Staff Report for the 2006 Article IV Consultation, Review of Developments Under the 2005 Staff-Monitored Program, and New Staff-Monitored Program for 2006
Author: International Monetary Fund
Publication Date:
21 Aug 2006
eISBN:
9781451815801
Language:
English
Keywords:
ISCR; CR; government; consultation; government policy; government program; U.S. dollar; retail price; debt relief; private sector
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Despite abundant natural resources and arable land, Guinea-Bissau is ranked at the lowest end of the UN human development index, mainly because of the civil war of 1998–99 and the ensuing prolonged political instability and serious governance deficiencies thereafter. Since mid-2004, Guinea-Bissau has made a major effort to address the political and economic problems of recent years. The fiscal balance improved, but cash flow problems persisted throughout 2005. Higher imports and strengthened tax and customs administration helped buoy tax revenue.

Abstract

Despite abundant natural resources and arable land, Guinea-Bissau is ranked at the lowest end of the UN human development index, mainly because of the civil war of 1998–99 and the ensuing prolonged political instability and serious governance deficiencies thereafter. Since mid-2004, Guinea-Bissau has made a major effort to address the political and economic problems of recent years. The fiscal balance improved, but cash flow problems persisted throughout 2005. Higher imports and strengthened tax and customs administration helped buoy tax revenue.

I. Introduction

1. Despite abundant natural resources and arable land, Guinea-Bissau is ranked at the lowest end of the UN human development index, mainly because of the civil war of 1998-99 and the ensuing prolonged political instability and serious governance deficiencies thereafter.1 These have led to considerable deterioration in the economy’s infrastructure and the living standards of the population, from which the country is trying to recover. The small industrial sector was virtually destroyed, leaving an economy heavily dependent on the cashew sector. After the conflict, real per capita GDP declined by an annual average of 2 percent until 2005 and the delivery of basic social services (potable water, hospital supplies, education) deteriorated sharply. The post-conflict strategy, which was based on an economic program supported by the Poverty Reduction and Growth Facility (PRGF) and interim debt relief from the Initiative for Heavily Indebted Poor Countries (HIPC), began to unravel because the political situation failed to stabilize. The precarious situation called for deep reforms to reverse the downward trend, but institutions and technical capacity remained weak. Government failure to enact sound policies resulted in mounting wage arrears that led to a bloodless military coup in September 2003.2

2. Since mid-2004 Guinea-Bissau has made a major effort to address the political and economic problems of recent years. After parliamentary elections in March 2004 and presidential elections in July 2005, the government began to rebuild the administration and address the country’s economic problems. The political tensions ignited by President Veira’s decision in November 2005 to dismiss the majority PAIGC government eased considerably after the Supreme Court ruled that the nomination of the new government was constitutional. Parliament’s subsequent approval of the government program and 2006 budget are signs of a broad consensus for political stability and reform. This consensus emerged with the agreement by all political parties to put the national interest above short-term political considerations, following international mediation from the regional institutions (ECOWAS, WAEMU, WADB) in February 2006. The majority PAIGC party signed on the government’s program because it features most of the reform policies envisaged by the previous PAIGC government.

3. During the 2006 Article IV consultation discussions, the mission also reviewed the country’s performance under the 2005 staff-monitored program (SMP) and reached understandings on a new SMP for April-December 2006.34 The new SMP aims to stabilize the macroeconomic situation by strengthening the fiscal position and pave the way for a program that could be supported by emergency post-conflict assistance (EPCA) as part of a concerted international effort. It should also enable the authorities to build a track record of policy performance, which is needed for consideration of a new PRGF-supported program and eventual debt relief.

II. Recent Developments and Performance under the Staff-Monitored Program for April-December 2005

4. Amid signs of a return to political stability, the economic and financial situation has shown some improvement, although serious difficulties remain. Economic activity in 2005 was stronger than expected. Real GDP growth is estimated to have recovered from an average of 0.5 percent for 2003-04 to 3.5 percent in 2005; it was driven by a good agricultural performance, though activity in other sectors was sluggish. Thus, for the first time since 2001, GDP per capita increased slightly (Table 1). Average consumer price inflation rose to 3.4 percent from 0.8 percent in 2004 as a result of higher import prices (oil and rice) in the first half of the year. Good cereal production later dampened inflationary pressures somewhat and 12-month inflation declined to 1 percent by December 2005.

