2008 Article IV Consultation and Request for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility: Staff Report; Staff Statement; Public Information Notice and Press Release on the Executive Board Discussion; and Statement by the Executive Director for Djibouti

This 2008 Article IV Consultation highlights that Djibouti’s macroeconomic performance improved significantly, but inflation pressures are intensifying. Real GDP growth accelerated to 5.3 percent in 2007, driven mainly by foreign direct investment concentrated in the construction and port services. Executive Directors have welcomed Djibouti’s strong economic growth driven by large foreign direct investments in the port and other key sectors of the economy. Directors have also emphasized the importance of maintaining the fiscal consolidation objective, with a view to controlling inflation and creating fiscal space to finance the poverty reduction strategy.


This 2008 Article IV Consultation highlights that Djibouti’s macroeconomic performance improved significantly, but inflation pressures are intensifying. Real GDP growth accelerated to 5.3 percent in 2007, driven mainly by foreign direct investment concentrated in the construction and port services. Executive Directors have welcomed Djibouti’s strong economic growth driven by large foreign direct investments in the port and other key sectors of the economy. Directors have also emphasized the importance of maintaining the fiscal consolidation objective, with a view to controlling inflation and creating fiscal space to finance the poverty reduction strategy.

I. Background

1. The political situation remains stable, despite renewed tension at the border with Eritrea. President Guelleh was reelected in 2005 for a second six-year term. The ruling party’s coalition won all seats in the February 2008 parliamentary elections as the opposition boycotted the polls. The prime minister and the minister of finance were reappointed to the new cabinet formed in March 2008. Renewed stress in the relations with Eritrea resulted in troop deployments and, in June 2008, border clashes resulting in several casualties. Nevertheless, the risk of escalation appears limited and a prompt and peaceful resolution is likely.

2. The 2008 Article IV consultation and program discussions were held against the backdrop of growing economic activity and improved prospects following large inflows of foreign direct investment (FDI). Djibouti’s political stability and strategic location on the horn of Africa along major shipping routes attracted about US$360 million of investments in the port construction and related infrastructure over the period 2006-07, transforming Djibouti into a nascent regional trade and financial hub. The challenge is to ensure that growth does not remain limited to an enclave around the port. So far, the highly capital-intensive FDI projects have provided only limited employment opportunities and the development of an export sector is hampered by the high domestic cost of inputs.

3.The authorities have elaborated a new poverty reduction strategy (PRS) and are requesting a new Poverty Reduction and Growth Facility (PRGF) arrangement to support it. The new PRS is critical for anchoring the reform program and unlocking donor support, spreading the benefits of growth by encouraging private sector development. A detailed account of the PRS is contained in the new Poverty Reduction Strategy Paper (PRSP) prepared with the assistance of World Bank and IMF staff, which has been published on the website of the Ministry of Finance (MoF).1 A new Fund-supported program would lend credibility to the PRS, anchor it in a stable macroeconomic framework, help expand the institutional and technical capacity for its implementation, and help close the financing gap exacerbated by the food and oil price shocks. To mobilize the support of their development partners, the authorities intend to hold a donors’ conference in November 2008. Limited available data indicates that progress toward achieving the Millennium Development Goals (MDG) remains limited, notwithstanding the advances made in improving education, reducing child mortality, and developing a comprehensive national strategy to combat HIV/AIDS and other diseases.

Figure 1.
Figure 1.

Djibouti: Selected Economic and Financial Developments

Citation: IMF Staff Country Reports 2009, 216; 10.5089/9781451810714.002.A001

1/ Sub-Saharan Africa excluding South Africa and oil-exporting SSA economies.

4. Since 1990, Djibouti has had two Fund-supported programs and two staff-monitored programs (SMPs). Under the 1996-99 Stand-By Arrangement, progress was made in reducing macroeconomic imbalances. Under the 1999-2002 PRGF, tax and pension reforms advanced, but progress was limited in adopting structural reforms to improve external competitiveness. Only one review was completed under the one-year SMP in 2004 as the government was unable to maintain fiscal discipline or implement the reform agenda against the backdrop of a presidential election period. Quantitative fiscal targets under the July-December 2005 SMP were largely met, and all key structural benchmarks have now been met.

II. Recent Economic Developments

5. Macroeconomic performance improved significantly, but inflationary pressure is intensifying. Despite a substantial acceleration of economic growth, Djibouti still lags behind the average of sub-Saharan Africa (SSA). Real GDP growth accelerated from 4.8 percent in 2006 to 5.3 percent in 2007 (Table 1), driven mainly by FDI concentrated in the construction and port services sectors. The share of investment in GDP grew from 23 percent in 2005 to about 42 percent in 2007 (of which slightly more than half is in the form of FDI). This rapid expansion, combined with the surge in food and oil import prices, pushed inflation from 3.5 percent in 2006 to 13.9 percent year-on-year in June 2008. In response, the authorities have eliminated consumption taxes on five basic food items, and reached agreement with importers and retailers to cap their profit margins on these and other basic items.

Djibouti and Sub-Saharan Africa (SSA): Selected Economic Indicators 1/

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Sources: National authorities; and Fund staff estimates.

SSA: Sub-Saharan Africa excluding South Africa, Zimbabwe, and oil-exporting SSA countries.

