Recent Economic Developments

Recent macroeconomic performance was satisfactory. Real GDP growth picked to 6.3 percent in 2007 from 5 percent in 2006, driven by massive Foreign Direct Investment (FDI) from two major mining projects that more than offset the adverse impact of the cyclones and floods on agriculture (particularly rice and vanilla). Inflation further declined to single digit to 8.2 percent at the end of 2007 from 10.9 percent one year ago, reflecting a tight monetary policy and the appreciation of the domestic currency that more than offset earlier food related price increase. Indeed, the authorities continued to implement a robust monetary policy to reign in inflation. In this context, the central bank mopped up about eighty percent of the liquidity injected and reduced budgetary financing needs. The central bank also took actions to strengthen its internal auditing system. As regards the exchange rate, central bank interventions in the market and a pick-up of imports have helped stabilize the nominal exchange rate since May 2007.

With regard to fiscal policy, the authorities undertook an adjustment in 2007 to reflect both revenue shortages and expenditure overruns stemming from the recapitalization of the BCM and the underestimation of certain expenditure (reimbursement of VAT credits, civil service pensions, and transfer to JIRAMA). Nonetheless, budget execution remained broadly on track, as lower-than projected tax revenue performance caused by weakening tax administration was offset by slower execution of expenditure and cuts in non-priority outlays to meet the program objectives. As a result, net domestic financing was below the program ceiling. On the external front, despite the widening of the current account deficit stemming from mining projects and Export Processing Zone (EPZ) imports, the overall balance of payments improved, owing to reduced external debt service and FDI inflows. As a result, the central bank has accumulated larger foreign reserves.

Performance under the PRGF remained positive. All the quantitative performance criteria were met, with the exception of the ceiling on domestic financing of the central government (end-December 2006) and the floor on tax revenue (end-June 2007). The authorities have taken corrective measures by revising upward credit for obligatory expenditure and implementing offsetting cuts in nonpriority spending, in order to keep the ceiling on domestic financing within the program objectives. They have also taken corrective steps to strengthen revenue administration, in order to meet end-January 2008 PC for the floor on tax revenue. Albeit with some minor delays, the authorities have also implemented two structural PCs related to the recapitalization of the central bank and the issuance (end-March) and the issuance of quarterly commitment ceilings. As planned, the authorities have raised water and electricity prices by 15 percent in October 2007. But given the time and consensus needed to implement some structural reforms, they have requested postponing four benchmarks on trade policy, public financial management and electricity sector reform from 2007 to 2008. In order to avoid any recurrence of misreporting on the absence of waivers of the established procedures for the import, clearance and valuation of goods, the authorities commissioned an independent audit of import operations by a private international accounting firm and have started to implement seven distinct corrective measures designed in close cooperation with the Fund’s staff to strengthen revenue collection by the Customs Administration. In addition, the government is committed to discuss the results of the audit with staff on the occasion of the next program review with a view to agreeing on further priority measures in customs administration.

Economic and financial policies for 2007–2008

The 2008 macroeconomic framework is based on the MAP priorities and aims at consolidating the progress achieved in 2007. Economic growth is projected to be 7.3 percent, owing to the impact of major mining investments on the construction sector and the strong performance of the textile sector and tourism. This will push investment to 34 percent of GDP. Despite rising international fuel prices, inflation will remain at about 8 percent, thanks to prudent monetary and fiscal policies. In this context, the authorities will focus on strengthening tax revenue, improving the quality of public expenditure, further reducing inflation, and implementing key structural reforms to foster growth.

In the fiscal area, the 2008 budget approved by parliament is closely aligned with the MAP and PRSP priorities and involves the regions closely in defining and implementing fiscal policy. The key budget priorities are to further mobilize domestic revenues, finance priority PRSP spending and strengthen Public Finance Management.

On the revenue side, the authorities are determined to pursue their efforts to modernize the tax code, with a view to increasing tax revenue and creating a growth-friendly climate. Building on FAD recommendations, the authorities have taken a number of measures to consolidate the income tax regime into a single flat tax, raise the VAT threshold, increase VAT from 18 to 20 percent and reduce the list of products subject to excise duty. My Malagasy authorities also intend to promote new legislation to eliminate the EPZ regime, while grandfathering existing EPZ firms and review the fiscal regime for mining projects with the assistance of the World Bank. These policy measures will be complemented with the continued implementation of the priority action plans to strengthen tax and customs administration of large and medium sized tax payers. To improve tax and customs administration, the authorities will abolish all “ad hoc” tax or customs duty exemptions, improve transparency and introduce a new electronic platform linking all economic agents involved in external trade.

On the expenditure side, the authorities will use the room created by increased tax revenue and external aid to increase the level of priority outlays, without incurring further domestic indebtedness. In addition to earmarking expenditure for the priority sectors, the 2008 budget also focuses on the rehabilitation of civil service retirement funds and the regularization of arrears outstanding prior to the start of the program in July 2006, as well as the payment of VAT on externally financed capital expenditure. The authorities have also put in place a reserve account to face contingency situations in the second half of the year, depending on revenue and expenditure performance.

