Abstract
This paper discusses key findings of the Sixth Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF) for Tanzania. Economic growth, inflation, and the external position have evolved in a manner consistent with program objectives, and the program has remained broadly on track. All end-March and end-June 2006 quantitative targets were met, as were structural reforms, with the exception of delays in the energy and pension sectors. The PRGF was extended through end-2006 to permit a fuller articulation of the authorities’ policy framework, mainly in energy.
On behalf of my Tanzanian authorities, I would like to thank staff for the constructive dialogue on the sixth and final review of the PRGF, and on a three-year PSI-supported program which will form a basis for future relationship with the Fund.
It is encouraging to note that the hard work and commitment by the authorities and staff on the program, with the support of the international community, has resulted in continued robust performance of the Tanzanian economy although challenges still remain. The Tanzanian authorities are in general agreement with the assessment by staff on the overall economic developments and program implementation during the review period.
They regret that the Board discussion on Tanzania had to be postponed due to alleged impropriety in the management of the government external payment arrears (EPA) account at the Bank of Tanzania (BOT). The account was established in the mid-1990s to settle arrears incurred during the 1980s and early 1990s when foreign exchange shortages and controls prevented settlement of private sector import payments. The allegations pertain to the validity of documentation for payments made from the account during 2005/06.
My authorities would like to reiterate that the government is keen to find out the truth about the allegations and as pointed out by staff in their supplement to the report, they have fully cooperated with staff during their initial inquiry and will continue to do so in future. The government is instituting a special audit at the BOT, to be conducted by an international ISA-compliant audit firm and the terms of reference for the special audit will be agreed with staff. My authorities are committed to adopting and implementing appropriate remedial measures, which will be discussed by staff in the context of the reviews under the PSI. The government will also continue to delegate all future BOT audits to ISA-compliant auditing firms, selected competitively.
Without prejudging the outcome of the audit, my authorities believe that this is an isolated incident and do not pose reputational or safeguards risks at the BOT. The BOT has been the first institution in Tanzania to become IFRS compliant and remains so.
Performance on Quantitative and Structural Benchmarks
The PRGF-supported program has remained on track and all quantitative performance criteria and indicative targets for end-March and end-June were met. The structural reform agenda has also proceeded as envisaged in the program, except for unexpected delays in the two benchmarks relating to the pension and energy sectors. The Inter-agency Committee on financial sector reform could not submit to the Government a proposed unified legal framework and regulatory framework for pension funds and investment guidelines by end June 2006 due to difficulties in securing an expert technical advisor. A consultant has now been secured with World Bank support and has already produced an inception report, with a comprehensive work plan. The proposal will be submitted to Government by end-June 2007. The authorities have also implemented the end-December structural benchmark on developing an action plan for integrating ASYCUDA and TISCAN system based processes at the Tanzania Revenue Authority (TRA).
Economic Performance and Policy Developments
Overall, macroeconomic developments in Tanzania continued to be robust over the review period, supported by prudent economic management, strong external inflows and continued structural reforms. During the year ending December 2005, GDP grew strongly by 6.8 percent, despite a severe drought, which adversely affected agricultural production, and higher operational costs to the economy originating from high international oil prices. This was driven by strong performance in trade and tourism, manufacturing, mining and construction, which accounted for a combined total of 40 percent of the GDP. However, inflation inched upwards from 4.2 percent in June 2005 to 5 percent in December 2005, following the impact of rising oil prices and a countrywide drought, which affected food production and hydropower generation.
Recent information from authorities show that annual inflation reached 6.7 percent in December 2006, slightly above the program projection, also on account of the high oil prices. Monetary policy targets for December 2006 appear to have been broadly achieved, including Net International Reserves of the Bank of Tanzania (BOT) which appear to have been met with a comfortable margin. Reserve money target however may have been slightly missed, due to poor market demand on government paper.
Fiscal Policy
Consistent with the objectives of the MKUKUTA, the Government continued to take measures aimed at enhancing revenue and consolidating expenditure, to ensure that the budgeted fiscal deficit target for the year was attained. These measures resulted in better than programmed fiscal performance for the year ending June 2006, despite the energy crisis which led to long periods of power rationing. Revenue collection reached 14.4 percent of GDP, up from 13.3 percent in the same period last year, following efforts to improve tax administration.
Government expenditure over the fiscal year remained on track, despite pressures arising from the postponement of last year’s elections, subsidies to TANESCO, and food aid outlays to drought affected areas. Over the budget period, the government continuously re-prioritized its expenditure to match actual developments. The overall budget deficit before grants was contained at 11.6 percent of GDP, below the programmed level of 14.2 percent. Similarly, financing of the budget remained at 2.3 percent of GDP envisaged under the program, despite shortfalls in foreign financing. The authorities continued to implement measures to strengthen expenditure management, including broadening the Integrated Financial Management Information System (IFMIS) and capacity building in government Ministries, Departments and Agencies (MDAs).
Most current provisional data show that despite weaknesses in the energy sector, fiscal developments remain broadly in line with program projections. There appears to be an over performance in overall deficit, before and after grants. Similarly, net domestic financing of the government appears to be well below program projections. However, program budgetary support and exports both appear to be lower than projected. Nevertheless, net international position remains at comfortable levels, due to lower-than-projected imports and also lower-than-projected international oil prices.
Monetary Policy and Financial Sector Policies
The monetary policy stance of the Bank of Tanzania continued to be well balanced, while maintaining the primary objective of price stability. Liquidity pressures remained subdued over the period and the Treasury Bills market remained vibrant, with interest rates falling in line with the declining level of inflation. Demand for credit from the banking system remained strong, with deposit rates increasing substantially as banks tried to satisfy the increased demand for credit. The declining interest rates in the Treasury bills market have been reflected in the lowering of commercial banks’ lending rates and a consistently declining velocity for money, giving room for the growth in money supply to finance the growing level of economic activity.
