Bolivia
2008 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Bolivia
Author: International Monetary Fund
Publication Date:
29 Jan 2009
eISBN:
9781451805857
ISBN:
9781451805857
Language:
English
Keywords:
ISCR; CR; government; NPV; CBB authorities; debt ratio; U.S. dollar; broad money; interest rate; real GDP; terms of trade; Public sector; Inflation; Currencies; Current account; Monetary base; Global
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This 2008 Article IV Consultation highlights that Bolivia’s overall fiscal position has improved in 2008. Booming hydrocarbon and mining exports, together with high remittance inflows, led to a record-high current account surplus and large reserve accumulation, with major pressures on monetary/exchange rate policy during the first three quarters of 2008. Executive Directors have noted that strong hydrocarbon and mining exports have continued to support Bolivia’s growth and macroeconomic performance. Directors have also emphasized the importance of well-designed structural reforms for further strengthening Bolivia’s fiscal position.

Abstract

This 2008 Article IV Consultation highlights that Bolivia’s overall fiscal position has improved in 2008. Booming hydrocarbon and mining exports, together with high remittance inflows, led to a record-high current account surplus and large reserve accumulation, with major pressures on monetary/exchange rate policy during the first three quarters of 2008. Executive Directors have noted that strong hydrocarbon and mining exports have continued to support Bolivia’s growth and macroeconomic performance. Directors have also emphasized the importance of well-designed structural reforms for further strengthening Bolivia’s fiscal position.

I. Economic and Political Setting

1. In recent years, Bolivia experienced an export boom led by the hydrocarbons and mining sectors, which supported an improvement in the growth performance and a strengthening of the external and fiscal positions, but inflation accelerated and investment remained low in the context of persistent political tensions. The rise in export prices through mid-2008 led to exceptionally high external current account surpluses and reserve accumulation. Changes in the hydrocarbons taxation regime in 2005-06 further boosted fiscal revenue, shifting the public sector accounts from deficits into substantial surpluses. External surpluses fueled demand pressures, which—combined with increases in food prices—caused inflation to rise to double digits in 2007-08. As part of its policy response, the central bank gradually allowed the Boliviano to appreciate, which contributed to a significant reduction in deposit dollarization. However, despite the predominantly positive trends, the adverse investment climate resulting from political tensions and lingering uncertainty about property rights has contributed to keep private investment rates among the lowest in the region.

2. As Bolivia’s integration with international capital markets is very limited, the current global crisis affects Bolivia mainly through declines in commodity prices and remittances. Capital inflows have been negligible for many years, except for FDI in hydrocarbons and mining, thereby largely insulating Bolivia’s financial system from the external turmoil. However, current trends in commodity prices will have a major impact on export receipts and related fiscal revenue—starting in 2009, because of the lagged response of contractual gas export prices.

3. Following a protracted period of rising political polarization, tensions have eased significantly in recent weeks. The tensions revolved around constitutional reform, and in particular around presidential re-election rules, regional autonomy, and proposed constraints to the size of private land holdings. The draft constitution passed by the national assembly in December 2007 was strongly resisted by opposition forces, which until recently impeded congressional approval of the referendum that is required for the new constitution to take effect. Following an agreement between the government and the opposition on critical issues—notably, that the president can be re-elected only once, and that the cap on land size does not affect existing holdings—such a referendum was finally approved by Congress, and is now scheduled for January 25, 2009. If the new constitution is approved, early general elections would be held in December 2009.

4. While the authorities’ macroeconomic policy actions have been broadly in line in with past Fund advice, the complex political environment has posed challenges on other fronts. Regarding macroeconomic policies, a fiscal surplus has been maintained and greater flexibility has been exercised in exchange rate policy in the face of strong appreciating pressures. On the structural front, however, a number of past Fund recommendations remain pending (as discussed in Section II).

