Abstract
The staff report for the First Review Under the Three-Year Arrangement for the Republic of Madagascar reviews economic and financial policies. The 2007 economic program is designed to sustain growth, promote fiscal consolidation, and reduce poverty while keeping inflation to single digits and reducing the economy’s vulnerability to shocks. Central bank interventions will be limited to smoothing large variations in the exchange rate and meeting the program’s foreign reserve target. Planned spending reductions should offset any shortfall in revenues, which would allow the domestic financing target to be met.
I. Introduction
I also would like on behalf of my Malagasy authorities, thank management and staff for their support and constructive policy dialogue over the past year, which has led to the conclusion of the current PRGF-supported program. My Malagasy authorities are also grateful to the Executive Board for their continued understanding and support. They remain committed to implementing structural reforms and sound policies, in order to continue making significant progress in public expenditure management, in macroeconomic performance and in poverty reduction. This commitment has enabled them to satisfactorily implement the current PRGF-supported program in meeting all quantitative performance criteria at the end of July 2006. The structural performance criterion missed in July has since been observed and the remaining benchmark is also expected to be met by year end.
My authorities are committed to ensure that the program will remain on track through the rest of the year a part from the revenue target, due to the lower than envisaged of customs receipts as tax free export processing zone imports have been stronger than programmed. In view of such unexpected revenue shortfall, my authorities are requesting the Board’s support for waiver and a downward revision of the performance criterion on tax revenue for December 2006, together with the completion of the first review and disbursement of the second loan under the three- year arrangement under the Poverty Reduction and Growth Facility.
My Malagasy authorities are strongly committed to pursue policies and measures set out in their PRGF-supported program and the Madagascar Action Plan, in order to reach stronger and more stable economic growth, enhance good governance and promote better public services. Notably as articulated in my authorities MAP, the 2007 Budget Law will be characterized by implementation of appropriate macroeconomic and structural policies and an increase in priority spending on agriculture, education, health, infrastructure, environment and justice. My Malagasy authorities are aware that the country faces difficult development challenges, owing in particular to exogenous shocks, institutional capacity constraints and weaknesses at the public utility company (JIRAMA). To this end my authorities will continue to deepen their regional integration efforts in order to increase their export diversification and resilience of Malagasy economy. They are also committed to restoring the financial viability of JIRAMA and transferring its management to a private operator.
II. Recent developments and program performance
Despite the rise in world oil and domestic energy prices, the real GDP for 2006 is expected to reach 4.7 percent, driven mainly by strong performance in construction, tourism and commerce. The export processing zones have also performed better than expected since the multi fiber arrangement expired. Inflation declined from 13 percent in June to 10.6 percent in September 2006, thanks to the decrease in food prices and tight monetary polices. Exports of goods and services increased by 18 percent, compared to the first half of 2005 and imports rose by 10 percent during the same period, in spite of the sharp increase in world oil prices. These developments, coupled with an increase in official transfers, resulted in a sizeable reduction of the current account deficit. Foreign reserves exceeded the targets and were equivalent to 2.9 months of imports. The exchange rate, supported by a stronger than envisaged export performance, has remained competitive.
In the fiscal area, tax collection until July was strong and expenditure was below the target set out in the program. In their efforts to improve tax collection, the authorities simplified the tax system and enhanced the tax administration. In this context, monitoring and control of the taxation of large enterprises have been stepped up. The elimination of ad hoc tax and custom duty has been pursued. On the expenditure side, the authorities’ spending was below target owing to the delay in the approval by the Parliament of the revised Finance Law and the slower than expected in the execution of foreign-financed capital expenditure. As a result, domestic financing of the budget deficit was well below the program ceiling.
In December 2005, Madagascar qualified for debt relief under the MDRI. This achievement has led the World Bank and the African Development Fund, together with the Fund, to provide the country with a total MDRI relief amounting to US$2.3 billion, equivalent to 42 percent of GDP. Resources freed up by the MDRI are effectively used to fight poverty. Moreover, my authorities are undertaking needed actions to avoid accumulation of arrears and limit new foreign borrowing to concessionary loans, in order to strengthen the sustainability of the country’s foreign debt.
As regards program performance, all quantitative performance criteria for end of July have been met. The domestic financing requirement was lower than planned, owing to the increase in tax and customs receipts exceeding program targets, while expenditure were contained. In addition, the net foreign assets exceeded their target and net domestic assets stood at below their ceiling. On the other hand, all structural performance criteria have also been observed, except the parliamentary approval of the supplementary finance law. It is worth noting that the authorities ordered an audit of public administration’s VAT on capital expenditure through 2005, which was completed in September. Since July 2006, all transactions between the treasury and the central bank have been restricted to those specified in the central bank law. The information system to enhance the security of customs processing and curb frauds will be installed by the end of 2006. Along with the deployment of the information system, the authorities will complete by December 2006 an action plan and a schedule of measures in order to improve tax collection.
III. Medium-Term Policy Framework
Maintaining macroeconomic stability and pursuing the necessary structural reforms to address the challenges and weaknesses facing the economic remain at the center of my Malagasy authorities’ policy agenda. In this regard, the macroeconomic objectives set out for 2007 and 2008 are: (i) achieving a real GDP growth of 5.6 percent from 4.7 percent in 2006; (ii) bringing down inflation to 8 percent in 2007 and 6 percent in 2008; (iii) building up international reserves to cover three months of imports; (iv) keeping the fiscal deficit on a cash basis to less than 5 percent of GDP and (v) raising tax-to GDP ratio more than 10.7 percent target for 2006. My authorities are hopeful that investment will grow significantly with the implementation of structural reforms, construction and rehabilitation of infrastructure and the activation of large-scale mining and agricultural projects. Furthermore, buoyant exports, combined with a rebound of imports, including a return to normal levels of rice imports, will help stabilize the current account deficit around 10 percent of GDP.
