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

Madagascar is one of the poorest countries in sub-Saharan Africa, ranking 146 out of 177 on the United Nations Human Development Index. The country has one of the lowest tax revenue-to-GDP ratios in the world (10.1 percent in 2005). To address these challenges, the authorities are requesting a new three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) to support their economic program for 2006–08. Broad money growth declined sharply in 2005, but credit to the private sector was strong. The banking system is profitable and well capitalized.

Abstract

Madagascar is one of the poorest countries in sub-Saharan Africa, ranking 146 out of 177 on the United Nations Human Development Index. The country has one of the lowest tax revenue-to-GDP ratios in the world (10.1 percent in 2005). To address these challenges, the authorities are requesting a new three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) to support their economic program for 2006–08. Broad money growth declined sharply in 2005, but credit to the private sector was strong. The banking system is profitable and well capitalized.

July 21, 2006

Introduction

On behalf of my Malagasy authorities, I would like to thank management and staff for their constructive policy dialogue and candid exchanges during the series of discussions held in Antananarivo and Washington, on a new PRGF-supported program. They are also grateful to the Executive Board for its continuous support under previous Fund-supported programs, and for the debt relief provided under the HIPC Initiative and the MDRI. My authorities are of the view that their policy challenges have been well identified in the report, and call on the support of the Executive Board for a new PRGF arrangement that would help them address the difficult challenges ahead.

Madagascar has made satisfactory progress in poverty reduction, in improving macroeconomic performance, and in public expenditure management. These achievements enabled Madagascar to qualify for debt relief under the MDRI, in December 2005. The authorities remain committed to keeping external debt at a sustainable level by giving priority to seeking external financing in the form of grants and nonconcessional borrowing. The substantial resources made available under this initiative –and the HIPC Initiative before–, will help my authorities achieve faster progress towards meeting the MDGs. Efforts to strengthen public expenditure management, including through the adoption of a functional classification of the budget to better track poverty reduction expenditure will give assurances to the donor community that the MDRI resources will be used effectively. Madagascar also became the first country to qualify for U.S. assistance under the Millennium Challenge Corporation last year, based on the soundness of the country’s policies and progress in governance.

Maintaining macroeconomic stability and pursuing the necessary adjustments to address the sizable fiscal revenue shortfalls are at the center of my authorities’ policy agenda. They have also taken key steps, with the help of development partners, to tackle the structural and financial weaknesses at the public utility company (JIRAMA). The Madagascar Action Plan (MAP) –the authorities’ new PRSP–, covering the period 2007/11, will continue to address these issues while fostering stronger and more stable economic growth, founded on good governance, the promotion of pro-poor growth, and better public services, especially in the education and health sectors.

My authorities are of the view that a PRGF-supported program is an appropriate framework to help them achieve the objectives they have set in their MAP, and to promote higher and more sustainable growth levels needed to halve poverty in Madagascar, by 2015. A substantial increase in investment, both private and public, and a scaling up of financial aid in the form of grants and FDI –to avoid unsustainable debt levels in the future–, will be needed to reach the levels of growth necessary to reduce poverty more rapidly. A PRGF-supported program along with further technical assistance from the international community will also help the authorities to raise the tax revenue-to-GDP ratio to more comfortable levels, and thereby increase the financing of crucial development expenditures.

The implementation of the Fund-supported program will also help make the economy more resilient to the main risks that the economy faces, notably a further deterioration of the terms of trade and climatic shocks. Other potential shocks include the elimination of textiles quotas and the termination of the Africa Growth and Opportunity Act (AGOA), for which the authorities are requesting the activation of the Trade Integration Mechanism (TIM), in case the effects of these shocks turn out to be greater than anticipated in the program.