II. Report on the Discussions

5. As the discussions took place in the context of a major slowdown of the global economy and turnaround in commodity prices, they focused on key developments in 2008 and on the policies needed to buttress the fiscal position and reduce financial sector vulnerabilities. Regarding developments in 2008, there was consensus that high rates of monetary growth had compounded the impact of food price inflation, although the authorities also emphasized exogenous factors (speculative and political) as contributors to Bolivia’s inflation developments. Regarding the outlook, sharp changes are likely to occur in the fiscal and external current accounts, both of which—according to staff projections—would shift into deficits in 2009, for the first time in several years. The discussions covered, in addition to the baseline scenario (reflecting then available WEO projections), a more adverse alternative scenario, consistent with a 25 percent lower path for oil prices relative to the baseline (somewhat more pessimistic than the current WEO projections). In the period ahead, macroeconomic policy management will benefit from Bolivia’s high level of reserves, which provides a buffer against disorderly adjustments. Moreover, fiscal measures and financial sector reforms would reduce the downside risks to the baseline medium-term scenario and enhance the economy’s resilience to adverse external shocks.

A. Developments in 2008

6. In 2008, strong hydrocarbons and mining exports has continued to support Bolivia’s growth performance as well as its fiscal and external positions. Real GDP growth has picked up to an estimated 5.9 percent (from an average of 4.7 percent in 2006-07), boosted in part by the start of production at a large mining project (Table 1). The external current account has recorded a surplus of 11 percent of GDP, and central bank reserves have risen to historical highs. The combined public sector1 has also remained in surplus, benefiting from continued high export-based revenues.

Table 1.

Bolivia: Selected Economic and Financial Indicators

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Sources: Bolivian authorities; and Fund staff estimates and projections.

For historical data, the investment-savings balance, as measured in national accounts, differs from that in the balance of payments due to adjustments in the former associated with estimations of re-exports and smuggling.

Includes nationalization costs and net lending.

Excludes reserves from the Latin American Reserve Fund (FLAR) and includes Offshore Liquidity Requirements (RAL).

Official (buying) exchange rate. For 2008, the nominal exchange rate is as of December 15, and the change in the real effective exchange rate is the year-on-year change as of October.

For 2008, as of December 15.

7. The external developments and associated partial monetization of the increase in reserves have contributed to double-digit inflation, which peaked in mid-year and has since eased somewhat. Following an increase to 17 percent in the first half of 2008, twelve-month inflation has declined and is now projected at 12 percent for the year. While the earlier increase was driven partly by food inflation, external developments generated significant demand pressures, compounding the effects of the supply shock (Box 1). The role of excess aggregate demand in the inflationary process is evidenced by increases in non-food inflation. The deceleration in recent months reflects moderation in food prices, slower monetary expansion, as reserves stabilized, a modest appreciation of Boliviano, and substantial depreciations of trading partners’ currencies.

uA01fig01

CPI Inflation Rate

(12-month percent change)

Citation: IMF Staff Country Reports 2009, 027; 10.5089/9781451805857.002.A001

uA01fig02

Median Inflation for Food and Non-Food Items

(12-month percent change)

Citation: IMF Staff Country Reports 2009, 027; 10.5089/9781451805857.002.A001

Main Inflation Drivers

Preliminary empirical evidence confirms that, while supply shocks have been critical, domestic factors have been important drivers of inflation in Bolivia.

  • A first empirical approach involved estimating a general equilibrium model with forward-looking features. Using quarterly Bolivian data for 1995Q1-2008Q1, the model incorporates an interest rate-based monetary policy rule, takes into account expectations about the future of the economy, and imposes exchange rate flexibility. Preliminary simulations suggest that about half of the variability in inflation is explained by food price shocks, and about a third is explained by domestic demand shocks (7.2 percent) and the interest rate on open market operations (26.4 percent)—a proxy for monetary policy instrument.

