Guinea-Bissau
Use of Fund Resources: Request for Third Purchase Under Emergency Post-Conflict Assistance: Staff Report; Staff Supplement; Press Release; and Statement by the Executive Director for Guinea-Bissau
Author: International Monetary Fund
Publication Date:
31 Jul 2009
eISBN:
9781451815870
Language:
English
Keywords:
ISCR; CR; government; Emergency Post-Conflict Assistance; EPCA-supported program; debt; debt relief; Guinea-Bissau authorities; government saving; authorities' measure; clearance strategy; Arrears; Emergency assistance; Global
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Global economic developments in Guinea-Bissau, especially lower export demand and prices, are expected to slow growth significantly and put pressure on the balance of payments. The 2009 fiscal framework aims to stabilize public finances and avoid new domestic arrears. The authorities are requesting a third Emergency Post-Conflict Assistance (EPCA) purchase of 12.5 percent of quota to support their 2009 economic framework. A third EPCA purchase would give them time to demonstrate a track record of policy performance that could pave the way for a new Poverty Reduction Growth Facility arrangement.

Abstract

Global economic developments in Guinea-Bissau, especially lower export demand and prices, are expected to slow growth significantly and put pressure on the balance of payments. The 2009 fiscal framework aims to stabilize public finances and avoid new domestic arrears. The authorities are requesting a third Emergency Post-Conflict Assistance (EPCA) purchase of 12.5 percent of quota to support their 2009 economic framework. A third EPCA purchase would give them time to demonstrate a track record of policy performance that could pave the way for a new Poverty Reduction Growth Facility arrangement.

I. Background

1. After several years of political instability, which has undermined economic policies and performance, Guinea-Bissau faces an extremely difficult fiscal and economic situation. Frequent changes in government, lack of accountability and ownership, and poor fiscal controls have left a legacy of low growth, unsustainable fiscal deficits, and large stocks of domestic arrears. Though some progress was made under the 2008 EPCA-supported program to reform fiscal management, the fiscal situation was still difficult and domestic arrears continued to accumulate, including several months of government wages. The country has also been hit hard by global economic developments. Last year’s surge in food and fuel prices and more recently the slowdown in global growth have put pressures on inflation, the external sector, and government resources, and threaten to severely weaken economic activity.

2. Yet there are encouraging signs that the political and security situation is slowly stabilizing. Following the recent assassinations of the president and the army chief of staff, two long-standing leaders at the center of domestic tensions, a peaceful transition to a new president is underway. In accordance with the constitution, the president of the parliament was promptly installed as interim president, and an interim army chief has been appointed. A presidential election is scheduled for June 28, with the support of the international community. The election is not expected to change the current government, led by the Prime Minister and backed by a two-thirds majority in Parliament, or the direction of economic policy. At a recent roundtable on security sector reform, the international community pledged support to Guinea-Bissau to fight drug trafficking, mainly by strengthening the police and the judiciary, and to reform the armed forces, partly by establishing a pension trust fund for retiring military.

3. The main challenge will be to stabilize the fiscal situation and avoid new domestic arrears. The 2009 fiscal framework focuses on keeping basic expenditures within available resources, domestic and external. The fiscal situation, however, is very tight. With no resources to pay the sizeable domestic arrears or outstanding commercial debt, payments will have to be postponed. Timely donor support will be critical. The authorities are requesting a third EPCA purchase to support their 2009 program. Satisfactory performance could pave the way for discussion of a new PRGF arrangement later this year. Moving to a PRGF arrangement is necessary to shift focus to critical medium-term growth and development needs, ensure continued donor support, and move to the HIPC completion point.

II. Recent Developments and Program Performance

4. Economic activity continued to recover in 2008. Real GDP growth reached 3.3 percent, from 2.7 percent in 2007, thanks in part to increased agricultural production as rains returned to normal (Figure 1 and table 1). Nevertheless, economic developments in 2008 were dominated by the surge in global food and fuel prices.1 Consumer price increases, especially for food, peaked at 14.6 percent (year-on-year) in October but steadily declined thereafter. For the year as a whole inflation averaged 10.4 percent, up from 4.6 percent in 2007 and significantly higher than the recent annual average of under 2 percent. The external current account deficit (excluding official transfers) worsened to 14.9 percent of GDP in 2008, from 9.3 percent in 2007, as buoyant cashew exports were outweighed by higher import costs (Table 2). Broad money growth slowed somewhat in 2008 but still reached an estimated annual rate of about 21 percent (Table 3). There was an increase in credit to the private sector as domestic banks, for the first time, participated in financing the cashew campaign.