Macroeconomic Performance in 2005/06

In 2005, real GDP growth declined slightly to 4.6 percent. Although some sectors, notably agriculture and tourism, performed strongly, other major sectors of the economy were affected by rising oil and electricity prices. However, a substantial decline in food prices led to a fall of the consumer price index from 18.4 percent in 2005 to 14 percent in 2006. The current account deficit widened to 10.8 percent of GDP, due to the increase in world oil prices and a slowdown in exports following the termination of the Agreement on Textiles and Clothing along with the collapse of vanilla prices. Government finance was below expectations, as a result of a 12 percent shortfall in tax revenues due, in part, to difficulties in VAT collection and higher expenditure.

In the first quarter of 2006, the economy also experienced a slight slowdown, partly due to further increases in world oil prices and lower-than-expected rainfall impacting hydroelectric and agricultural production. Consequently, the government had to borrow on the domestic financial markets, which pushed interest rates higher, on treasury bills. The central bank, however, maintained a restrictive monetary policy stance during the first quarter, and inflation declined slightly compared to end-2005. To enhance the effectiveness of monetary policy, efforts are being made to strengthen coordination with the Treasury on liquidity management. In 2006, the overall deficit will stand at 5.1 percent of GDP. For the remainder of the year, the government intends to reach a real GDP growth rate of about 4.7 percent, while the average inflation should decline to 11.2 percent. The tax-to-GDP ratio should increase to 11 percent of GDP, compared to 10.1 percent in 2005. This should hold the budget deficit to no more than 0.9 percent of GDP. The current account deficit should stand at 10.5 percent with gross foreign reserves of the central bank stabilizing at 2.9 months of imports of goods and nonfactor services.

On the fiscal front, the government is committed to addressing the weaknesses in tax collection and expenditure control. In this regard, they will build on the IMF’s Fiscal Affairs Department 2003 and 2006 technical assistance recommendations to improve the collection of domestic taxes with the objective of raising the tax revenue-to-GDP ratio from 10.1 percent in 2005 to 12 percent by 2008. On the revenue side, the government will continue to expand the tax base notably by the adoption of the VAT with a single rate for both local and imported goods, while simplifying and pursuing a more coherent tax system. To this end, steps will be taken to review all existing tax and tariff exemptions and exonerations to eliminate them where necessary. In the customs area, the rates of import duties and taxes have been restructured and simplified, and customs clearance has been streamlined. In addition, no more ad hoc tax and/or tariff exemptions will be granted, outside those specified in the Customs Code, international treaties, and conventions. Efforts are also being made to achieve greater transparency and sound management of public expenditure. Also, to insure domestic debt sustainability, the government will rein in net domestic financing of the budget, in accordance with the levels agreed upon for the program. In addition, continuous adjustment of energy prices will help alleviate the impact of rising oil prices on the budget.

As regards monetary and financial policy, the central bank monetary program for the rest of 2006 will focus on attaining the targets set for inflation, and allowing for an adequate expansion of credit to the economy, sufficient to achieve the GDP growth target. The central bank will also give priority to achieving the projected foreign reserves level of 2.9 months of imports cover, and intends to only intervene in the foreign exchange market to smooth exchange rate volatility.

With regard to the external sector, the current account deficit should start to improve in 2006 (narrowing from 10.8 percent of GDP in 2005 to 10.5 percent in 2006). This will mainly result from a slowdown in imports, which should make itself felt from 2006, supported by a robust exports performance, as a result of the recent efforts to diversify exports of goods and services by expanding both traditional and nontraditional exports, as well as diversifying into new exports products (essential oils, mining products).

Efforts to increase external openness will also continue, particularly through regional integration and the implementation of an effective trade policy. In this regard, Madagascar’s recent admission to the Southern African Development Community (SADC) is expected to give investors new market opportunities, particularly in agriculture and textile.

Institutional and structural reforms will focus on the fight against corruption, the establishment of the rule of law, and bring government closer to the citizenry through civil service reform, and decentralization. Furthermore, reforms aimed at reducing government involvement and liquidating public enterprises will also continue with the financial support of development partners. Liquidation through the divestiture of assets of 22 public enterprises are scheduled in 2006/07.