  • A second approach addressed the analysis of inflation using VAR’s. Under this alternative, a Bayesian VAR was estimated with the same sample, but assumed a money-based monetary policy framework—closer to Bolivia’s actual monetary regime—and used the stock of currency as the measure of money supply. Similarly, preliminary simulations yield that 22 percent of the variability in inflation is explained by changes in the currency stock, whereas domestic demand shocks contribute 7 percent. Both approaches thus suggest that domestic factors account for an important fraction of the variability of inflation.

Variance Decomposition of Inflation

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8. Bolivia’s overall fiscal position has improved in 2008, benefiting from high hydrocarbons-based revenue (Tables 2 and 3). The overall fiscal surplus is estimated to rise to 3.5 percent of GDP (from 2.6 percent of GDP in 2007), reflecting in part a strong increase in the surplus of the state energy company YPFB, which benefited from high natural gas export prices and the incorporation of activities such as refining and distribution, previously carried out by private sector enterprises.2 However, the non-hydrocarbon deficit3 has risen to an estimated 8.5 percent of GDP—reflecting, inter alia, outlays on new social programs and higher fuel subsidies. Net public debt has continued to fall, with the overall fiscal surplus reflected in rising public sector deposits at the central bank.

Table 2.

Bolivia: Operations of the Combined Public Sector

(In millions of Bolivianos)

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Sources: Bolivian authorities, and Fund staff estimates.

In 2007, university salaries was reclassified from other spending into wages and salaries.

Excludes the following hydrocarbon-related revenues: IDH, royalties, and the operating balance of YPFB.

Table 3.

Bolivia: Operations of the Combined Public Sector

(In percent of GDP)

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Sources: Bolivian authorities, and Fund staff estimates.

In 2007, university salaries was reclassified from other spending into wages and salaries.

Excludes the following hydrocarbon-related revenues: IDH, royalties, and the operating balance of YPFB.

9. Booming hydrocarbon and mining exports, together with high remittance inflows, led to a record-high current account surplus and large reserve accumulation, with major pressures on monetary/exchange rate policy during the first three quarters of 2008. In the period through September, the central bank stepped up open market operations, mainly through greater placement of indexed instruments. However, foreign exchange inflows were only partially sterilized, so that monetary expansion remained strong. Meanwhile, the authorities continued to implement small nominal upward adjustments to the exchange rate under the crawling peg regime. Since September, central bank reserves have declined somewhat, in part as a result of lower foreign exchange inflows and greater demand for foreign assets, resulting in a significant slowdown of monetary expansion. As a result, the growth rates of broad money and currency in circulation declined somewhat to, respectively, 24 percent and 35 percent for the year as a whole (Tables 4 and 5). During the last three months, the exchange rate has been stable, following about three years of gradual nominal increases. In real effective terms, the Boliviano has appreciated markedly over the past year, reflecting mainly the high inflation in Bolivia and significant currency depreciations in trading partners.

Table 4.

Bolivia: Central Bank of Bolivia 1/

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Sources: Central Bank of Bolivia; and Fund staff estimates.

Stocks and flows in foreign currency are valued at accounting exchange rates for 2004-05 and at beginning-of-period exchange rates for 2006-09.

Includes direct placements to individuals

Table 5.

Bolivia: Financial System Survey 1/2/

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Sources: Central Bank of Bolivia; and Fund staff estimates and projections.

The financial system comprises the central bank; commercial banks; nonbanks financial institutions; and the National Financial Institution of Bolivia and FONDESIF, which are state-owned second-tier banks.

Stocks and flows in foreign currency are valued at accounting exchange rates for 2004-05 and at beginning-of-period exchange rates for 2006-09.

uA01fig03

Exchange Rates

Citation: IMF Staff Country Reports 2009, 027; 10.5089/9781451805857.002.A001

uA01fig04

NIR Accumulation and Sterilization

(12-month flow s in US$ million)