Figure 1.
Figure 1.

Guinea-Bissau: Main Economic Trends, 2000 – 10

Citation: IMF Staff Country Reports 2009, 236; 10.5089/9781451815870.002.A001

Sources: Guinea-Bissau authorities; and IMF staff estimates and projections.
Table 1.

Guinea-Bissau: Selected Economic and Financial Indicators, 2007–11

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Sources: Guinea-Bissau authorities, and IMF staff estimates and projections.

Change in percent of beginning-of-period stock of broad money.

Values in 2010 and thereafter reflect assumed impact of HIPC debt relief.

Table 2.

Guinea-Bissau: Balance of Payments, 2007–11

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Sources: BCEAO and IMF staff estimates and projections.

Includes food aid and technical assistance to projects.

Excludes the financing gap, which BCEAO includes in the capital account.

Excludes prospective 2009 EPCA drawing.

Table 3.

Guinea-Bissau: Monetary Survey, 2007-09

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Sources: BCEAO, and IMF staff estimates and projections.

5. The 2008 fiscal situation was very difficult, reflecting global economic pressures and continued political instability. The authorities made some progress in reforming revenue and expenditure management. They also made firm efforts to keep spending within budgeted levels. Revenue shortfalls, however, led to a worse than expected domestic primary deficit. Donor budget support also fell short of programmed amounts and led to a sizeable accumulation of arrears.

6. The 2008 domestic primary deficit exceeded the program target by about CFAF 3.9 billion (Text Table 1). Government revenues, both tax and nontax, were lower than expected by CFAF 2.5 billion. Among nontax revenues, fishing licenses under-performed by CFAF 1 billion, reflecting continued weaknesses in monitoring territorial waters. Tax revenue, despite efforts to recover tax arrears, was below the target by about CFAF 1.5 billion. The authorities attributed the shortfall to disruptions at customs caused by political instability surrounding the November 2008 legislative elections. This was compounded by revenue losses from tax exemptions on rice and fuel imports in response to the global price increases.2 Expenditures were generally as budgeted, although additional savings did not materialize as planned.

Text Table 1.

Guinea-Bissau: Quantitative Indicators for the EPCA-supported program for 2008

(Cumulative, CFAF millions)

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Source: Guinea-Bissau authorities, and IMF staff estimates.

Adjusted for shortfalls in EU fishing compensation.

Adjusted for shortfalls in external budget assistance, including EU fishing compensation.

7. Pledged donor grants were lower than expected by some CFAF 10 billion (5 percent of GDP) (Text Table 2). Sizeable domestic arrears accumulated, reaching four months of government salaries (about 4 percent of GDP), and a large amount of Treasury bills held by regional financial institutions (CFAF 7.2 billion, 3.5 percent of GDP) and outstanding since 2006, could not be repaid as planned.3 The authorities also could not repay large amounts of short-term commercial bank debt, or make scheduled payments to the BCEAO. Key quantitative indicators of the 2008 EPCA-supported program, namely revenue, domestic primary balance, accumulation of domestic arrears and payment of previous years’ arrears (four out of seven quantitative indicators) were missed.

Text Table 2.

Guinea-Bissau: External Budget Support, 2008-09

(CFAF billions)

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Source: Guinea-Bissau authorities, and IMF staff estimates and projections.

8. Most of the EPCA structural benchmarks were met (Text Table 3). The installation of new software for unifying payroll and personnel management (SIGASPE) (benchmark for end-September 2008) was delayed pending formal agreement with the regional partner that was supposed to provide the software. Lack of financial resources also prevented the government from upgrading the automated custom systems to ASYCUDA++ as planned for December 2008. That will now be implemented by the end of October 2009, as will the system for payroll and personnel management, which will now be supported by a technical assistance agreement with Portugal (MEFP ¶ 17 and 18). The remaining structural benchmarks that were not met were nonetheless implemented with a delay.

