Sierra Leone
2010 Article IV Consultation and First Review Under the Three-Year Arrangement Under the Extended Credit Facility, Request for Modification of Performance Criterion, and Financing Assurances Review-Staff Report; Public Information Notice and Press Release on the Executive Board Discussion; and Statement by the Executive Director for Sierra Leone
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International Monetary Fund
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Publication Date:
20 Dec 2010
eISBN:
9781455212934
Language:
English
Keywords:
ISCR; CR; Three-Year arrangement; Three-Year; request; spending; bank financing; financing gap; project support; world ranking; financing need; Budget planning and preparation
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After a period of economic slowdown, the outlook for Sierra Leone appears more favorable. Development priorities and their financing while maintaining a competitive economy and a sustainable debt outlook will help. Structural reforms will focus on improving tax administration, strengthening public financial management, and deepening the financial sector. A key constraint to economic growth in the medium term is the lack of basic infrastructure. Executive Directors support the request to modify the target on net domestic bank credit to the government.

Abstract

After a period of economic slowdown, the outlook for Sierra Leone appears more favorable. Development priorities and their financing while maintaining a competitive economy and a sustainable debt outlook will help. Structural reforms will focus on improving tax administration, strengthening public financial management, and deepening the financial sector. A key constraint to economic growth in the medium term is the lack of basic infrastructure. Executive Directors support the request to modify the target on net domestic bank credit to the government.

I. Background

1. Although macroeconomic stability has been achieved, Sierra Leone remains a post-conflict country whose growth prospects hinge on rebuilding infrastructure and developing an accessible financial sector. The rebuilding efforts that followed the end of the civil conflict in 2001 are far from complete—the country still suffers from lack of basic infrastructure and weak institutions. Despite relatively high economic growth in recent years, per capita income remains low, poverty is pervasive (estimates show that about 60 percent of the population remains below the poverty line), and Sierra Leone ranks at the bottom of the UN’s Human Development Index.

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Real GDP per capita, index

(1990=100)

Citation: IMF Staff Country Reports 2010, 370; 10.5089/9781455212934.002.A001

Development Indicators: Sierra Leone (SLE) and Sub-Saharan Africa (SSA)

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Sources: Human Development Report, UNDP and IMF staff calculation.

In 2007, Sierra Leone ranked 180 out of 182 countries for which this index was calculated.

Percentage of population aged 15 years and over.

2. The Government of Sierra Leone launched in 2009 the Agenda for Change to identify the key policy priorities for its poverty reduction strategy through 2012. The Agenda for Change identifies lack of infrastructure as the key impediment to economic growth and presents a strategy to accelerate public investments in infrastructure and promote private sector development. The strategy also identifies a need to support agricultural development and gradually strengthen health and education services. Although external donors have provided substantive concessional resources to finance an increase in public spending on infrastructure and social development, the financing gaps to implement the strategy are still significant. The focus of the current ECF-supported program is to create fiscal space for those spending priorities by strengthening tax performance and improving the public financial management system, as well as deepening the financial sector.

3. The medium term outlook for the Sierra Leonean economy is favorable. Following a period of slow growth, real GDP growth is expected to recover to 4.5 percent in 2010 and increase gradually to 6 percent by 2012, benefiting from the recent completion of the Bumbuna I power station, investment in basic infrastructure, and initiatives to improve the business climate and increase agricultural productivity. The global economic recovery would increase export demand for minerals and cash crops, which should contribute to exchange rate stability. Combined with expanding domestic food production, this should ease inflationary pressures. Monetary and exchange rate policies will aim at returning to single-digit inflation next year. However, import coverage of gross foreign exchange reserves is expected to decline from the current relatively high level as imports rebound with economic recovery and expansion in investment.

II. Policy Challenges Ahead

4. Against the backdrop of a difficult international economic environment with continued weak external demand and a likely decline in external budget support to Sierra Leone, the discussions focused on (i) development priorities and fiscal sustainability; (ii) domestic revenue potential including from mining; (iii) competitiveness of the economy; and (iv) the outlook for debt sustainability.