The government has launched an ambitious plan to restore the profitability of the state electricity and water company JIRAMA. In April 2005, it transferred management of the company to a private enterprise under a two-year management contract. Also in 2005, it implemented two tariff increases, raising electricity prices by 76 percent. It has also contracted with financial experts to review JIRAMA’s financial situation and prepare a financial restructuring plan, which was presented at a conference of development partners held in Paris, in January 10-12, 2006. The donor community has committed to provide financial support to JIRAMA’s restructuring. The government has increased water and electricity prices by a further 20 and 15 percent, respectively, in 2006, and will increase the capital of the company by the end of the year.

Medium-Term Policy Framework (2006/08)

Over the medium-term, my authorities’ objective is to ensure macroeconomic stability while sustaining higher levels of growth and reducing the country’s vulnerability to shocks. During the period 2006/08, real GDP growth, will be initially driven by a strong increase in spending on social and economic infrastructure which is expected to boost private sector investment in the medium term. The strongest growth is expected to come from the secondary and tertiary sectors, owing to the effects of increased investment activity. The projected reduction of inflation to 6 percent during the period will be achieved through prudent fiscal and monetary policies, and expanded domestic production.

Furthermore, in accordance with the guidelines adopted in the updated PRSP and the MAP, the strategy pursued will be based on the development of key sectors such as export-oriented manufacturing, mining, tourism, and particularly agriculture, where there will be special emphasis on improving infrastructure and restoring agricultural productivity. Support for this strategy has already been obtained from financial partners, through projects and programs such as the Millennium Challenge Account (MCA) and the Integrated Growth Pole (PIC).

Fiscal consolidation will also continue over the medium-term. Accordingly, the authorities will redouble efforts to bring the budget in line with the priorities defined in the PRSP. The resources freed up by the debt relief granted under the MDRI will be allocated to priority expenditure in line with the PRSP and the MAP.

During 2006/08, the central bank will continue to implement a monetary policy aimed at controlling inflation in a flexible exchange rate environment. The central bank is committed to only intervene in the foreign exchange market to avoid excessive exchange rate volatility. In addition, the Governor of the Central Bank approved a time-bound action plan for strengthening the central bank’s control, accounting, reporting, and auditing systems, in line with the main recommendations of the March 2006 Safeguards Assessment. In addition, the authorities are committed to limit transactions between the government and the central bank to only those permitted by the Central Bank Act.

Efforts are also under way to develop the country’s financial sector and strengthen its stability to better mobilize savings and channel it into productive investments. Particular attention will also be given to reduce the cost of doing business, monitoring the soundness of the banking sector, and developing microfinance institutions.

Conclusion

Despite the macroeconomic and structural progress achieved in recent years, Madagascar remains a poor country and continues to be highly vulnerable to weather and trade-related shocks. Moreover, a very low tax revenue-to-GDP ratio has impeded the government’s ability to finance crucial development expenditure. To address the challenges they face, my authorities are determined to pursue the adjustment efforts and promote a more rapid diversification of the economy which they hope will raise growth to higher and more sustainable levels in order to meet the MDGs. Hence, they are requesting the Board’s support for a new PRGF arrangement that would help them underpin their economic policies for 2006/08.

In view of the potential adverse effects of the termination of the Agreement on Textiles and Clothing and the scheduled expiration of certain provisions of the American Growth and Opportunities Act, my authorities also call on the Board’s support for the activation of the TIM, should the impact of the end of these agreements be greater than currently anticipated.

My authorities greatly value the support they have received from the Fund over the years, under various Fund-supported programs and for the debt relief provided under the HIPC and MDRI initiatives. They are also grateful for the substantial technical assistance they have received. However, to achieve the MDGs, Madagascar will continue to require large amounts of financial resources in support of their reform efforts. Therefore, I call on the international community to scale up its financial and technical assistance to Madagascar.