Text Table 3.

Guinea-Bissau: Structural Benchmarks for Emergency Post-Conflict Assistance

January 1, 2008—December 31, 2008

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9. Revenue and expenditure performance for the first quarter of 2009 appear to have been as expected. Tax revenue in the first two months of the year was as expected, although generally lower than for the same period in 2008, reflecting global conditions. There was a slight drop in tax revenues in March when business confidence weakened after the assassinations; a large volume of containers in the port remained unopened in the immediate aftermath. Preliminary indications point to a gradual resumption of business activity since April. First-quarter expenditures were in line with the budget. The authorities have paid all January and February 2009 salaries, using domestic resources, and are beginning to pay March salaries.4 Inflation declined to 5.8 percent (year-on-year) in February 2009. There are already signs of a drop in remittances, which were lower by nearly 25 percent in the first quarter of 2009 compared to the same period last year.

III. Outlook and Policies for 2009

A. Overview

10. Achieving a stable fiscal situation in 2009 and avoiding new domestic arrears will be challenging. Weak external trade is expected to hurt tax revenues. There are pressures to repay the outstanding domestic arrears and short-term commercial debt. Donor support is also subject to increased uncertainties given the current global environment.

11. The authorities are nonetheless determined to improve fiscal performance in 2009. In their program for 2009 (MEFP), they agreed to (i) limit the use of 2009 budget resources, domestic and external, to the payment of current-year expenditures; (ii) postpone payment of domestic arrears and commercial debt until resources are available; and (iii) speed up efforts to further strengthen revenue collection and expenditure controls. The authorities have already secured a significant amount of donor financial and technical assistance for 2009. They are requesting a third EPCA purchase to support the 2009 program.

12. Guinea-Bissau continues to meet the Fund’s conditions for EPCA support. First, though improving, its institutional and administrative capacity remains weak, and it needs more time to implement a comprehensive program that could be supported by a medium-term PRGF arrangement. Second, despite the weaknesses, there is sufficient capacity for policy planning and implementation, as evidenced by the progress in 2008 made on structural reforms. Third, there is an urgent need to meet essential external payments, especially to multilaterals. Finally, there is concerted international support for Guinea-Bissau (¶ 16). Contingent on satisfactory performance under the 2009 EPCA-supported program, discussions for a new PRGF arrangement could begin later this year.

B. Macroeconomic Outlook

13. Global economic developments are likely to severely weaken real GDP growth in 2009 and over the medium-term (Box 1). Prices for cashew nuts, the main export crop, are expected to be almost 30 percent lower than last year, constraining real GDP growth, affecting the poor in rural areas, and putting pressure on the budget and external current account. Remittances, which account for about 8 percent of GDP, are expected to be lower by more than 10 percent, with negative impact on real incomes and the current account. Real GDP growth of 1–2 percent is now expected for 2009, much lower than in 2008. Lower food and fuel prices, on the other hand, will help suppress inflation. The external current account is projected to worsen because of the lower cashew export prices, offset only partially by lower prices for imported food and fuel. Provisional projections indicate a slight pick-up in economic activity over the medium-term, and inflation should return to trend (Text Table 4).

Text Table 4.

Guinea-Bissau: Medium Term Scenario 2006–11

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Sources: Guinea-Bissau authorities, and IMF staff estimates and projections.

Values in 2010 and thereafter reflect assumed HIPC debt relief.

Guinea-Bissau: Impact of the Global Financial Crisis

Like many other countries in Sub-Saharan Africa, Guinea-Bissau is expected to experience significant adverse effects from the global financial crisis. This impact will be tempered, however, by the positive impact on the terms of trade from lower world prices for food and fuel.