A. Development Priorities and Fiscal Sustainability

5. The authorities are determined to implement the Agenda for Change—Sierra Leone’s poverty reduction strategy paper (PRSP). They are embarking on an acceleration of public investments in basic infrastructure to remove one of the key constraints to create an enabling environment for businesses and to reach a sustainable growth path. At the same time, to ensure broad-based economic growth, where the quality of life for all Sierra Leoneans improves, more investment is needed in health and education. The authorities therefore intend to expand public spending on two fronts, in particular, in the coming years:

  • (i) Development of basic infrastructure. The authorities have identified priority projects for roads, energy, water, and sanitation systems across the country (Box 1). The plan will require a more than 10-fold increase in public infrastructure investment in the period 2011–13 compared to 2008–10. Only about one-fourth of the increase in investment is financed from current donor commitments and the projected medium-term budget. However, a significant increase in commitments of concessional project financing is expected from several donors, including the African Development Bank, the European Union (EU), Japan International Cooperation Agency (JICA), the Islamic Development Bank, and India. Nevertheless, a substantial residual financing gap for the three years will need to be closed by either raising domestic resources or identifying additional sources of external financing.

  • (ii) Improvements in health care. To reduce infant and maternal mortality and achieve the MDGs, the government launched a new free health care initiative (FHCI) in April 2010. The initiative involves provision of cost-free medical care and drugs to these vulnerable groups, hiring of health professionals and a significant improvement in the compensation to professional health workers to ensure elimination of user fees in all government hospitals and health centers. This initiative nearly doubled the domestically financed expenditure on health care in 2010. The annual total cost for 2010–12 is estimated at 2.8 percent of GDP. About 40 percent of this reflects the costs of medicines and other expenses, which are currently funded outside of the budget by donors. Staff emphasized the importance of transparently showing the full medium-term cost of this initiative in the budget to ensure the sustainability of the initiative as donor support tapers off.

Sierra Leone: Infrastructure Needs, 2010–13

The absence of basic infrastructure is a major obstacle to economic growth in Sierra Leone. The civil war destroyed most of the key transport system, power generation and distribution installations, and water pipelines. The government considers the achievements made since the end of the war as insufficient and it intends to accelerate investments in infrastructure in the coming years. To this end, the government has identified a number of priority projects to develop infrastructure for (i) roads, (ii) energy; and (iii) water and sanitation systems. So far, external donor contributions to infrastructure development have been relatively small. During 2008–10, donors provided US$301 million in project support, of which only US$36 million was intended for infrastructure development. For the same period, out of US$113 million domestically financed capital expenditures, the government spent US$68 million on infrastructure.

The government expects that closer cooperation with external donors, including nontraditional donors like the Islamic Development Bank, India, and China, will generate a stronger interest in supporting investments in infrastructure. For 2011-13, the government estimates an infrastructure need of US$1.4 billion, of which, based on current commitments, donors are projected to finance about US$176 million and the government US$161 million. This leaves a financing gap of about US$1.1 billion, or 15 percent of 2011–13 GDP (Table 1). The government expects that donors could provide an additional US$335 million. Furthermore, the plan is to attract private investors to construct and own the Bumbuna II hydropower station at an estimated cost of US$624 million. The remaining financing gap is US$96 million, which accounts for 1.4 percent of 2011–13 GDP. To finance this remaining gap, the government is considering two options: (i) increasing domestic revenues; and (ii) issuing long-term government bonds. However, the authorities are cognizant of the need to further develop the bond market in Sierra Leone before any significant amounts of long term-bonds could be issued at a reasonable financing cost. Therefore, the focus will need to be on domestic revenue mobilization.

Table 1.

Sierra Leone: Financing for Infrastructure Developments, 2008–13

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Source: GoSL and IMF staff estimates

The identified key infrastructure projects include:

Road projects: (i) reconstructing key roads connecting different regions of the country such as Makeni-Matotaka, Kenema-Koindu, Freetown- Conakry and the Port Loko-Lungi roads; and (ii) building rural roads and roads connecting rural areas with main inter-region roads.