In April 2006, the parliament approved key amendments to the Bank of Tanzania Act and the Banking and Financial Institutions Act. The amendments in the two laws are aimed at further strengthening the autonomy and accountability of the Central Bank, while facilitating the development of a stronger financial sector with a robust framework for corrective action. In line with this objective, the Bank of Tanzania initiated a risk-based supervision of the banking system and a prudential requirement for quarterly capital adequacy reporting.
External Sector
Developments in the external sector over the review period were highly influenced by developments in global oil prices. A sharp increase in international prices of oil, coupled with increased demand for food imports following the countrywide drought, erased the gains of higher exports recorded over the period, with consequent widening of the current account deficit. Despite a marked depreciation of the Tanzanian shilling during the year ending June 2006, and a widening of the current account deficit, gross official reserves remained strong, equivalent to about 4½ months of imports.
According to most recent provisional information, external sector developments appear to be broadly in line with projections, despite lower than projected exports and donor inflows.
Policies Under the New PSI
The Tanzanian authorities have agreed in principle, with staff recommendations on broad policies to be implemented under the PSI, given their consistency with the authorities’ medium term growth strategy, the MKUKUTA. Under the PSI, key policy objectives will be:
enhancing domestic revenue mobilization and improving the efficiency of spending to help support and better align government expenditures with key economic and poverty reduction objectives, while minimizing net domestic financing of the budget to avoid the crowding-out effect;
accelerating financial sector reforms to boost growth and increase the effectiveness of monetary policy;
improving further the business environment to stimulate private sector-led investment and growth.
Against this background, fiscal policies will continue to focus on broad based growth, while ensuring improved efficiency and composition of spending. The authorities recognize that the current level of revenue to GDP ratio is low even by regional standards and need to be elevated. This will be mainly driven by enhanced reforms in tax administration. On the expenditure side, ongoing efforts to improve expenditure planning and management capacity will be enhanced. The authorities intend to improve their spending by better aligning poverty spending with growth-promoting spending, including gradual increase in the share of development spending to improve infrastructure, which has been a growth bottleneck for a long time. In this regard, they will use the MDRI proceeds for top priority growth critical economic projects and pro-poor outlays. Therefore, all development partners need to complement these efforts by ensuring that all development assistance is channeled through the budget, in line with commitments under the Joint Assistance Strategy (JAS). Meanwhile, the authorities will continue to consolidate their efforts to gradually reduce Tanzania’s dependence on aid, through policies that will promote economic diversification, while enhancing structural reforms to mobilize and efficiently use domestic resources.
Monetary policy will continue to focus on sustaining price stability, while at the same time, facilitating an increased flow of credit to the productive sector. The Bank of Tanzania intends to sharpen its liquidity forecasting framework to ensure that it becomes more efficient in determining the correct level of liquidity in the economy. To facilitate credit growth, the central bank will ensure that the established credit guarantee schemes continue to facilitate an efficient and effective flow of credit to the economy. In the meantime, efforts to operationalize the envisaged Development Finance Guarantee Facility (DFGF) will be enhanced. Financial sector reforms will be stepped up in the context of the Financial Sector Implementation Action Plan (FSIAP), to which development partners have generously pledged their support.
Risks and Challenges
The Tanzanian authorities recognize that there are many downside risks to the attainment of the PSI objectives. They understand that despite the successful completion of the PRGF, the reform effort must be strengthened and deepened under the PSI, while consolidating macroeconomic stability and significantly addressing poverty. The energy crisis is a major constraint to growth and poverty reduction. The authorities have finalized the preparation of a Power Sector Reform Strategy, which aims at addressing medium and long term inadequacies in the sector and will be discussed by the Cabinet soon.
In December 2006, the government appointed a former BOT Governor to head the power utility company. The new CEO is expected to announce his senior management team soon. The Financial Recovery Plan (FRP) for TANESCO, which was a benchmark for December 2006, has been finalized and approved by the government. The first 6 percent increase in electricity tariffs was approved in January 2007 and will be implemented in February, 2007. Now that the FRP for TANESCO has been approved, the team will be aiming at substantially expanding investment on energy generation capacity and improving transmission, while substantially bringing the electricity power company back to profitability. It is encouraging that power rationing in Tanzania has now ended, following good rains received over the last few months, which facilitated stepped-up electricity generation from all hydro plants. Efforts to step up gas based generation capacity are also going on.
In tandem with the reforms in the energy sector, measures to improve the business environment will be implemented. These include the passage of a new bill that will facilitate a more efficient business climate, while creating room for voluntary registration of informal activity and improved tax compliance by informal business operators.
The government is committed to public sector reforms including improving wages for middle professional cadres, in order to attract and retain staff in critical areas of public service. The authorities are also undertaking appropriate policies to further enhance the business environment. They plan to improve vocational training to boost the level of specialized technical skills among Tanzanians and raise the quality of education to regional standards. A National Identity Card Project will also be implemented in 2006/07, which, together with other measures, will improve public security and support revenue collection.
In conclusion, I would like to reiterate that my authorities regret the circumstances leading to the postponement of the Board discussion but reaffirm their commitment to the proposed three-year macroeconomic framework and reform agenda under the PSI, which as admitted by staff, is fully feasible and internally consistent. They are confident that with the continued support of this Board and the international community, the envisaged polices for the year ahead will propel Tanzania to a higher and more sustainable growth path.