Table 1.

Guinea-Bissau: Selected Economic and Financial Indicators, 2001-06

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Sources: Guinea-Bissau authorities, and IMF staff estimates and projections.

Based on government budget for 2006.

Projections based on population growth of 2.5 percent per year.

There is a break in the series in July 2002, when Guinea-Bissau adopted a new harmonized CPI index.

In 2004, domestic revenue includes CFAF 2,342 million in payments to Guinea-Bissau soldiers participating in the UN Liberia peacekeeping mission. The same amount is recorded in current expenditure under salaries.

In 2004 and 2005, includes CFAF 3.4 billion for legislative elections and CFAF 1.6 billion for presidential elections.

Change in percent of beginning-of-period stock of broad money.

In 2003, the BCEAO corrected its estimate of currency in circulation resulting in a large drop of base money.

Table 2.

Guinea-Bissau: Central Government Operations, 2001-07

(In billions of CFA francs)

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Sources: Guinea-Bissau authorities, and IMF staff estimates and projections.

In 2004, domestic revenue includes an amount of CFAF 2,342 million representing payment to Guinea-Bissau soldiers for services toward the peacekeeping mission in Liberia. The same is recorded in current expenditure under salaries.

In 2004, includes an amount of CFAF 3.4 billion in donor funding for legislative elections.

Demobilization, reinsertion, and reintegration program DRRP).

Defined as revenue (excluding grants) minus primary current expenditure, minus domestically financed capital expenditure.

Table 3.

Guinea-Bissau: Monetary Survey, 2001-06

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Sources: Central Bank of West African States (BCEAO); and IMF staff estimates and projections.

In 2003, the BCEAO revised its estimate of currency in circulation, broad money, and net foreign assets. The mission will check these figures.

Based on government budget for 2006.

Table 4.

Guinea-Bissau: Balance of Payments, 2001-09

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Sources: BCEAO; and IMF staff estimates and projections.

Based on staff proposal for 2006

Including food aid and technical assistance to projects

In 2004, includes CFAF 2,342 million for remuneration to Guinea-Bissau soldiers for participation in the UN peace keeping mission in Liberia.

Does not exclude fishing licenses.

A drop in the level of net foreign assets in 2003 reflects a change in the methodology for the calculation of this series BCEAO applied for 2003 and afterward. The counterpart of this break in the net foreign assets series in 2003 is included under errors and omissions. The mission will discuss these changes with the authorities.

Table 5.

Guinea-Bissau: Obligations to the Fund 2006-10

(As of April 30, 2006)

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Sources: IMF, Finance Department (FIN); and IMF staff estimates and projections.

EPCA (from General Resources Account) already payed off in 2005.

Based on World Economic outlook projections for SDR per US dollar.

5. Notwithstanding the strong growth in exports, the external current account worsened in 2005 because of a large increase in imports and a drop in official transfers and private remittances (Figure 1). Earnings from cashews, the main export crop, were boosted by a substantial increase in world prices as well as a further expansion in production (which was modest, however, after the strong increase of previous years).5 Imports grew significantly, driven partly by a recovery in domestic demand fueled by rising income from strong export earnings. Current transfers fell, reflecting a substantial decline in external budget support together with lower fishing license revenues. The deficit in the balance of payments, which widened slightly, was financed mainly through debt relief and the accumulation of arrears.

Figure 1.
Figure 1.

Guinea-Bissau: Real GDP and Cashew Nut Production, 2000-05

(Annual percentage change)

Citation: IMF Staff Country Reports 2006, 312; 10.5089/9781451815801.002.A001

Sources: Guinea-Bissau authorities; and IMF staff estimates.
Figure 2.
Figure 2.

Guinea-Bissau: Current Account Balance and Grants, 2001-06

(As a percentage of GDP)

Citation: IMF Staff Country Reports 2006, 312; 10.5089/9781451815801.002.A001

Sources: Guinea-Bissau authorities; and IMF staff estimates.

6. In spite of the strong appreciation of the euro against the U.S. dollar over the last five years, the real effective exchange rate (REER) did not change significantly. The REER has appreciated by only 2.9 percent since 2000 as average inflation remained below that of Guinea-Bissau’s trading partners.

Figure 3.
Figure 3.

