Statement by Christopher Legg, Alternate Executive Director for Seychelles and Simon Duggan, Advisor to Executive Director

This paper discusses key findings of the Third Review Under the Stand-By Arrangement for Seychelles. The program is on track, and macroeconomic stabilization has advanced rapidly. The authorities continue to implement the program with a high degree of ownership and success. All quantitative performance criteria (PC) and structural benchmarks at end-September 2009 were met. The structural reform effort is progressing well. Key progress has been made on public financial management, notably through the treasury single account. The 2010 budget features a much improved and complete presentation of government finance.


This paper discusses key findings of the Third Review Under the Stand-By Arrangement for Seychelles. The program is on track, and macroeconomic stabilization has advanced rapidly. The authorities continue to implement the program with a high degree of ownership and success. All quantitative performance criteria (PC) and structural benchmarks at end-September 2009 were met. The structural reform effort is progressing well. Key progress has been made on public financial management, notably through the treasury single account. The 2010 budget features a much improved and complete presentation of government finance.

December 18, 2009

Our Seychellois authorities’ determined adherence to their economic reform program has delivered rapid macroeconomic stabilization, providing a solid base from which to launch a second phase of economic reforms, directed at consolidating macroeconomic stabilization, achieving external debt sustainability and durably raising growth.

Economic Developments and Outlook

Macroeconomic trends continue to evolve favorably. The nominal exchange rate has appreciated steadily since January and inflation has fallen to around zero. Nominal interest rates on short-term T-bills have declined to under 5 percent, consistent with tight fiscal policy and exchange rate trends. Seychelles’ current account deficit has narrowed sharply and the authorities’ accumulation of international reserves has exceeded program targets. Real GDP is now expected to contract 7.6 percent in 2009, somewhat better than the 10.7 percent contraction projected in June.

Seychelles’ economic recovery is expected to gain traction from 2010 as the economy responds to the reforms and improving global conditions. There are positive signs that tourism and related construction activity - the main drivers of growth in Seychelles -commenced a gradual recovery in the second half of 2009. Real GDP growth is projected to recover to 4 percent in 2010 and to 5 percent in 2011-12, while inflation is expected to remain in the low single digits. The external current account deficit is expected to widen in 2010, due to higher growth and rising foreign direct investment, but narrow over the medium-term as tourism earnings recover. Foreign exchange reserves are projected to rise gradually to about 2½ months of import coverage by end-2012.

Program Performance and EFF Request

Progress on macroeconomic stabilization is underpinned by exemplary program performance. Our authorities met all of the end-September quantitative targets with margins and observed each of the structural benchmarks for the third review. The end-December structural benchmarks are also expected to be met.

Given deep-rooted structural imbalances in the economy, which require sustained reform efforts in the medium-term, our authorities have requested the Fund’s continued support for their reform program through a three-year arrangement under the EFF in an amount of SDR 19.8 million (equivalent to 225 percent of quota). The EFF would provide the macroeconomic framework to guide fiscal and financial policies over the next three years, bridging Presidential and Parliamentary elections, underpinning the debt reduction strategy and serving a coordinating function for donors and other stakeholders. Our authorities are convinced that the EFF’s medium-term, structural focus make it the appropriate instrument to underpin the second phase of their reform efforts.

Fiscal Policy

Fiscal policy remained tight throughout 2009, out-performing program targets in each of the first three quarters. This provided the space for a supplementary budget of around 2 percent of GDP in the fourth quarter to finance urgent expenditure priorities, while keeping within the annual 2009 primary surplus target of about 13½ percent of GDP (equivalent to a fiscal tightening in the order of 9½ percent of GDP in 2009). The government’s fiscal performance, coupled with falling interest rates, will finance a reduction in domestic debt of 5½ percent of GDP in 2009.

Given the rapid macro stabilization, low inflation, improved debt outlook and large development needs, an easing of the fiscal stance to a 7 percent primary surplus is programmed for 2010. The reduction in the primary balance will mainly reflect a fall in revenues associated with one-off positive factors in 2009. The authorities will prudently reduce recurrent spending further as a percentage of GDP in 2010, creating the space to increase capital expenditure to 6.8 percent of GDP, directed primarily at urgent rehabilitation of electricity and water infrastructure. This includes an expenditure contingency of about 1 percent of GDP ear-marked for investment projects that will proceed from the second quarter of the year following confirmation that the fiscal position remains on track.

Going forward, the goals of fiscal policy are to put public finances on a sustainable path while creating the fiscal space to raise public investment. Primary fiscal surpluses will be targeted at 4½-6 percent of GDP in 2011-12, levels that are consistent with achieving medium-term debt sustainability, assuming full external debt restructuring.