Citation: IMF Staff Country Reports 2009, 027; 10.5089/9781451805857.002.A001

10. The banking system appears to be stable and liquid, although some vulnerable areas require special attention. Mainly reflecting sluggish demand in the context of political uncertainties, credit to the private sector has continued to expand at a very low pace, contributing to high levels of bank liquidity. Bank capitalization stands at 14 percent, and nonperforming loans have fallen to 5 percent of total loans. However, the level of restructured loans (about 9 percent of total loans or 40 percent of equity) still raises concerns.4 In addition, the system remains exposed to exchange-rate-induced credit risk, as loan dollarization remains high.

uA01fig05

Banks’ Liquid Assets

(In percent of total assets)

Citation: IMF Staff Country Reports 2009, 027; 10.5089/9781451805857.002.A001

B. Outlook for 2009

11. The baseline staff projections5 suggest that the negative terms of trade shock from lower energy and mining prices, as well as an expected decline in remittances, will slow GDP growth markedly in 2009—to 4 percent (from 6 percent in 2008)—while the fiscal and external current accounts would shift into small deficits. At the same time, further reductions in food prices would contribute to a decline in the twelve-month inflation rate to about 8 percent by end-2009. While the baseline scenario suggests that current fiscal/monetary policies, as well as the exchange rate level, are sustainable, Bolivia’s outlook is highly sensitive to developments in export prices, and their further weakening could give rise to significant financing needs and undermine external and fiscal sustainability. The authorities envisaged somewhat higher export prices and real GDP growth than suggested by the staff’s baseline projections, and expected that fiscal and external current account deficits could be averted.

uA01fig06

External Current Account

(In percent of GDP)

Citation: IMF Staff Country Reports 2009, 027; 10.5089/9781451805857.002.A001

uA01fig07

Fiscal Position

(In percent of GDP)

Citation: IMF Staff Country Reports 2009, 027; 10.5089/9781451805857.002.A001

1/ Before nationalization costs

Fiscal policy

12. Staff projects that the overall fiscal position would shift from a surplus of 3.5 percent of GDP in 2008 to a deficit of 0.5 percent in 2009. This would reflect a reduction in hydrocarbons-based tax revenue, a lower operating surplus of the state energy company, and higher current spending—the latter due to a catch-up increase in wages and pensions. The mission took the view that, while financing a small deficit is manageable and does not impair debt sustainability, the authorities need to target a reduction in the non-hydrocarbons deficit by about 3½ percentage points of GDP over the medium term (to about 5 percent). Under the baseline assumptions, this would imply an overall surplus in the order of 3 percent of GDP (somewhat lower than the average of the last three years). Such an adjustment would reduce dependency on volatile export-based revenue6 and lead to greater inter-generational equity in the use of hydrocarbons wealth.

uA01fig08

Impact of Changes in Oil Prices on the Fiscal Balance

Citation: IMF Staff Country Reports 2009, 027; 10.5089/9781451805857.002.A001

13. To strengthen the fiscal position, the authorities may need to consider a reduction of explicit and implicit hydrocarbons subsidies7—projected at about 1 percent and 4 percent of GDP, respectively, in 2009—while using part of the substantial resulting fiscal savings to protect vulnerable groups.8 This is particularly relevant since there is consensus that these subsidies are inefficient, give rise to smuggling, and discourage investment and energy conservation. The authorities are keenly aware of these distortions and of their fiscal cost, and are considering policies to address them. The mission also recommended wage and pension restraint9 and a rigorous prioritization of investment projects.

Structural Fiscal Issues

The authorities concurred with the thrust of the mission’s recommendations on fiscal reform. However, they indicated that progress was likely to be limited until the ongoing constitutional reform process is completed.

  • Tax reform. There is a need for measures aimed at simplifying the tax system and improving its efficiency and equity. In line with previous IMF technical assistance, the mission recommended eliminating the transactions tax and the complementary tax to the VAT (RC-IVA). The associated revenue loss (about 2½ percent of GDP) could be more than offset by an increase in the VAT rate (currently 13 percent), the closing of loopholes in the corporate income tax, and the transfer of special regime (such as simplified regimes for small taxpayers and free trade zone regimes) taxpayers to the regular tax regime. Appropriate turnover thresholds would need to be added to the VAT and the corporate income tax, below which taxpayers would be exempt from the VAT and liable to presumptive taxation only under the corporate income tax.