Energy projects: (i) Bumbuna II hydropower station; (ii) creating capacity for generation of renewable energy through mini-hydro dams and solar energy at the rural level; (iii) extending capacity of thermal power generation at Bo and Western Area; and (iv) expanding and rehabilitating of transmission and distribution networks across the country.

Water and sanitation projects: (i) rehabilitating water supply in key provincial and district headquarter towns such as Mile 91, Pujehun, Kabbala and Makeni; (ii) improving access to drinking water in Freetown especially through installation of sub-mains; (iii) constructing of boreholes in rural areas; and (iv) providing safe drinking water in government hospitals across the country.

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Sierra Leone: Total Expenditure on Health, 2008-12

Citation: IMF Staff Country Reports 2010, 370; 10.5089/9781455212934.002.A001

Source: MoFED, UNICEF and Staff estimates.

6. The authorities are conscious of the challenge to finance the envisaged increase in priority spending. With an anticipated gradual reduction in external budget support, the authorities are considering issuing longer-term government bonds to fund an increase in infrastructure spending. Staff pointed out the need to carefully analyze the financing costs of issuing longer-term bonds because of the lack of depth of financial markets in Sierra Leone. Moreover, to maintain debt sustainability, there is no scope for increasing non-concessional borrowing beyond the domestic financing already envisaged in the medium-term fiscal framework. Given tight budget constraints and weak project implementation capacity, staff advised the authorities to select projects with the highest priority, contain nonpriority spending, and strengthen domestic revenue collections. While the authorities acknowledged the need to focus more on containing nonpriority spending, they were confident that tax revenue would rise in the future from newly signed iron ore mining projects.

B. Revenue Potential from Mining

7. Efficiency gains from goods and services tax (GST) and other taxes notwithstanding, there is a need to find new avenues to raise revenue to generate sufficient fiscal space to implement the government’s investment plans for infrastructure and social services. While the implementation of the 6.5 percent royalty on diamonds and elimination of GST exemptions would help, a more significant revenue potential lies in the country’s vast mining resources. The estimated mining potential, including recently signed agreements for iron ore mining, could raise total exports 10-fold while revenue from royalties alone could increase by about 6 percent of GDP (Box 2).

Sierra Leone: Mining Exports and Revenue Potential

Although mining has been an important economic activity in Sierra Leone since the 1930s, a significant potential for extraction and export of minerals remains untapped. Key minerals are rutile, bauxite, diamonds (alluvial and hard-rock deposits), gold, and iron ore. Other minerals include lignite, clays, base metals (copper, nickel, molybdenum, lead, and zinc), chromite, and platinum. Before the conflict, the mining sector played a major role in economic activity: GDP (20%), exports (90%), and fiscal revenues (4%). The Mines and Minerals Act of 2009 is expected to contribute to restoring the sector as the main engine of economic growth.

The general geology suggests that endowments are abundant and that new exploration and development would open new mines under the right conditions. The basic information available on the mineral potential of Sierra Leone is very poor, and the geological data is incomplete and outdated. The World Bank (Tapping the Mineral Wealth for Human Progress—A Break With the Past, 2005) has estimated that successful realization of the large-scale mineral potential of the country in diamonds, gold, rutile, and bauxite, could result in the establishment of four new mines, in addition to reactivation of three existing mines. As a result, total annual mineral export revenues could top US$370 million.

While the mining of iron ore dates back to the 1930s, it was abandoned in the 1980s. But with renewed market interest in minerals, an existing mine is being restored by a foreign investor (Marampa, London Mining). In addition, new exploration has discovered 10.5 billion tons of iron ore deposits (Tonkolili, African Minerals). Annual production is conservatively estimated at 35 million tons annually in the medium term. Potentially, it could be as much as 45–75 million tons annually, if fully implemented over the next decade. Chinese investors have reportedly expressed interest in the project.

Preliminary geological investigations in the 1960s identified favorable conditions for hard-rock gold minerals. Potentially, the volume of gold production could increase from 6,000 to 300,000 oz under the right conditions. But more systematic exploration is needed to determine the extent of gold deposits.