6. Fiscal policy remained expansionary. The overall deficit remained at about 2.5 percent of GDP in 2007, even as the basic fiscal deficit (which excludes externally financed revenue and expenditure) narrowed from 7.2 percent in 2006 to 4.9 percent in 2007 (Table 2). Tax revenue declined by about 1 percent of GDP, as a result of tax exemptions granted to new investments and sluggish job creation. This decline was offset by an exceptional collection of overdue taxes, largely from the Electricity Company (EDD). Current expenditure declined from 30 percent of GDP in 2006 to about 26.5 percent in 2007, reflecting the non-recurrence of extraordinary outlays in 2006 associated with the regional elections and the Common Market for Eastern and Southern Africa (COMESA) summit. Thus, the slight rise in the overall deficit in 2007 is explained by the large increase (3.7 percent of GDP) in public investment. Most non-Paris Club government external arrears outstanding at end-2006 have been repaid, but the transitory accumulation of new arrears to multilateral official creditors led to disbursement delays of some loans.2 Preliminary information indicates that new external arrears, including with multilateral official creditors, have accumulated during the first half of 2008. External public and publicly guaranteed debt remained at about 60 percent of GDP.

7. After remaining stagnant for several years, credit to the private sector increased by 23 percent in 2007 (Table 4), owing in part to a real estate and construction boom and competition from recently established foreign banks. Broad money growth slowed down to 9.6 percent as the surge in credit was compensated by a lower accumulation of banks’ foreign assets. Banking soundness ratios remain well above regulatory requirements. The capital adequacy ratio fell from 17.4 to 8.1 percent at end-2007 ( Table 11), reflecting the entrance of three new banks. Asset quality has improved through the reduction of nonperforming loans and the increase in the loan portfolio. Profitability remained high, despite increased competition. Greater confidence in the currency board and in the banking system has also led to a decrease in dollarization from 52.4 percent of total bank liabilities in 2006 to 51.4 percent in 2007, reducing financial vulnerability. The arrival of three new foreign banks in 2006-07, increasing the number of institutions from two to five, has fostered competition by reducing interest rate spreads and increasing the range of financial instruments (Box 1).

Djibouti: Selected Banking Sector Indicators

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

Reform of the Financial Sector

Djibouti’s financial system is dominated by a banking sector characterized, until recently, by a very narrow focus on short-term trade operations, that did not provide an adequate basis for the development of the private sector. As a consequence, financial intermediation remains weak as reflected in the relatively low level of credit to the private sector as a percent of GDP. High market concentration (two banks account for 95 percent of the country’s total assets), weak enforcement of creditor rights, and the absence of comprehensive information on borrowers, keep lending risks high.

Djibouti: Comparative Banking Sector Performance

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Source: International Financial Statistics (IMF).

Lending minus deposit rates (percent per annum).

Broad money is likely to include unquantified non-resident deposits.

The entrance of three new banks in the past two years, however, has increased competition among banks, resulting in lower intermediation spreads and new banking services. The authorities are closely working with banks to expand their range of financial products and services (such as automated teller machines, Islamic products, and products for small and medium-size enterprises). A shift has already occurred away from short-term foreign trade financing instruments to the incipient development of a mortgage market, linked to the recent real estate and construction boom. This renewed competition largely accounts for the 10 percent annual growth in deposits at end-2007, prompted by the authorities’ efforts to increase bancarization by reaching new customers via innovative products, and to attract depositors from neighboring countries to develop a regional financial hub.

New Banks Operational as of 2007 or to Start Operations in 2008

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The banking system’s growing size and range of instruments has also raised the bar for the Central Bank of Djibouti’s (CBD) regulatory and supervisory resources and standards. In the coming months, the number of banks expected to operate in Djibouti will increase to eight, with very diverse capital origins and regulatory structures. Furthermore, unlike the previous situation, in which the CBD could entrust the supervisory authorities from the parent institution (France) to oversee the global operations of the only two financial groups operating in the country, some of the new institutions do not have strong home supervisory and regulatory agencies.

The microfinance sector remains at an embryonic stage. The Poverty Reduction Strategy (PRS) places great emphasis on building the capacity of micro-credit associations, to be transformed into genuine microfinance institutions (MFIs). The MFIs are expected to develop a range of new services including micro-insurance and micro-transfers, which will significantly boost household access to microfinance (currently only 4 percent of the population benefits from microcredit).

Figure 2.
Figure 2.

Djibouti: Competitiveness Indicators

Djibouti: competitiveness remains poor...

Citation: IMF Staff Country Reports 2009, 216; 10.5089/9781451810714.002.A001

Sources: National authorities; and Fund staff estimates.

8. The widening current account deficit reflects mainly a surge in imports financed by foreign investment, but also the increase in food and oil prices. The external current account shifted from a small surplus in 2003 to a deficit of about 25 percent of GDP in 2007 (Table 3), but this has been more than offset by the large capital and financial account surplus, resulting in a small increase in gross official reserves to US$130 million at end-2007 (equivalent to a currency board cover of 116 percent). This increase, however, lagged behind imports, thus resulting in a reduction of the import cover to less than two months. The real effective exchange rate (REER) has depreciated by a cumulative of 24 percent in 2001-07, relative to its 2000 average, reflecting mainly the weakening of the U.S. dollar. Nevertheless, a variety of indicators suggest that competitiveness remains low. Electricity, labor, and other domestic production costs are high, while skill level is low, and the institutional environment is weak.

9. Significant progress has been made in implementing structural reforms. A new Labor Code came into force in 2006, a physical audit of the civil service was completed in 2007, the three key pending structural benchmarks of the SMP were completed (see Table 9 and a PRSP was prepared with assistance from World Bank and IMF staff. In particular, reform of the civil service has advanced with the completion of the physical audit and by the recent establishment of a single registry of civil servants. An assessment of the anti-money laundering and combating the financing of terrorism (AML/FT) system was conducted by the Fund’s Legal Department (LEG) in 2007, in the context of a forthcoming Financial Sector Assessment Program (FSAP). The authorities have started to reform the social safety system by merging two of the three pension funds in January 2008. In the area of statistics, the Fund’s Statistics Department (STA) provided technical assistance (TA) to improve balance of payments and monetary statistics, while the Fund’s Monetary and Capital Markets Department (MCM) provided TA to implement the International Financial Reporting Standards (IFRS) at the CBD.