Prices for cashews, which account for over 95 percent of Guinea-Bissau’s export revenues, are expected to weaken 25 to 30 percent in 2009, albeit from the relatively high levels observed in 2008. Export volumes, however, are expected to continue on a rising trend, boosted in part by the shipment of accumulated inventories. At the same time, markedly lower prices for imported foodstuffs (notably, rice and wheat) and a more than 50 percent decline in the price of imported fuel are expected to help contain the deterioration in Guinea-Bissau’s terms of trade to a relatively modest 4 percent in 2009. However, looking ahead, WEO projections for the prices of Guinea-Bissau’s imports and exports suggest that a further medium-term deterioration of the terms of trade is possible.

uA01fig01

Import Growth, by Component

Citation: IMF Staff Country Reports 2009, 236; 10.5089/9781451815870.002.A001

uA01fig02

Export and Import Prices and the Terms of Trade

Citation: IMF Staff Country Reports 2009, 236; 10.5089/9781451815870.002.A001

uA01fig03

Exports, Remittances, and the Current Account

Citation: IMF Staff Country Reports 2009, 236; 10.5089/9781451815870.002.A001

Guinea-Bissau is also expected to be hard hit by a sharp fall in remittances, reflecting deteriorating labor market conditions in the advanced countries, namely in South-Western Europe, where the majority of remittances originate. Remittances have been on a sharply rising trend since the early part of this decade, reaching 7.7 percent of GDP in 2008. Preliminary data suggest that remittances could decline by 15–20 percent in 2009.

Taken together, these developments are expected to lead to a significant deterioration in the external balance in 2009, with the current account deficit (excluding grants) expected to deteriorate from14.9 percent of GDP in 2008 to 16.2 percent in 2009.

C. Fiscal Policy

14. The 2009 fiscal framework aims to meet basic current-year expenditures with available resources, domestic and external, and avoid new domestic arrears.5 However, the domestic primary deficit is projected to deteriorate to some 8 percent of GDP, from an estimated 6 percent in 2008. Tax revenues, in particular, will be adversely affected by the global economic slowdown, the expected sharp decline in international prices for cashew nuts, and the projected drop in imports. Total revenues are expected to decline by about 2.7 percent of GDP, with tax revenues lower by 1.3 percent of GDP (Text Table 5). Rice imports continue to be exempted from taxes, as a social safety net in the difficult economic environment. The government will consider removing the exemptions later this year. Nontax revenues will be lower by about 1.6 percent of GDP in 2008 as EU fishing compensation returns to a single annual disbursement.6

Text Table 5.

Guinea–Bissau: Fiscal Indicators, 2007–11

(Percent of GDP)

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Sources: Guinea-Bissau authorities, and IMF staff estimates and projections.

15. Current primary expenditures are expected to decline by about 0.8 percent of GDP in 2009 because of a nominal freeze of current expenditures, including the wage bill. The authorities recognize that the 2009 spending plan is once again very tight and covers only minimum requirements. 7 They aim to achieve additional wage bill savings during the year in order to free resources for priorities like health, education, and basic infrastructure. Efforts are underway to clean up the public payroll to reduce fraud and duplicate payments by, for instance, enforcing the “in-person” payment of wages and pensions. A biometric survey of civil servants will be launched in April, and the authorities plan to complete the merger of the payroll databases of the ministries of Finance and Public Administration (MEFP ¶ 18). The 2009 budget also incorporates a large increase in capital expenditures, financed by external grants, for construction of a new government office complex and the renovation of two hospitals. Construction on these projects is already underway.

16. A significant amount of budget support has been confirmed for 2009, mainly from traditional donors. 8 At about CFAF 22 billion (US$44 million), budget support in 2009 is expected to be higher by about 2.4 percent of GDP than in 2008. There is still a small financing gap of CFAF 2.8 billion (about US$5.6 million) for 2009, which is expected to be filled by the third EPCA purchase (SDR 1.775 million or US$2.8 million). The remainder could be filled by a fourth, final, EPCA purchase later this year, or, by PRGF resources. 9 If there are any shortfalls in external financing or domestic revenues in 2009, the government is committed to avoiding new domestic arrears by taking further efforts to reduce expenditures or finding additional sources of revenues.

17. There are no resources in the 2009 fiscal framework to pay large amounts of outstanding domestic arrears or to service bank debt (Text Table 6). In the first quarter of 2009 the authorities paid some CFAF 2 billion in 2008 wage arrears to teachers. For the rest of 2009 the authorities agreed to avoid any further payment of arrears until resources are available. The authorities also intend to reschedule current debt service owed to the BCEAO (CFAF 1.9 billion).

Text Table 6.