Exports of major mineral deposits could range from US$370 million to US$3.3 billion annually in the next decade. This compares to mineral exports of US$203 million (total exports of US$341 million) in 2010 (Table 1). Revenue from royalties alone could range from US$16 million to US$114 million annually (assuming royalty rates of 6.5% on diamonds, 5% on gold, and 3% on other minerals) compared to US$3 million for the same commodities in 2010. Even at the lower end of this potential range, it would be a major contribution to exports and fiscal revenue, raising the low fiscal revenue-to-GDP ratio and lowering the high debt-to-exports ratio. New policy measures taken in 2010 increased the royalty rate on diamonds to 6.5 percent.

Table 1:

Mining Potential in Sierra Leone

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8. Two mining lease agreements on iron ore, signed by the government earlier this year, could increase tax revenues significantly. While staff previously had raised strong concerns about the extensive tax exemptions provided in the first agreement (ratified by parliament in early 2010), the fiscal regime in a second mining lease agreement ratified in August is more attractive for the government, despite containing some tax concessions. Staff reiterated its position that the fiscal framework defined in the current tax legislation and the new Mines and Minerals Act is appropriate and should be applied to all future mining investments. While the authorities argued that limited tax concessions were necessary to attract investors for the second project, they are committed to applying the existing fiscal regime in the future. The related revenue potential from royalties, income tax, and licenses could be substantial in the medium term. Estimates prepared by staff indicate that annual tax revenues from iron ore could reach 10–12 percent of GDP in 2014–15, if the projects are implemented as planned. Staff stressed that at this early stage, when uncertainties about timing and production amounts remain significant, it is important to manage expectations and contain spending until the revenue starts to be collected.

C. Competitiveness of the Economy

9. Staff sees the value of the leone as broadly in line with fundamentals. The mission discussed with the authorities the results of its analysis of external stability and structural competitiveness.

10. The exchange rate assessment: Sierra Leone’s exchange rate regime is classified as floating, with the value of the leone determined by the market. The Bank of Sierra Leone (BSL) maintains a weekly foreign exchange auction, which is used mainly to sterilize domestic government spending financed by foreign grants and loans. The competitiveness of the leone was assessed using the three CGER approaches and an alternative approach based on monthly observations (Box 3). Despite sensitivity to methodological differences, none of the approaches used show significant exchange rate deviations from estimated equilibrium values at end-2009. The authorities welcomed the staff’s assessment and agreed to maintain exchange rate flexibility to allow full adjustment to exogenous shocks.

11. Structural competitiveness: The World Bank’s Doing Business Report 2010 ranks Sierra Leone 148th out of 183 countries in the world, and 22nd among 46 Sub-Saharan African countries. Sierra Leone’s world ranking improved from 160 in 2008 to 148 in 2010 as the economy underwent structural reforms. For example, business start-up has become easier with the establishment of a one-stop shop for business registration. In addition, tax administration has been simplified with better training and equipment at the tax authority, a consolidated income tax act, and a new value added tax that replaced seven existing indirect taxes. However, the authorities understand the need to further improve the business climate, especially by rationalizing tax administration, reducing bureaucracy, enforcing contracts and developing property rights.

Sierra Leone: Exchange Rate Assessment

After depreciating in the first half of the 2000s, the real effective exchange rate (REER) has started to recover, though with significant fluctuations. More recently, the REER appreciated strongly at the onset of the global crisis in late 2008, mainly reflecting price compression among major European trading partners and a strong depreciation of the British pound. However, this trend reversed with the marked depreciation of the leone in 2009, resulting in a depreciation of the REER of about 30 percent from its peak in early 2009 to early 2010. This depreciation was caused mainly by a decline in export proceeds and transfers due to the second round effects of the global economic crisis.

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Sierra Leone: Recent Development of REER and NEER January 2000-June 2010

Citation: IMF Staff Country Reports 2010, 370; 10.5089/9781455212934.002.A001

Sources: IMF, Information Notice System; and Fund staff estimates and projections.