In spite of significant progress made under the current PRGF-supported program, my Malagasy authorities are cognizant of the daunting challenges ahead and the vulnerability of Madagascar’s economy to a number of risks. They reiterate their commitment to prudent fiscal and monetary policies and sound reforms with the continued support and advice of the Fund and their development partners. They will pursue implementing their reform agenda, in order to consolidate the substantial achievements they have made so far and to promote sound and transparent management of their national resources.
Fiscal policy
The authorities will pursue reforms to improve the public financial management through (i) a tighter grip on macroeconomic management; (ii) a stronger role for the budget as an instrument for economic development; (iii) a major impact in the fight against poverty; (iv) higher-quality services to the public; (v) better use of the organic law of finance laws to enhance the effectiveness of government expenditure; (vi) better definition and use of indicators; (vii) more effective budget execution by streamlining budgetary procedures; (viii) more rigorous enforcement of budget execution and control regulations; (ix) improved monitoring of budget execution; (x) improved budget accounting and (xi) a major contribution to better governance. In the short-term, the principal fiscal policy target is to reduce net domestic financing, in order to keep domestic indebtedness sustainable. In 2007, the objective is to significantly increase tax revenue by 0.5 percent points of GDP, compared to 2006. With the full application of the Organic Law on Budget Laws, the major challenge for 2007 is for the budget to play its role as the means of implementing the Madagascar Action Plan (MAP) strategies. In addition, the authorities plan to reform the tax and customs codes, in order to make them more supportive to investment, broaden the tax base and move away from special regimes and incentives. These crucial steps will be implemented with the IMF, the World Bank and other donors’assistance.
Monetary Policy and Financial Sector Development
The authorities will continue to implement a monetary policy geared to achieving inflation target in a flexible exchange rate environment. Indeed, the authorities are aware of the need to achieve low inflation, which will help enhance confidence and facilitate sustainable growth. Therefore, indirect monetary instruments will be widely used in managing the banking sector liquidity such as the bank rate, reserve requirements and operations to inject or mop up liquidity on the money market. In addition to meeting the inflation target, the authorities will also seek to attain the foreign exchange objective, while allowing enough growth of credit to the economy, in order to sustain a strong economic growth. Moreover, to make the central bank more financially viable in line with the recommendations of the Safeguards Evaluation, the authorities will implement their action plan with technical assistance from the IMF. Regarding the financial sector development, the recommendations contained in the 2005 FSAP will be fully implemented, notably the strengthening of the financial sector supervision.
Reform of public enterprises
In this area, restoring the financial viability and operational efficiency of the national utility for power and water services (JIRAMA) will be at the center of my authorities’ efforts with the support from the World Bank and IFC. In this regard, they intend to increase the role for the private sector, including through the public-private partnerships. The authorities’ program to sell or liquidate state-owned enterprises will be pursued. This program schedules for 2006-07 the liquidation of 22 public enterprises evolving mainly in the sectors of distribution, transport and wood industry. As for the airports management company, the strategic orientation report presented by IFC on the franchising of 12 airports is under consideration. Regarding the southern rail network, a leasing option is preferred and a report on its economic and financial state is expected in 2007.
Social Policies and Poverty Reduction
My authorities are committed to improving the standard of living of the population and enhancing the economy’s competitiveness. To this end, they will continue to make special efforts in the fields of education, health and infrastructure. The resources freed up under the MDRI debt relief will be allocated to these fields in line with the PRSP and the MAP.
Trade Policy
Trade liberalization will continue through the regional integration process and the implementation of an appropriate trade policy. My authorities plan to strengthen Madagascar’s integration into the Southern African Development Community. In this respect, the majority of customs duties on products from SADC members have been eliminated. A study on economic impact of a uniform nonzero customs tariff and other options will be undertaken in 2007 with a view to enhance the regional integration.
Governance
The process of democratization has continued to solidify as Madagascar’s population went to presidential elections on December 3, 2006 as scheduled. Parliamentary, regional and municipal elections will also be held as scheduled in 2007.
Further steps in the area of governance will be further intensified in 2007 through; (i) a public opinion survey to assess the impact of the operations conducted by the Independent Anti-Corruption Bureau (BIANCO); (ii) setting up of an anticorruption unit in each ministry; (iii) stepped up enforcement measures and (iv) focusing of investigations in 2006-07 on the key economic sectors. In the Justice sector; the authorities’aim is to establish an effective and impartial judiciary system. Given the growing importance of mining and oil sectors, the authorities have decided to adhere to EITI, as it is an important step towards greater transparency and good governance. In this context, they will accelerate the implementation of their obligations under this initiative.
IV. Conclusion
My Malagasy authorities highly value the continued support and policy advice they benefited from the Fund over the past years. They are also very appreciative for the valuable technical assistance they have received. They remain committed to economical and financial reforms needed to sustain high growth and reduce poverty and achieve the MDGs. They will continue to require a strong support from the international community in their efforts to enhance macroeconomic stability, sustain competitiveness and improve the business environment for private sector-led growth. Therefore, I would like to seek the Executive Board’s support of my authorities’ reform efforts, including their request for waiver for the structural performance criterion on the issuance of revised expenditure ceilings, so that this first review under the PRGF arrangement can be completed.