Guinea-Bissau: Stock of Domestic Arrears

(End-2008)

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Source: Guinea-Bissau authorities, and IMF staff estimates.

18. The government nonetheless will make a major effort to resolve its large overhang of arrears. Along with external debt relief, clearing domestic arrears will be important to reduce Guinea-Bissau’s total public debt to more sustainable levels (¶ 22). Clearing arrears would also help to restore economic confidence and alleviate social tensions caused by the difficult global environment. Given their magnitude, the authorities recognize that clearing domestic arrears can only be accomplished within a sustainable and financed medium-term budget framework. They are seeking donor assistance to help prepare a medium-term action plan to clear domestic arrears,10 starting with finalizing the external audit of domestic arrears from 2000-07. 11 The arrears clearance strategy will be central to the medium-term expenditure framework of a PRGF arrangement.

19. The authorities are working hard to reach out to both traditional and new donors for budget support in 2009. A donors meeting is tentatively planned for the second half of 2009. If donor budget grants in 2009 exceed the amount needed to finance the fiscal gap, priority will be given to using the resources to repay commercial debts, wage arrears, and other audited domestic arrears, as well as increasing spending in priority social sectors, in consultation with the Fund.

20. The fiscal situation is expected to continue to improve over the medium term, as revenues recover—although not to 2008 levels—and expenditures decline gradually as a share of GDP. A gradual reduction in the domestic primary deficit, together with continued donor support, would create fiscal space over the medium term to gradually pay down domestic arrears and to allow the country finally to focus external assistance on meeting critical development needs.

D. Structural Reforms

21. The authorities agreed to a number of revenue and expenditure measures to further improve administrative capacity and strengthen fiscal performance (MEFP ¶ 17–19). The rationale and macro-criticality of each measure are indicated in Table 2 of the MEFP. Importantly, the authorities will agree on a medium-term action plan for public financial management (PFM), in consultation with the World Bank and the EU and drawing on the outcome of the recent EU-financed study on public expenditure and financial accountability (PEFA). The authorities also intend to strengthen customs administration by fully implementing ASYCUDA++ and improving control of territorial waters. For this, the Ministry of Finance is offering better incentives to patrol agents to apprehend illegal fishing boats. As an interim measure to improve revenue collection, the authorities are also proceeding with their plans to retain a preshipment inspection agency, pending longer-term measures to strengthen customs administration.12 They also intend to enact a new investment code that will eliminate exemptions for investment projects and replace them with tax credits, in line with established best practices.13 In preparation for possible discussions of a new PRGF arrangement later this year, the authorities are updating their PRSP.

E. Debt Sustainability

22. Guinea-Bissau remains in a situation of debt distress. At the end of 2008 its stock of external debt amounted to US$1.04 billion, 246 percent of GDP in nominal terms (316 percent in NPV terms), of which US$382 million were arrears. As shown in the attached Debt Sustainability Analysis (DSA), Guinea-Bissau’s external debt ratios are well above country-specific indicative sustainable thresholds, even after assuming full delivery of HIPC Initiative and MDRI debt relief. 14 Domestic debt is also unsustainable.

23. Guinea-Bissau reached the HIPC decision point in 2000. At that time, creditors pledged to provide debt relief equivalent to 85 percent cancellation in NPV terms. However, interim relief from the Fund and Paris Club creditors stopped after 2001, when the PRGF-supported program went off track. The African Development Bank (AfDB) and IDA provided interim debt relief, which was recently extended to 2011. Since 2001 Guinea-Bissau has not repaid any creditor that did not provide interim relief except the IMF.

24. Reaching the completion point for the Enhanced HIPC Initiative and receiving debt relief would significantly reduce Guinea-Bissau’s debt. However, the country would remain at high risk of external debt distress even after any HIPC and MDRI debt relief, and additional donor support is needed to reduce the domestic debt burden. The authorities are moving toward satisfying the remaining requirements to reach the HIPC completion point, having made progress in regularizing relations with all external creditors and having met most of the completion point triggers (Table 5). The remaining requirement is establishing a satisfactory PRGF track record. Reaching the completion point is currently targeted for 2010, before World Bank and African Development Bank interim debt relief expire.

Table 4.