Assessing the exchange rate with tools developed by the Consultative Group on Exchange Rates (CGER) indicates that the real effective exchange rate in 2009 was very close to its estimated equilibrium level and thus broadly aligned with macroeconomic fundamentals. Specifically, the exchange rate was within a range of less than 5 percent of the estimated equilibrium rate in 2009.

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In addition to the standard CGER approaches, the relationship between the nominal effective exchange rate (NEER), the relative price between Sierra Leone and trading partners, and international oil prices has been analyzed using monthly data. By defining equilibrium according to this modified Purchasing Power Parity model, the exchange rate was found to be practically fully aligned with price fundamentals. While the variation around equilibrium has been quite volatile in recent years, the NEER was only 0.2 percent away from its equilibrium in June 2010.

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Sierra Leone: Monthly NEER Disequilibrium in PPP Model (Percent) January 2002-June 2010

Citation: IMF Staff Country Reports 2010, 370; 10.5089/9781455212934.002.A001

Sources: IMF, Information Notice System; and Fund staff estimates.

It should be emphasized that data limitations, model selection, and structural changes in the economy severely limit the scope for precise point estimates of the equilibrium exchange rate in the context of a post-conflict country like Sierra Leone. This applies particularly to the two indirect CGER approaches that depend critically on estimating current account norms that are not well defined in post-conflict circumstances

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Ease of Doing Business

Citation: IMF Staff Country Reports 2010, 370; 10.5089/9781455212934.002.A001

Source: Doing Business, World Bank
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Paying Taxes

Citation: IMF Staff Country Reports 2010, 370; 10.5089/9781455212934.002.A001

Source: Doing Business, World Bank

12. The multiple-price Dutch auction system applied by BSL gives rise to a multiple currency practice (MCP) subject to Fund jurisdiction. The current auction system has been in operation before the start of the current ECF arrangement. Staff continues to work towards a resolution of this issue in the context of a more comprehensive review involving MCPs of this nature in a number of countries.

D. Debt Sustainability

13. Sierra Leone’s risk of debt distress remains moderate.1 Although the present value of external debt-to-export ratio remains close to the 100 percent threshold, external debt indicators are expected to remain below the DSA thresholds through 2030. Staff reiterated the need for continued prudent macroeconomic policies and reliance on grants and highly concessional resources to finance government operations. The authorities concurred and explained that the government is reaching out to a broader group of donors to seek concessional financing for development programs. Staff welcomed the authorities’ resolve to strengthen debt management; they are in the process of adopting a new debt management law and are seeking technical assistance from the Bank and the Fund to develop a medium-term debt management strategy (MTDS). The dialogue with commercial creditors over debt relief is ongoing and the IDA Debt Reduction Facility is scheduled for implementation in 2011. The authorities are also pursuing negotiations with a few remaining official bilateral creditors in line with the enhanced HIPC Initiative.2

III. Recent Economic Developments and Program Performance

14. While economic activity has shown signs of a pickup in 2010, inflation has remained high (Figure 1 and Table 1).

Figure 1.
Figure 1.

Sierra Leone: Selected Macroeconomic Indicators, 2006-10

(Percent changes, unless indicated otherwise)

Citation: IMF Staff Country Reports 2010, 370; 10.5089/9781455212934.002.A001

Sources: Sierra Leonean authorities; and IMF estimates and projections.1/ Alternative calculation with weights based on economic importance of the three main currencies (USD, EUR, and GBP).
Table 1.

Sierra Leone: Selected Economic Indicators

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Sources: Sierra Leonean authorities; and Fund staff estimates and projections.

For 2010 data is for September.

  • Real GDP growth decelerated to 3.2 percent in 2009 owing to weak output in mining and manufacturing. However, economic activity appears to have picked up in 2010, reflected by marked growth in the services sector, buoyant agricultural production, and a rebound in exports. While lower fuel and domestic food prices eased inflationary pressures during most of 2009, inflation jumped by about 7 percent in the first two months of 2010 due to the introduction of the GST and higher domestic fuel prices. However, seasonally adjusted monthly inflation rates have stabilized since then, and inflation was 18.5 percent in the 12 months through September, but it is expected to decline to 16 percent by year-end.