Competitiveness: Djibouti Versus Fast Growing and Comparator Economies, 2007

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Sources: IMF World Economic Outlook and World Bank’s databases, and UNCTAD World Investment Report, 2007.

IMF staff reports and International Energy Agency, Energy Statistics, 2007 Edition.

Net secondary school enrollment rate as percent of age group.

Average of voice and accountability, political stability, government effectiveness, regulatory burden, rule of law and control of corruption. The scores lie between 0 and 100, with higher scores corresponding to better outcome.

Rank out of 178 countries. Based on starting a business, dealing with licenses, employing workers, registering property, getting credit, protecting investors, paying taxes, trading, enforcing contracts, and closing a business.

III. Policy Discussions

10. The discussions focused on three key areas: (a) debt and fiscal sustainability in a poverty reduction context; (b) financial sector issues; and (c) exchange rate alignment and the role of structural reforms to improve competitiveness and broaden economic growth. These areas, as well as issues related to strengthening institutional capacity, particularly in the area of statistics, are relevant both in the context of the Article IV consultation and the program to be supported by a PRGF arrangement.

A. Outlook and Risks

11. Short- and medium-term growth prospects remain strong, driven by a solid pipeline of large investment projects (Tables 5 and 8). These projects are part of the government’s strategy to transform Djibouti into a regional trade and services hub, and reflect the interest of international investors in the country. Based on the authorities’ medium-term policies discussed in this section (including those related to program conditionality—see Section IV.A below), the baseline scenario envisages that real GDP would increase by 5.9 percent in 2008 and by about 7 percent a year in 2009-13. Inflation is expected to be slightly above 8 percent in 2008, but would decline gradually thereafter as world food and oil prices ease. The fiscal stance would tighten substantially to reach a balanced position by 2011. After peaking at 33 percent of GDP in 2008, the current account deficit is projected to narrow gradually to about 23 percent by 2011. Since Djibouti cannot pay its external arrears and meet its financing needs, external financial assistance under the program from the Fund and donors will be essential to filling the 2008 financing gap estimated at US$37 million (2.13 percent of GDP) (Table 3). After accelerating to 35 percent in 2008 due to the low starting point, private sector credit growth will decline progressively to an average rate of about 20 percent over the medium term. While broadly agreeing with the staff’s medium-term outlook, the authorities flagged the uncertainties associated with food and oil prices.


Djibouti: Short- and Medium-Term Outlook, 2008–13

(In percent of GDP)

Citation: IMF Staff Country Reports 2009, 216; 10.5089/9781451810714.002.A001

Sources: Djibouti authorities; and Fund staff estimates.

12.The main downside risks to this outlook relate to Djibouti’s vulnerability to external economic and political shocks. Recent increases in food and oil prices have negatively impacted the country’s projected external position. The projected increase in the current account deficit will be financed only in part by projected FDI and other financial inflows, thus weakening Djibouti’s external position in the absence of additional external support. The authorities are also concerned about food security. Aside from temporary measures to limit the pass-through of international food prices to domestic consumers, the authorities are planning to diversify food imports by tapping new and less expensive external sources, and to increase domestic agricultural production by developing the rural water supply, providing credit to agriculture, and leasing agricultural land in Sudan and Ethiopia. Finally, a worsening of the security situation in Somalia or Eritrea could adversely affect Djibouti’s development prospects.

B. Fiscal Policy

13. Fiscal policy is geared toward increasing the revenue base, containing current expenditure and improving budget management, in order to release resources to finance the PRS without compromising fiscal sustainability or competitiveness. A unified and integrated tax department at the ministry of finance, including its collection enforcement unit, has greatly improved tax administration, resulting in a surge of over 300 percent in tax recovery in 2007. In addition, the authorities intend to review the overall tax framework and streamline tax exemptions to eliminate their negative effects. In order to contain current expenditure, the authorities resisted calls to increase salaries despite mounting inflationary pressures, developed a system for the centralization of public procurement, and made progress in the civil service reform. They requested TA from the Fund’s Fiscal Affairs Department (FAD) in order to strengthen their public management framework (PMF), including a reform of the budget classification system and the unification of government accounts. They also intend to strengthen fiscal transparency by increasing the range and frequency of the publication of fiscal data.

14. The authorities intend to accelerate the repayment of outstanding arrears. All outstanding external arrears will be cleared before consideration of the PRGF arrangement by the IMF Executive Board, while the repayment of domestic arrears will proceed according to the existing ten-year repayment plan. A large part of these arrears is owed to the public utilities companies, particularly to the EDD and the water and sewage company (ONEAD). Consequently, repayment of these debts will contribute to reestablishing these utilities’ financial viability, improving their competitiveness and, eventually, reducing domestic production costs. To prevent the accumulation of new arrears, the authorities intend to improve cash management and expenditure controls and rebuild the stock of government deposits.

15. The authorities plan to go ahead with the introduction of a value-added tax (VAT), despite the delay of the COMESA in reaching final agreement on the external common tariff (TEC). Progress has been made in modernizing tax administration and establishing the unified integrated tax department, a critical step to support the introduction of a VAT, with technical and financial assistance from FAD, the European Union (EU), and France. Failure to agree on all categories of the TEC in the latest COMESA summit, however, forced the authorities to change the implementation plan. Instead of introducing the TEC and VAT simultaneously, and immediately eliminating both the existing sales tax (TIC) and services tax (TPS), the VAT will be introduced starting in January 2009, coexisting with the TIC until the TEC is introduced. However, the TIC rates will be reduced to avoid a surge in the fiscal burden.