Guinea-Bissau: Central Government Operations, 2007–11

(CFAF billions)

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Sources: Guinea-Bissau authorities, and IMF staff estimates and projections.

Project grants in 2009 includes new public investments externally financed such as the new government offices complex and two hosp

In 2008 includes World Bank debt relief, EPCA, and authorities’ measures to fill the financing gap.

Table 5.

Progress with HIPC Completion Point Triggers

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Source: Updated by the World Bank and authorities in April 2009.

F. Program Monitoring, Access, and Capacity to Repay

25. The fiscal framework underlying EPCA covers calendar 2009. This allows enough time to demonstrate a track record of credible policies to restore fiscal control and avoid domestic arrears for the full period.

26. The authorities’ MEFP contains quantitative indicators through December 2009 and a few structural indicators that are critical for fiscal sustainability (MEFP Tables 1 and 2). The structural indicators relate to fiscal management measures that can be implemented in 2009. The prior actions identified for the program have already been met. Definitions and adjusters of financial indicators and requirements for transmitting data to staff are described in the Technical Memorandum of Understanding (Appendix II, Attachment II).

27. Guinea-Bissau has sizable arrears to sovereign and multilateral creditors,15 and external arrears are expected to accumulate further during the EPCA-supported program. Paris Club creditors have been informed of this. The authorities have also informed non-Paris Club creditors that they will continue to have difficulties servicing external debt even during the EPCA program period; they are taking steps to reschedule arrears with multilateral creditors. Given these actions and the commitments the authorities have received from other donors, staff considers that financing for their 2009 program, which includes a continued build up of external arrears, is adequate, and the authorities can therefore request EPCA.

28. The proposed third EPCA purchase is for SDR 1.775 million, equivalent to 12.5 percent of quota. This would bring Guinea-Bissau’s total EPCA purchases to SDR 5.325 million (37.5 percent of quota). Guinea-Bissau could receive subsidies to lower the annual basic charge on the EPCA purchase to 0.5 percent if resources are available. With the proposed third purchase, its credit outstanding to the Fund would increase from 42.9 percent of quota in 2008 to 44.6 percent of quota in 2009 (Table 6).

Table 6.

Guinea-Bissau: Indicators of Capacity to Repay the Fund, 2008–13

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Sources: IMF staff estimates and projections.

Assumes one EPCA purchase of 12.5 percent of quota (SDR 1.775 million) in 2009. No subsidization of EPCA credit is assumed.

Total debt service includes IMF repurchases and repayments.

Assuming that the rate on EPCA purchase is subsidized down to 0.5 percent per annum plus adjustment for deferred charges. Subsidization is subject to the availability of resources.

The figure in 2010 assumes debt relief.

29. There are considerable risks to the program, especially delays in donor disbursements and political instability. The risk of delayed donor disbursements has become more pronounced as developing countries in general face the possibility of reduced aid flows because of the global financial turmoil. The absence of donor support could lead to further wage arrears, reigniting social instability, as well as delays in reforms crucial to fiscal sustainability and economic growth (e.g., civil service, security, and energy sector reforms). Further political instability, particularly around the time of the presidential election, could delay implementation of the 2009 program and jeopardize donor support. The limit on access to EPCA incorporates the risk to Fund resources, and any further purchases would be subject to an updated risk assessment.

30. Notwithstanding these risks, there is little risk to the Fund from EPCA disbursements to Guinea-Bissau. The government is current on its Fund obligations, and the BCEAO has an exemplary record of honoring debt service to the Fund on behalf of WAEMU members, even without reimbursement by the member country.16

31. To ensure that the fiscal reforms are effective and sustainable, the 2009 EPCA program will continue to be supported by technical assistance (Table 7). The IMF will continue to provide support, including technical assistance from West AFRITAC and AFRISTAT, to firm up budget management and tax collection and improve economic statistics. The World Bank is helping with these reforms with a grant from the State and Peace-Building Fund (SPF), including financing for a long-term resident fiscal advisor. Other donors, including the EU and bilaterals, are providing technical assistance to government revenue and expenditure departments.

Table 7.

Guinea-Bissau: Ongoing Technical Assistance Program

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Technical Assistance requested and under consideration.

Technical Assistance in place.

World Bank State and Peace-Building Fund (SPF).