and Tunisia.

As reflected in the staff report, Tunisia has achieved and maintained macroeconomic stability and has built enough resilience in the economy to withstand various external shocks as evinced in recent years. This resilience has been reflected, in 2005, in a further narrowing of the current account deficit to 1.3 percent of GDP and in a minor increase in the budget deficit to 3.2 percent of GDP despite the impact of high international oil prices. The authorities are determined to sustain the hard-won stability gains and, in this regard, are implementing a comprehensive energy strategy which, inter alia, includes increases in domestic petroleum retail prices—already increased five times since 2005; proactive substitution policy to encourage the use of alternative and renewable energy; introduction of a mandatory energy audit in the industrial sector to promote efficiency; and extensive public awareness campaign focused on the importance of energy conservation and the burden of energy subsidies on the budget.

While macroeconomic stability will be preserved, the staff report correctly suggests that accelerated reforms are needed to place the economy on a higher growth trajectory, in order to reduce unemployment and raise per capita income to a high enough level, at least, to bridge the existing gap with lower-tier OECD countries within a decade. As the staff report suggests, the latter requires at least 1–1.5 percentage points higher growth rates than achieved in recent years. Fully aware of this challenge, the authorities have developed a medium-term growth strategy—well summarized in Box 2 of the staff report—which focuses on a gradual liberalization of the capital account, in consultation with the Fund, as detailed in the Selected Issues paper, and a private sector-oriented reform program supported by the World Bank. The immediate challenges to a successful implementation of this strategy, identified by the authorities and staff, are further reforming the banking sector and improving debt indicators.

The authorities consider that a sound financial system is critical for the achievement of higher economic growth and a prerequisite for smooth integration of the country into the global economy. In recent years, financial sector reform was cast within the 2002 FSAP recommendations, and Table 1 of the FSSA details progress in their implementation.

Furthermore, the 2006 amendments of the Banking and the Central Bank Laws, together with the 2005 law on financial security, include measures to strengthen credit culture, enhance transparency and governance, improve creditor rights, and strengthen bank regulation and supervision. In addition, the authorities have implemented a number of corrective measures to deal with the adverse impact on the banking sector of the 2001-02 terrorism events and four consecutive years of droughts. These include an effective ban imposed by the central bank on the distribution of dividends in 2005 and 2006 by banks with shortfalls in provisioning and its requirement that, by 2009, banks have to achieve a provisioning ratio of NPLs of 70 percent, regardless of existing collateral. Moreover, the authorities have made provisioning fully tax-deductible and have streamlined the legal procedures for the realization of collateral. As a result, the financial soundness indicators of commercial banks have improved markedly. The authorities are confident of continued strengthening of the financial system; nevertheless, they recognize that acceleration of the financial sector reform would allow a faster pace of implementation of their medium-term growth strategy. To better identify financial sector vulnerabilities and chart out an accelerated course of reforms, they requested an update to the 2002 FSAP. Our authorities broadly agree with staff recommendations, which include a policy objective of reducing NPLs ratio to total loans, strengthening management and governance of the remaining public banks, and accelerating the restructuring of bank loans to the tourism sector.

The authorities recognize that the level of external debt is relatively high, compared to other emerging market economies with similar ratings. To reduce this vulnerability, they have decided to allocate US$1.6 billion or two-third of the proceeds from the partial privatization of Tunisie Telecom to debt reduction operations. When completed, these operations will contribute to a significant improvement in debt indicators and in the country’s external position. The authorities consider that continued fiscal consolidation, supported by the ongoing tax reform, will also contribute to improving debt indicators. Recent policy announcements in this area include a reduction in the corporate income tax rate from 35 percent to 30 percent, a cut in the number of VAT rates from 4 to 3, as well as measures to modernize tax administration.

Staff and the authorities have also discussed other policy priorities, in particular measures to enhance labor market flexibility and to improve the business and investment climate. The Selected Issues paper offers some interesting insights and conclusions.

Finally, after completing broad consultation with stakeholders, the authorities are now in the process of finalizing their strategy for the period 2007-2016. The main objectives of this strategy are reducing unemployment to 10 percent and doubling per capita income by 2016. Staff will have the opportunity to report back to the Board on the progress in the implementation of this strategy.