16. The fiscal restraint objective embedded in the 2008 budget was rather ambitious, particularly taking into account the negative effects of the food and oil price shocks. According to the budget, the overall fiscal deficit would be halved. The authorities are of the view that the prudent budget revenue targets remain achievable—even after the tax reductions on food products introduced in the first half of 2008 (estimated to cost about 0.5 percent of GDP), largely compensated by a World Bank grant. However, the budget expenditure targets would require a considerable containment effort, in view of the additional spending requirements posed by the PRS, the increase in the transfers to the EDD related to the increase in oil prices (estimated at about 1.2 percent of GDP as of end-May 2008 oil prices), and the increase in military expenditure associated with the border clashes with Eritrea. Therefore, the authorities have already revised their overall fiscal balance target deficit for 2008 to 1.9 percent of GDP. The authorities are confident in their ability to mobilize additional external financing in the form of budget support loans and grants for about 2.2 percent of GDP which might be needed to support the EDD and improve government liquidity, including through the catalytic effect of a PRGF arrangement.

17. The authorities concurred with the conclusions of the debt sustainability analysis carried out jointly with World Bank staff (Box 2, Appendix I), which indicates a high risk of debt distress in the short term. They agreed that, notwithstanding the improvements in the underlying economic assumptions and the resulting debt profile, important vulnerabilities remain. These include external factors such as the worsening of financial conditions, shortfalls in projected FDI flows or a deterioration in the current account as a consequence of further food and oil price increases, as well as internal reasons, such as the triggering of contingent liabilities arising from government guarantees on external debt or the failure to implement the necessary fiscal consolidation measures.

External Debt and Fiscal Sustainability

External and total government debt are estimated respectively at 59.3 percent and 62 percent of GDP in 2007, including arrears. After improving considerably in 2006 following a debt restructuring agreement with Italy, Djibouti’s debt situation remained broadly stable in 2007. Most of the external debt portion is owed to official donors (notably the World Bank and the African Development Bank), and bilateral Arab creditors. Domestic government debt includes mainly arrears to government employees and providers, and outstanding loans to banks and to the Port of Djibouti. While most external arrears correspond to bilateral Paris Club loans, some outstanding arrears towards multilateral official creditors exist as of end-June, 2008. Since Djibouti has no access to international capital markets, there is no reported outstanding external debt or arrears against external private parties. According to the authorities’ data, still to be reconciled with the creditors’, Paris Club debt amounts to about $58 million, most of it owed to Italy, with smaller amounts due to Spain and France. About one-half of this debt is in arrears. Djibouti’s debt to the Paris Club was rescheduled in May 2000 under “classic terms.” In addition, part of the debt to Italy was swapped for social projects in 2006. The authorities are expected to negotiate a multilateral agreement with the Paris Club shortly, and to follow suit with bilateral agreements under the terms set by the multilateral agreement.

The debt sustainability analysis (DSA) indicates that Djibouti—s risk of debt distress continues to be high, despite some improvement in the medium-term projections (Appendix I). The net present value (NPV) of external debt-GDP ratio remains above the sustainability threshold, in the baseline scenario, until 2017 (and occasionally thereafter), reflecting a vulnerable situation in the short term, although it improves markedly in the long term. Fiscal sustainability indicators are also projected to improve in the medium term. Revenue measures to reverse the erosion in the tax base caused by widespread exemptions, along with measures to contain current expenditure growth and the repayment of arrears, are projected to reduce the NPV of government debt from 55 percent of GDP in 2007 to about 33 percent by 2011. These ratios are projected to improve further in the long term as sustained growth, improvements in revenue collection, and a more efficient expenditure execution contain the primary deficit well below the estimated debt-stabilizing value.

The DSA illustrates the negative impact of less optimistic scenarios and negative shocks emanating from some of the major sources of vulnerability. The stress scenarios show that external sustainability remains particularly vulnerable to a worsening of external borrowing conditions, while fiscal sustainability is more sensitive to a decline in economic growth. An increase of 2 percentage points in the cost of new borrowing would cause the NPV of external debt-GDP ratio to remain well above the sustainability threshold, with an upward trend after 2020. The “high investment, low growth” scenario, which assumes a lower growth path scenario than projected in the baseline, also weakens debt sustainability, but to a lesser extent. Similarly, a temporary setback in growth in the short term could result in a much less favorable evolution of fiscal sustainability. If real GDP growth outturn in 2009 and 2010 were to be close to 1.6 percent, equivalent to its historical average less one standard deviation, the NPV of debt would eventually climb back to about 50 percent of GDP by 2028, while the debt service would increase to absorb about 20 percent of fiscal revenue.

C. Financial Sector Issues

18. The authorities shared the staff’s view on the need to introduce liquidity management instruments to mitigate the current inflationary pressures along with the gradual tightening of the fiscal stance. Unlike other countries with currency board arrangements (CBA), the CBD has made little use of liquidity management instruments to ease the current inflationary pressures. With limited domestic financial instruments and in the absence of remuneration of deposits at the CBD, banks systematically transfer excess liquidity abroad. The rapid increase in credit in 2007 was largely financed through the mobilization of these liquid reserves, thus putting additional pressure on domestic demand and prices. The development of effective mechanisms to control liquidity is important to ensuring that structural excess liquidity does not endanger macroeconomic stability, particularly in a context of rising inflationary pressures. In this regard, the authorities concurred with the staff’s recommendation to gradually introduce reserve requirements on bank deposits within the framework allowed by the Banking Law, while preserving the banking system’s profitability and financing capacity.