Monetary Policy and the Exchange Rate

Price stability is the primary objective of monetary policy. The Central Bank’s early success in containing inflation and significant appreciation of the rupee provided scope to loosen monetary policy in the second half of 2009. This contributed to a significant reduction in T-bill rates, from over 30 percent at the start of the year to under 5 percent now. However, reflecting the nascent stage of financial sector development, the lending rates of commercial banks have been slow to respond and private sector credit growth remains subdued. The CBS is monitoring credit and price developments closely and stands ready to tighten monetary policy should inflationary pressures re-emerge.

Seychelles is committed to a floating exchange rate regime. The CBS’s interventions in the foreign exchange market are limited to smoothing out excessive volatility and ensuring orderly market conditions. The establishment of a foreign exchange market has provided a platform for a more efficient allocation of foreign currency among domestic banks; however, institutional factors coupled with market conditions (notably a surplus of foreign exchange in the system) have thus far held back the development of an inter-bank market. The CBS continues to work closely with banks, and make use of technical assistance from the IMF, to improve the efficiency of the foreign exchange market.

Financial Sector

The CBS continues to strengthen supervision and regulation of the financial sector. A modern Financial Institutions Act was recently put in place, strengthening the framework for financial sector regulation and development. The government also recently transferred supervision of state-owned non-bank financial institutions to the CBS, facilitating more effective oversight. Looking ahead, the CBS continues to implement an 18-month action plan to strengthen risk-based supervision, has plans to increase the minimum paid-up capital requirement for holders of a domestic banking license and will promote the use of the net tangible capital ratio as an added measure of capital adequacy. The CBS is also considering the possibility of introducing a deposit insurance scheme towards the end of the program period to enhance trust of the public in the banking system, and is developing guidelines for a crisis preparedness program.

Structural Reform Agenda

The government’s structural reform agenda is gaining momentum, focused on: fundamental reform of the tax system; rationalizing and reinforcing control over public expenditure; reducing the role of the state in the economy; financial sector development; modernizing labor and pension laws; and improving the business environment.

A fundamental medium-term reform of the tax system was launched with the 2010 Budget. The government’s objective is to have a simple, fair, and equitable system, which will promote growth, improve self-compliance and level the playing field for investors. The government’s tax reforms have three pillars: business tax rates will be reduced and the business tax base will be broadened by eliminating exemptions and sectoral preferences (tourism and fishing) and reducing thresholds (January 2010); a personal income tax (PIT) will be introduced, broadening the income tax base from withholding on wages to include other domestic-sourced income (July 2010); and a single rate VAT will replace the current GST, broadening the tax base and improving the efficiency of the indirect tax system (January 2012). The tax reform is projected to be broadly revenue neutral over the medium-term and will be accompanied by efforts to modernize and reinforce revenue administration.

The government is committed to implementing expenditure rationalization measures to create the space for growth-enhancing investment, drawing on the recommendations of World Bank Public Expenditure Reviews. Government employment has been reduced by some 2,500 employees (about 15 percent of the public sector workforce) over the last year through a voluntary departure and early retirement scheme. Building on these efforts, the functions of the civil service are being further streamlined, starting with the outsourcing of 650 non-core support staff, the removal of vacant posts from the government payroll and a targeted voluntary departure scheme for the security forces in 2010. The government is now in the process of articulating strategic plans for the health and education sector directed at improving the efficiency of government service provision. Introduction of a Treasury Single Account has reinforced control over public expenditure, while public sector wage policy is also being reformed through the implementation of a new wage grid that will improve transparency and establish a clearer link between remuneration and performance.

The government has adopted a public enterprise reform strategy to make the sector more efficient, transparent and accountable. The legal basis for this work was established with the National Assembly’s recent approval of the Public Enterprise Monitoring and Control Act, mandating strengthened reporting arrangements for public enterprises and setting uniform governance rules. In parallel, the government is also taking steps towards further rationalization of public sector ownership, with the Ministry of Finance preparing strategic assessments for each public entity - drawing on recently concluded external financial audits and management audits - evaluating the case for public ownership. The government recently launched tenders for an expert assessment of options for the future of the national airline and has requested IFC help on the privatization of the two publicly-owned banks. The government has also sought the assistance of the FIRST initiative to assess the government’s strategic options with regard to the three publicly-owned non-deposit taking institutions with a view to their consolidation and/or privatization.

Public Debt Negotiations

The Seychelles government has continued its good faith discussions with creditors on a comprehensive public external debt restructuring consistent with their medium-term payments capacity and the Fund’s lending into arrears policy. Seychelles successfully negotiated a debt restructuring with the Paris Club in April 2009 and has since signed a bilateral rescheduling agreement with Malaysia on comparable terms. A debt exchange offer to external commercial bondholders was launched in early December, compatible with Seychelles’ limited payments capacity and on terms comparable to those agreed with Paris Club creditors. The offer is supported by a guarantee operation from the African Development Bank that will raise the attractiveness for commercial creditors. Our authorities hope to conclude negotiations with commercial creditors early in the new year.

Finally, our Seychellois authorities would like to express their gratitude to Management for their support and the IMF mission chief and his team for their continued hard work in helping to shape Seychelles’ economic reform program.