The authorities are also determined to advance the Public Finance Management agenda, in order to improve budget execution and strengthen public finances. To this end, they intend to fully exploit the potential of the budget information system to strengthen budget preparation, monitoring and execution and further decentralize the implementation of capital spending to improve its impact on the ground. The authorities will also strengthen public finance by taking measures to eliminate the structural deficit of the pay-as-you-go civil service pension funds and further implement the Extractive Industry Transparency Initiative.

As regards monetary policy and exchange rate, my authorities will continue to adhere to a prudent policy aimed at keeping inflation in the single digits and avoiding potential overshooting of the exchange rate. Inflation has been declining and Central Bank intervention in the exchange rate market has served the country well in achieving its external objectives. In response to the surge in the demand for money caused by FDI flows and the deepening of financial intermediation, the central bank has revised upward its growth objective for base money. My authorities have seized this opportunity to build up foreign reserves, while mopping up excess liquidity through open market operations. Should monetary growth deviate from the program path, the monetary authorities are prepared to increase open market operations to maintain single digit inflation. In order to preserve the competitiveness of the Malagasy economy, the authorities have taken measures to ease pressure on the MGA to appreciate, including extending the time limit for repatriating export receipts and raising the ceiling on the foreign exchange position of credit institutions.

In the structural area, my authorities are determined to continue implementing the agenda outlined in the MAP aimed at reducing the cost of doing business and improving financial intermediation. To foster private sector development, parliament adopted a new investment law designed to secure and facilitate investment, streamline administrative procedures and improve access to commercial property. In the electricity sector, based on the daunting challenges facing the national company JIRAMA, the authorities recognize the need to make further progress. In the near term, in order to ensure a move towards financial balance, they are committed to two more 15 percent electricity price increases during 2008, subsequent implementation of an automatic pricing formula and budget transfers to finance priority rehabilitation investments. These efforts will pave the way for a more fundamental restructuring and development, which require significant financing. To meet these longer-term challenges, the authorities are working on a medium-term strategy for private sector involvement, while extending the current management team, so as to have enough time to launch a new management contract in 2009.

In the financial sector, the key reforms in 2008 consist of strengthening the financial independence of the central bank, through recapitalization, the implementation of new monetary policy instruments and the development of a cost control system. As part of the reform efforts, the authorities will also review the Central Bank’s foreign exchange management guidelines and update the central bank act to ensure consistency with requirements of the Southern African Development Community (SADC). To foster financial intermediation and economic growth, the authorities are preparing a financial sector strategy aimed at setting up a credit registry to improve the quality of financial system data, implementing a real-time payments system and stepping up supervision of financial institutions. In close consultation with the World Bank and other donors, the authorities are also contemplating the opportunity to launch new initiatives, including the possibility to establish a development bank, to set up a securities exchange and to transform the public savings institution into a bank. In all these areas, my authorities intend to proceed with caution and seek any assistance available, while respecting transparency, adequate governance mechanisms and limiting fiscal risks.

As regards trade liberalization, my authorities have stepped up efforts to phase out import duties on imports from the SADC with a view of eliminating them by 2012. They have also reached an interim agreement with the European Union (EU) that covers market access, fisheries and development issues of the Economic Partnership Agreement. Under this agreement, Madagascar will phase out 80 percent of its import duties from the EU over 15 years. The near term revenue impact of the EPA and the free trade agreement with SADC will be minimal and more than offset by the increase in VAT.

With regard to governance, the authorities are committed to fiscal transparency in managing the country’s significant oil and mineral resources. They have already taken a number of positive steps, including adhering to the Extractive Industries Transparency Initiative, and setting up a joint committee with mining companies, government representatives and civil society to prepare an action plan for enhanced transparency in the collection and allocation of revenue from mining and petroleum extraction. They are also working with the Norwegian government and other development partners to devise a scheme to avoid “Dutch disease” and intend to create a fund for future generations, with a mandate to invest a portion of the mineral resources’ revenue abroad.

Conclusion

My authorities have achieved significant progress and ownership in the implementation of policies and reforms defined in the PRGF program. Since the HIPC Completion point, they have outlined a clear strategy to align the Madagascar Action Plan (MAP) and PRSP priorities with the allocation of budgetary resources. The authorities have also taken a number of remedial measures to keep the program on track, including implementing a set of corrective measures to further protect customs revenue and launching a comprehensive independent audit by an international accounting firm to strengthen customs administration, while heightening transparency in the management of public finance and extractive industries. In light of the sound macroeconomic policy performance in 2006–07, the ambitious program for 2008, and the effective remedial actions implemented in response to the missed PCs, I would like to request completion of the second and third reviews and the granting of waivers for the nonobservance of two quantitative and three structural PCs, and modification of two continuous PCs.