19. Rising inflation is a concern. In the context of a CBA, monetary policy has very limited influence on price levels. Thus, the authorities expect to partially contain the impact of higher food and oil prices on overall CPI inflation through measures such as capping wholesale and retail food distribution margins, eliminating indirect taxes on basic food products, and maintaining administered prices of electricity and other utilities. The authorities agreed with the staff that caps on margins should only be seen as a temporary emergency measure, and that over the long term efforts to contain inflation should hinge on fiscal restraint3 and on a marked-based response aimed at alleviating capacity constraints and spurring competition.

20. The authorities agreed with the staff that the CBD’s ability to oversee the financial sector needs to be strengthened (Box 1), but they did not see an immediate need to restructure the banking supervision unit. The authorities look forward to the forthcoming FSAP recommendations to provide additional guidance in this area. They intend to increase the effectiveness of their AML/CFT framework by raising awareness, strengthening the Financial Intelligence Unit (FIU), and reinforcing the legal, regulatory, and operational framework.

D. Competitiveness and Exchange Rate Policy

21. The authorities see considerable merit in maintaining the CBA. They argued that the currency board has served to enhance confidence in Djibouti’s currency and banks, and remains essential to attract new investment. The staff agrees that the CBA has contributed positively to fiscal restraint and macroeconomic stability, and that there is no compelling case for changing the exchange rate regime or its parity. Nonetheless, the recent food and oil price shocks necessitate additional external financial support to restore the gross official reserves coverage of the currency board and to maintain its credibility.

22. Although there is no evidence of a large misalignment of the Djibouti franc (Box 3), and the recent trend shows a gradual correction of its overvaluation, several other indicators suggest that competitiveness remains poor. The authorities agreed that this can be attributed primarily to the high costs of critical production factors (power, telecommunications, and labor), which continue to hamper private sector development. Reducing these costs, including by downsizing and improving the management of the two main loss-making public enterprises (ONEAD and EDD), will be essential to encouraging domestic and foreign investment, ensuring sustainable and balanced growth, and reducing the contingent liabilities that these enterprises pose for the budget. In the energy sector, the authorities aim to reduce costs and expand capacity by completing the interconnection with the Ethiopian power grid and developing alternative energy sources, including geothermal, solar, and wind power (Box 4). The authorities took note of the staff’s suggestion to explore opportunities for the outsourcing of EDD’s management to the private sector, but stressed that the successful experience with the Port of Djibouti could not be used as a guide in view of the small domestic market, weak profitability margins, and overarching social constraints that characterize the electricity sector.

23. Enhancing competitiveness also requires improving the business climate. The authorities have prepared a new code of commerce with the assistance of the EU, which will be submitted shortly to the National Assembly for approval. The final stages of the implementation of the labor code will be finished within one year, and the regulations and procedures that affect the cost of doing business will be simplified by further strengthening coordination among public sector agencies.

24. The staff stressed the urgency to address data weaknesses and low implementation capacity that severely hamper economic management in Djibouti. The authorities are working to improve the quality and timeliness of statistics on national accounts and balance of payments with the technical assistance of the Fund, the World Bank, and the United Nations Development Program (UNDP). Additional efforts are being undertaken to strengthen the poverty monitoring system and to develop a social targeting mechanism to deliver food aid. The Fund has also provided technical assistance in the areas of monetary statistics, monetary operations, banking supervision and public financial statistics.

Exchange Rate Assessment

A variety of indicators suggest that external competitiveness in Djibouti is weak, which points to an overvaluation of the Djibouti franc (DF). The staff’s exchange rate assessment confirms the existence of some overvaluation, but its quantification does not indicate that the current level of the real exchange rate is significantly out of line with fundamentals.1


Equilibrium Real Effective Exchange Rate

Citation: IMF Staff Country Reports 2009, 216; 10.5089/9781451810714.002.A001

Source: IMF staff estimate based on the CGER Methodology.

Estimates based on the equilibrium real effective exchange rate approach suggest that in 2007 the DF was slightly overvalued (in the order of 8-12 percent), which is well within the margin of error in this type of analysis. The improvement in competitiveness compared with earlier years largely reflects the weakening of the U.S. dollar, productivity gains in the port operations following new investments and the outsourcing of management to the private sector, and constrained public wage growth.

The macroeconomic balance (MB) approach indicates that the current account is close to its norm. The MB compares the projected current account deficit in 2013 of 13.8 percent of GDP (or 8.4 percent, excluding FDI-related imports) to an estimated normative equilibrium current account deficit of 12.2 percent of GDP (or 6.8 percent, excluding FDI-related imports). This implies a 7 percent overvaluation of the DF, also within the margin of error of the model.

The external sustainability (ES) approach is unsuitable in the case of Djibouti, given its rapidly changing economic structure and fast growth of FDI inflows in a context of a small country so far deprived of most natural resources and lacking an industrial productive basis. This makes it particularly difficult to estimate even an approximate sustainable equilibrium NFA position. Stabilizing the end-2007 NFA position using the Lane and Milessi-Ferretti database points to an overvaluation of 5 percent. However, it seems evident that the end-2007 NFA position is well below the equilibrium level and, therefore, the overvaluation should be above 5 percent.

Medium-term balance of payments developments and competitiveness reforms are expected to continue reducing the DF’s overvaluation, although risks remain and the process could be protracted. Short-term developments—including Djibouti’s vulnerability to external shocks and dependence on imports, its relatively high debt burden (and lack of debt instruments or access to financial markets), high unit labor costs, and weak NFA position (including in 2007)—point to an overvaluation of the DF. However, medium-term projections point to a self-correction of the DF’s overvaluation. Export growth is projected to outpace that of imports due to new productive capacity created by the massive FDI-financed projects, the progressive decline in FDI-related imports and the substitution of imported products by local production. Also, food and oil prices are projected to ease from the peaks of 2008. However, decisive action to increase competitiveness, particularly to reduce Djibouti’s high unit labor costs to a level in line with neighboring and competing countries, along with fiscal tightening (including through lower public sector labor costs) and structural reforms to reduce other production costs (particularly utilities), is indispensable to narrow the current account deficit in the medium term.