  • Intergovernmental relations. Also in line with previous Fund technical assistance recommendations, the mission emphasized the need to better balance expenditure allocations and resources available at each level of government, rationalize the transfer system, and strengthen controls over sub national borrowing.

  • Budget process. Adoption of the draft Budget Framework Law prepared in 2005 would contribute importantly to strengthening the budget process.

Monetary and exchange rate policy

14. The mission argued for a more active monetary policy to reinforce the downward trend in inflation. While lower food prices will facilitate progress towards price stability, inflation is still high, and real interest rates remain negative on non-indexed central bank instruments. The mission recommended conducting open market operations in a way consistent with bringing about higher interest rates on non-indexed bonds, which would not only have an impact on inflation but also reduce the incentives for dollarization and indexation.10 While accepting the thrust of the staff’s views, the authorities argued that supply-side factors (such as speculation and road blockades) had played a key role in fueling inflation, and that their reversal would also contribute to the disinflation process.

15. The external current account, which has recorded large surpluses over the last three years, is projected to move into a deficit of 0.5 percent of GDP in 2009 (Table 6). The value of exports is projected to decline by 23 percent in 2009, to US$4.7 billion, reflecting mainly lower export prices. In addition, manufactured exports to the United States will be affected by the recent suspension of trade preferences under the Andean Trade Promotion and Drug Eradication Act (ATPDEA), and remittances are projected to decline by about 10 percent, reflecting recessionary conditions in developed countries. Nonetheless, the overall balance of payments will remain in surplus as continued FDI would more than cover the current account deficit.

Table 6.

Bolivia: Balance of Payments

(In millions of U.S. dollars, unless otherwise indicated)

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Sources: Central Bank of Bolivia; and Fund staff estimates and projections.

Excluding reexports.

In 2006, includes effect of MDRI debt relief from the IMF and the World Bank equivalent to US$ 1,804.3 million. In 2007 includes equivalent to US$ 1,099 million.

16. Against this background, the mission discussed with the authorities the appropriateness of Bolivia’s exchange rate level and degree of flexibility of its exchange rate regime.11 While the Boliviano is mildly overvalued according to CGER estimates (Box 3), it would appear to be broadly appropriate given the high degree of uncertainty associated with such estimates. Regarding the exchange rate regime, the mission noted that the inflationary pressures associated with large reserve accumulation prior to the decline in export prices had underscored the need for greater exchange rate flexibility, which could be in the form of greater and/or more frequent adjustments under the exiting crawling peg. Looking forward, such flexibility would help absorb negative external shocks, like further declines in commodity prices, while intervention in the foreign exchange market could be used to forestall disruptive exchange rate adjustments.

Alternative scenario

17. In anticipation of downward revisions to the WEO oil baseline, the mission developed an alternative scenario in which oil prices are 25 percent lower than in the baseline (Table 7). In such a scenario—which has become more relevant given downward revisions to the WEO baseline since the discussions—, both the external current account and the overall fiscal balance would record significant deficits in 2009 (respectively, 4.3 percent and 2.8 percent of GDP). There was consensus that, in the event of a further deterioration in exports and related fiscal revenue, the first line of defense in the policy adjustment would be on the fiscal front. Specifically, the authorities indicated that, if oil prices were to display a sustained gap vis-à-vis the baseline path, they would compensate for lower revenue through cuts in government capital expenditure—where they see scope for streamlining while preserving critical investments and social spending. Staff concurred with such an approach.

Table 7.

Bolivia: Alternative Medium-Term Scenario 1/

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Sources: Bolivian authorities; and Fund staff estimates and projections.

Reflects a 25 percent reduction in oil prices relative to the baseline.

Includes nationalization costs and net lending.

Excludes reserves from the Latin American Reserve Fund (FLAR) and includes Offshore Liquidity Requirements (RAL).