Guinea-Bissau: Effective Exchange Rates, January 2000 - February 2006

(Index, 2000 = 100)

Citation: IMF Staff Country Reports 2006, 312; 10.5089/9781451815801.002.A001

Sources: Guinea-Bissau authorities; and IMF, Information Notice System.

7. The fiscal balance improved, but cash flow problems persisted throughout 2005. The budget deficit (including grants) was lower than programmed at 12 percent of GDP, compared to 15 percent in 2004, owing to stronger-than-projected tax revenues and lower nonwage expenditures. The domestic primary fiscal balance on a commitment basis (a program indicator) improved from a deficit of 7.6 percent of GDP in 2004 to 6.9 percent of GDP in 2005. Nevertheless, cash flow problems persisted, as evidenced by the accumulation of CFAF 4.2 billion (2.6 percent of GDP) in new domestic arrears. Budget support from the World Bank and EU that was expected during the second half of 2005 was delayed as a result of the political uncertainty following the presidential election; the government therefore contracted commercial debt amounting to 6.3 percent of GDP, which allowed it to clear part of the new domestic arrears in 2005.6

Figure 4.
Figure 4.

Guinea-Bissau: Fiscal Indicators, 2000-06

(As a percentage of GDP)

Citation: IMF Staff Country Reports 2006, 312; 10.5089/9781451815801.002.A001

Sources: Guinea-Bissau authorities; and IMF staff estimates and projections.

8. Higher imports and strengthened tax and customs administration helped buoy tax revenue. Custom receipts were boosted by the large increase of imports—which rose by 43 percent in U.S. dollar terms—and an improvement in customs administration through the verification of imports shipped by land at the destination instead of the border, and the required prepayment of export taxes before shipment. Tax administration was also strengthened through the creation of a Large-Taxpayers Unit with assistance from AFRITAC, and the simplification of the tax regime.

9. Budget execution improved. Authorization for expenditure commitments was centralized at the Ministry of Finance and government bank accounts that were not at the BCEAO were closed. To maintain better fiscal control, a Treasury Committee was appointed to reconcile accounts between the Budget Department, the Treasury, and the BCEAO. Still, there were some spending slippages, due in part to overruns on the wage bill, which exceeded program target by CFAF 1.9 billion.

10. Guinea-Bissau’s financial system is very thin, but the recent opening of two new regional banks in December 2005 and early 2006 augurs well for the growth of the domestic banking sector. Formal financial intermediation was very limited during 2005 even by regional standards.7 Money in circulation is by far the main financial asset, reflecting a preference for cash. Total deposits in 2005 amounted to only 8 percent of GDP. Although the local bank has been increasing its financing of the cashew harvest, average outstanding claims to the private sector during 2005 did not exceed 2.2 percent of GDP; average credit to the government amounted to the equivalent of 1.3 percent of GDP. As elsewhere in the region, the bank is very liquid. The lack of profitable projects has left it with excess reserves that can be used to manage seasonal needs of the private sector or the government. The BCEAO has been concerned about the lack of financial intermediation and is trying to encourage regional banks to operate in Guinea-Bissau. A regional policy bank focused on microfinance opened a branch in Bissau in 2005.

Figure 5.
Figure 5.

Guinea-Bissau: Recent Monetary Developments, 1995-2005

(Average)

Citation: IMF Staff Country Reports 2006, 312; 10.5089/9781451815801.002.A001

Sources: Banque Centrale des Etats de l’Afrique de l’Ouest (BCEAO).

11. Guinea-Bissau’s external debt is clearly unsustainable and can only be resolved through the HIPC Initiative. After most interim debt relief was suspended, external debt service obligations, except those to multilateral creditors, fell into arrears. Total external public debt including arrears amounted to 332 percent of GDP in 2005; scheduled annual external debt service was about 15.3 percent of GDP (Tables 6-7).

Table 6.

Guinea-Bissau: External Debt Outstanding, 2004-10 1

(Millions of U.S. dollars)

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Sources: Guinea-Bissau authorities; IMF and staff estimates and projections.

Estimates are based on incomplete and unreconciled data provided by the Guinea-Bissau authorities and on IMF and WB staff estimates and projections.

Table 7.

Guinea-Bissau: External Arrears Outstanding, 2004-10 1

(Millions of U.S. dollars)

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Sources: Guinea-Bissau authorities; and IMF staff estimates and projections

Estimates are based on incomplete and unreconciled data provided by the Guinea-Bissau authorities and on IMF and WB staff estimates and projections