Only one (high debt risk level) out of the seven indicators identified in the 2007 Decision on Bilateral Surveillance is triggered, thus underpinning the assessment of broad alignment of the DF and its sustainability.


Djibouti’s exchange rate has been assessed following the IMF’s Methodology for CGER Exchange rate Assessments ( This methodology has been adapted by the Middle East and Central Asia department’s working group on the Assessment of Exchange Rates to fit data availability constraints and economic conditions, including whether a country is an oil importer or exporter. The Djibouti team reestimated these results using the most up to date data and projections.


Lane, Philip, and Gian Maria Milesi-Ferretti, 2006, “The External Wealth of Nations Mark II: Revised and Extended Estimates of Foreign Assets and Liabilities, 1970-2004,” IMF Working Paper 06/69 (Washington: International Monetary Fund).

Electricity Cost

Electricity production in Djibouti comes at a high cost, but service delivery is poor. Despite energy tariffs amongst the highest in Africa and four times higher than in neighboring Ethiopia, EDD runs net operating losses, which have increased with the recent surge in oil prices. At the root of these problems is the dependence on imported oil, aggravated by large arrears from the public sector, an excessive, inadequately skilled and poorly motivated staff, and obsolete equipment. Cost recovery is also hampered by large technical and “non-technical” losses (illegal connections), respectively estimated at 10 and 6 percent of production. The ensuing precarious financial situation of the company has resulted in insufficient maintenance and investment, and inadequate service, with frequent power cuts at peak times.

There is little scope for substantial improvements over the short term. Some improvements can be achieved by enhancing financial transparency through the regular publication of audited accounts, enhancing efforts to reduce losses, and implementing a plan to increase savings in electricity consumption. The World Bank and other development partners are providing technical and financial assistance in these areas. According to the World Bank, some of the key areas of intervention in the short-term could be to:

  • increase the efficiency of power generation by replacing older equipment;

  • negotiate better fuel storage tariffs at the port or invest in own storage capacity;

  • make operational the interconnection with the Ethiopian power grid (which would expand capacity and reduce costs by up to 30 percent); and

  • reduce the EDD’s personnel costs. Wages and benefits represented 14 percent of total operating costs in 2006. Some personnel cost items, such as overtime payments and subsidized energy tariffs, could be reduced by improving personnel management and renegotiating contracts.

In the medium to long term, Djibouti’s competitiveness will depend on developing a reliable array of alternative energies. While fuel-based plants will continue to have a role as a flexible back-up, the main source of primary energy shall come from renewable resources, for which the country is well endowed. In order to achieve this objective, large investments are needed, structured along the lines of a comprehensive strategic plan, with assistance from Djibouti’s development partners and with full involvement from the private sector. Exploration and development of geothermal resources to help address power shortages and reduce carbon emissions has started in 2008, in partnership with foreign investors (Reykjavik Energy Invest/Iceland and InfraVentures). This is the first project to be funded by InfraVentures, a new International Finance Corporation fund created to finance infrastructure development in low-income countries (LICs). The capacity of this geothermal plant is expected to be at least 50 megawatts (about 80 percent of the current EDD capacity). Also, other smaller projects in the wind and solar energy fields are at different stages of development.

IV. The Economic And Financial Program

A. Program objectives and Medium-Term Policy Framework

25. Program objectives: taking into account the issues discussed above, the program aims at fostering sustainable and balanced economic growth through macroeconomic stability, improved competitiveness, reduced inflation, and a strengthened external position. In the meantime, the program will liberate fiscal resources to support the implementation of the authorities’ PRS. It intends to increase the growth rate to about 7 percent; keep the inflation rate close to 3-3.5 percent; sustain a currency board coverage ratio of at least 105 percent, and reduce the stock of domestic arrears from 18 percent of GDP at end-2007 to 7.5 percent at end-2011 (see 14 above).

26. The program focuses on: (a) bringing the overall fiscal position to a balance in the medium term while increasing the share of social and infrastructure projects in total spending; (b) strengthening financial sector soundness; (c) improving competitiveness mainly through a reduction in domestic production costs; and (d) building institutional capacity, particularly strengthening the statistical framework, fiscal transparency, and public sector governance. The specific policy measures envisaged under the program are consistent with the Article IV policy discussions, and are detailed in the Memorandum of Economic and Financial Policies (MEFP). The authorities will consider prompt implementation of FSAP’s recommendations in areas considered urgent and frame their medium-term banking supervision and money management policies along the lines of the guidance provided.

27. The authorities’ fiscal policy under the program aims at balancing the budget in the medium term while increasing spending for poverty reduction (MEFP ¶17). The overall deficit (on a commitment basis) would be brought to balance by 2011, while current expenditure on social programs would increase to about H½ percent in 2011. A balanced budget is needed to create fiscal space for social expenditures without compromising macroeconomic stability and is consistent with strengthening debt sustainability. Tax reforms and improvements in tax administration would reverse the decline in tax revenue and bring it back to about 20 percent of GDP by 2011. Additional measures would be adopted to contain current expenditure not related to the poverty reduction strategy, and the public investment program would be financed mainly by external grants and concessional loans. The wage bill would be further contained in the medium term by the reform of the civil service, including completion of organizational and strategic audits.

B. Key Measures Under the First Year of the Program (September 2008-August 2009)

28. A VAT would be introduced in January 2009 with a single rate of 7 percent (MEFP ¶19). The VAT law would be submitted to the National Assembly with the revised 2008 Budget, at the latest in November 2008. The VAT would be applied to all goods and services with few exceptions, which include banking and financial services and basic food items, thus widening the tax base and reducing exemptions. It is projected to increase revenue by about 1.1 percent of GDP in 2009 and 2.5 percent in the medium term. In order to ensure a smooth transition to the new regime, the staff encouraged the authorities to complete the implementation of all FAD’s TA recommendations. The authorities also intend to phase out the TIC and TPS, introduce the TEC in 2010, revise the personal income tax regime, and make additional efforts to expand the tax base by streamlining exemptions by February 2009 (MEFP ¶20, Box 2 and ¶15 above).

29. Current primary spending would be contained by improving expenditure management, reducing expenditure in low-priority areas, and gradually reducing the wage bill (MEFP ¶22). Given the negative impact of relatively high labor costs on Djibouti’s competitiveness, a freeze in public sector recruitment (except for the ministries of Health and Education and to strengthen the MoF’s Tax Department) and in the salary structure4 would be imposed throughout the program’s duration. It is expected that the conclusion of the civil reform by the end of the program creates the basis for a competitive public sector without the need for wage ceilings. The budget preparation process would be strengthened in line with the FAD TA recommendations, through a revision of budget classification by 2009 and through the introduction of a medium-term fiscal framework that shall form the basis for the 2010 budget law (MEFP ¶21).

30. All outstanding external arrears would be cleared and domestic arrears reduced by 1.2 and 1.3 percent of GDP in 2008 and 2009, respectively (MEFP ¶18 and 24). To prevent the accumulation of new domestic and external arrears, the authorities intend to introduce a single treasury account, prepare monthly treasury plans based on more accurate projections of revenue and expenditure needs, and increase the balance of government deposits at banks (MEFP ¶21 and ¶14 above). Moreover, they intend to request technical assistance to improve current debt management practices, including avoiding the accumulation of arrears (MEFP ¶18).

31. The fiscal discipline embedded in the program will help improve debt sustainability. The program assumes that the authorities will be able to mobilize a substantial level of exceptional financing from multilateral and bilateral creditors, on highly concessional terms. For projection purposes, staff assumed that the precutoff debt to the Paris Club will be rescheduled under classic terms. Furthermore, in order to facilitate the mobilization of concessional external financing for the public investment program, a conference of external donors will be organized by November 2008 (MEFP ¶23, Box 2, and ¶3 above).

32. The CBD would introduce reserve requirements on commercial bank deposits as a liquidity management instrument (MEFP ¶29, and ¶18-19 above). Required reserves would support the authorities’ multi-pronged effort to control inflation and mop up excess structural liquidity.5 The specific characteristics of reserve requirements (level, computational base, remuneration) would be decided in consultation with local banks, and with TA from MCM. Moreover, the CBD would intensify banking supervision by increasing the number of on-site inspections, and commercial banks’ capital requirements would be doubled (MEFP ¶31, Box 1, and ¶20 above).

33. The program entails short-term measures to reduce the cost of domestic utilities and improve the business climate (MEFP¶ 36-40). These include carrying out a study on the downsizing of the EDD that will trigger its downsizing, reducing the technical losses of the ONEAD, finalizing the interconnection agreement with Ethiopia, adopting the new commerce code, and enforcing the new labor code, including by adopting the implementation decrees and fostering the renegotiation of sectoral collective agreements (MEFP ¶37-41, Box 4, and ¶22-23 above).

34. Short-term measures to improve the statistical framework include completing a full population census, followed by a comprehensive household expenditure survey, and a survey of economic activities. This would help to update the various social indicators, including the provision of new estimates of poverty and income distribution, and improve the quality of national accounts’ estimates (MEFP ¶42, and ¶24 above).

C. Program Modalities, Access Level, Monitoring, Risks, and Safeguards

35. The staff concurs with the authorities’ request for an access level under the requested PRGF of SDR 12.72 million (80 percent of quota). The access level that would reflect Djibouti’s status as a second-time PRGF user would be 65 percent of quota. However, given the impact of the food and oil price shocks on the projected financing needs of the country, the authorities request an augmented access level of 80 percent of quota, which is consistent with the level of access received by other countries facing similar shocks, the latest estimates of Djibouti’s financing gap, and the projected capacity to repay the Fund (Table 7). To reinforce official reserves in 2008, 24 percent of quota would be frontloaded, while the rest of the facility would be disbursed in equal semi-annual tranches once reviews are completed (Table 6). The first review would assess performance of the criteria at end-2008. The program would be monitored by quantitative indicators on arrears, net credit to government, external borrowing and the currency board cover, and by structural performance criteria.

36. Performance criteria and benchmarks fall within the Fund’s areas of expertise and are critical to achieving the economic objectives and mitigating the program’s risks. The authorities see the introduction of the VAT in 2009 and improvements in liquidity management as essential to control inflation (MEFP’s Table 1). The nine structural benchmarks cover reforms that are fundamental for maintaining macroeconomic stability and improving competitiveness (MEFP’s Table 2). For example, reducing the cost of electricity is key for the development of the private sector (Box 4), and improvements in banking supervision and anti-money laundering are critical at this stage of development.

37. The risks to the program are manageable. Political and social tensions could hamper the implementation of the wide-ranging and thorny reforms, such as the freezing of recruitment in the public sector and of the nominal wage structure. Capacity constraints could limit the authorities’ ability to implement reforms sufficiently rapidly to meet the needs of incoming FDI. Regional stability could also pose serious risks. Finally, further increases in oil and food prices could pose added strain on inflation and compromise fiscal sustainability. These risks are mitigated by the strong ownership of the program, which closely mirrors the development strategy elaborated by the authorities.

38. The authorities have received an initial safeguard assessment (SA) mission. The preliminary assessment indicated that although risks are present in a number of safeguard areas, these are partly mitigated by the relatively straightforward nature of the CBD’s operations under the CBA. The full assessment is expected to be completed by the time of the first review under the PRGF arrangement. Based on the SA recommendations, a strategy would be developed to address any potential shortcomings in CBD’s legal framework and financial controls, and specific remedial measures would be incorporated into future program reviews as needed.

V. Staff Appraisal

39. Djibouti has a unique opportunity to achieve its development objectives. The continued massive FDI inflows and the authorities’ poverty reduction and investment strategies have the potential, if supported by adequate fiscal adjustment and structural reforms, to launch Djibouti on a broad-based, sustainable high-growth path and to achieve substantial progress in the pursuit of the MDGs.

40. The authorities’ poverty reduction strategy is a significant step in this direction. The new PRSP presents a coherent set of measures for addressing the key structural problems that have hindered economic development. In order to achieve these objectives, however, it will be essential to strengthen macroeconomic stability by balancing the overall fiscal position while creating fiscal space to increase the share of social and infrastructure projects in total spending. The enhanced discipline introduced by the PRGF would further increase domestic and foreign investor’s confidence.

41. The staff welcomes the authorities’ plan for a gradual fiscal adjustment based on a comprehensive tax reform, spending restraint, and better prioritization. The introduction of the VAT has the potential to widen the tax base and partly reduce the current system of tax privileges to attract investment with a more stable, transparent, and, on average, lighter taxation. If adequately supported by improved audit controls and simplified compliance procedures, these reforms could substantially increase tax revenue in the medium term. However, timely implementation of the reforms is of the essence, particularly in view of the rapidly declining revenue path.

42. The rapid expansion of the financial system is expected to lead to increased efficiency, but would require strengthening the oversight function of the CBD. In particular, it is essential that the CBD reorganizes and reinforces substantially its banking supervision capacities, and that the legal and regulatory framework is updated to keep pace with the introduction of new financial institutions and instruments.

43. In order to contain the mounting inflationary pressures, the authorities need to maintain their fiscal consolidation objectives and accelerate the implementation of structural reforms that increase productivity and competition. Also, the introduction of reserve requirements by the CBD would help mop up structural liquidity. The authorities should refrain from introducing price controls or other restrictions that hamper the effective functioning of the market, which may result in the rationing of products and the emergence of black markets. The social concerns raised by the increasing food and oil prices would be better addressed by promptly developing a system of targeted subsidies to the poorest, with World Bank assistance.

44. External financial assistance will be essential to address Djibouti’s short and medium-term financing needs and to strengthen external sustainability. The authorities should approach their bilateral and multilateral creditors to clear arrears, seek financial assistance to cover their financing needs, and establish a sustainable path for the external debt.

45. The staff agrees with the authorities that the CBA has contributed to maintaining macroeconomic stability. However, while the slight overvaluation of the DF does not provide compelling evidence of misalignment, a variety of indicators suggest that competitiveness remains weak.

46. The implementation of ambitious structural reforms remains critical to improve competitiveness and to foster economic growth. In addition to fiscal and financial reforms, action is urgently needed to reduce costs and increase the efficiency of public enterprises (particularly the EDD); and to simplify regulations and procedures that affect the cost of doing business.

47. Improving the statistical base is essential to guide and monitor macroeconomic and poverty reduction policies. In this regard, staff urges the authorities to expedite the population census process followed by the household income and expenditure surveys, and to take full advantage of the TA offered by Djibouti’s development partners.

48. Staff recommends the approval of the authorities’ request for a three-year PRGF arrangement for SDR 12.72 million (80 percent of quota), with an upfront disbursement of 24 percent of quota.

49. It is proposed that the next Article IV consultation be held in accordance with the decision on consultation cycles approved July 15, 2002.

Table 1.

Djibouti: Selected Economic and Financial Indicators, 2005-09

(Quota: SDR 15.9 million)

(Population: 0.82 million; 2006)

(Per-capita GDP: $946; 2006)

(Poverty rate: 42 percent; 2002)

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

Includes external arrears on amortizations.

Domestic arrears include wage arrears and arrears to private and public suppliers for goods and services, to the pension fund, and to public enterprises. External arrears include arrears on interest only (arrears on principal are counted as an item of “external financing”).

Unlike the May 2007 staff report, cattle reexports for 2006 and 2007 are recorded on net basis.

Includes external arrears and debt owed to Italy and Spain.

In months of the following year’s imports.

Gross foreign assets of the CBD, in percent of monetary liabilities (reserve money and government deposits at CBD).

Table 2.

Djibouti: Central Government Fiscal Operations, 2005-11

(In millions of Djibouti francs)

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

Excluding the French contribution.

Previously included in transfers.

Excluding housing subsidies.

Assumes Paris Club rescheduling, clearance of non-eligible Paris Club debt, and similar treatment of other non-Paris Club bilateral debt.

Defined as domestic revenue minus expenditure financed from domestic sources.

Table 3.

Djibouti: Balance of Payments, 2005-13

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

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

Includes net exports of cattle since 2006.

The large increase in exports and imports of goods in 2011onward reflects the coming online of the new refinery.

The large increase in imports starting 2006 reflects FDI-related imports, mainly rising investment on the new port facility and free zone.

Includes the French and U.S. contributions for the military bases and outflows of interest due on Paris and non-Paris Club debt.

Excludes exceptional financing.

Reflects FDI on oil terminal, the new port facility, the free zone, and other projects (particularly hotels).

In months of the following year’s imports. From 2010 onward, the ratio excludes crude oil imports destined for reexportation.