  • The external current account deficit declined to 8.4 percent of GDP in 2009 from 11.5 percent of GDP in 2008. While exports were basically flat in 2009, imports declined, reflecting weaker economic growth and lower oil prices. However, exports picked up in 2010 because of higher diamond export volumes and prices. Despite BSL interventions to support the leone in 2009, gross international reserves increased to 6.1 months of imports at end-2009, reflecting the SDR allocation in 2009. Gross reserves declined to 5.2 months of imports at end-June 2010 because of a recovery of imports and temporary delays in external budget support.

  • The exchange rate stabilized in the first half of 2010 after a depreciation of about 28 percent in 2009. The BSL continued to supply foreign currency to the market through foreign exchange auctions, although the offered amount decreased from US$2 million per week in January to less than US$1 million per week in September, reflecting reduced pressures in the market.

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Sierra Leone: External Trade, 2006-10

Citation: IMF Staff Country Reports 2010, 370; 10.5089/9781455212934.002.A001

Sources: Sierra Leonan authorities; and Fund staff estimates.

15. Fiscal policy performance during the first half of 2010 was broadly satisfactory (Tables 2 and 3). The overall deficit, excluding grants, was 6.1 percent of GDP, compared to 6.3 percent of GDP in the program. Revenue collections were above the target and current spending was close to the program, but the wage bill was higher owing to hiring in the health sector. Capital expenditures were below program because of shortfalls in external project support, while domestically financed capital spending was higher than envisaged.

Table 2.

Sierra Leone: Fiscal Operations of the Central Government

(In billions of leone)

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Sources: Sierra Leonean authorities; and Fund staff estimates and projections.

Replaced by GST on January 1, 2010.

Table 3.

Sierra Leone: Fiscal Operations of the Central Government

(In percent of GDP)

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Sources: Sierra Leonean authorities; and Fund staff estimates and projections.

Replaced by GST on January 1, 2010.

16. In the first two months of the third quarter of the year, however, budgetary spending accelerated. Despite continued improvement in revenue collections, this caused an unexpected deterioration in the fiscal position. The increase in spending was spread across many items, including wages for hiring another 3,000 health care staff to implement the FHCI, increased compensation to military families, higher than anticipated debt service payments, keeping the emergency power project beyond June, and payments to complete important road projects. In addition, arrears to oil marketing companies (0.3 percent of GDP) were cleared. The increased financing need in July and August was covered mostly by drawing on overdrafts in the BSL amounting to 1.2 percent of GDP.

17. Monetary policy remained tight through the third quarter of 2010. As envisaged in the program, the BSL managed to halt the monetary expansion that took place toward the end of 2009. As a result, reserve and broad money grew only about 3 and 5½ percent, respectively, in the first half of 2010 (Table 4). Despite the slowdown in money growth, credit to the private sector expanded by about 40 percent in the 12 months through June. Following a significant improvement in the quality of banks’ loan portfolios in the last few years, the ratio of nonperforming loans to gross loans increased to 13.6 percent in June 2010 from 10.6 in December 2009 (Table 9). Notwithstanding the significant direct credits from the BSL to the Government in the third quarter of the year, reserve money was contained in line with the program. The BSL sold a substantial amount of its holdings of treasury securities to the commercial banks to absorb the liquidity created by the fiscal expansion. As a result, interest rates on treasury bills increased by 400 basis points in the third quarter to about 18 percent.

Table 4.

Sierra Leone: Monetary Accounts 1/

(In billions of leone; unless otherwise indicated)

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Sources: Sierra Leonean authorities; and Fund staff estimates and projections.

End of period

Include public enterprises and the local government.

Including valuation.

Table 5.

Sierra Leone: Balance of Payments

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

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Sources: Sierra Leonean authorities; and Fund staff estimates and projections.
Table 6.

Sierra Leone: Indicators of Capacity to Repay the Fund

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Source: IMF staff estimates and projections.

There are no interest payments to the Fund in 2010-11.

Total debt service includes IMF repayments.

Table 7.

Sierra Leone: Schedule of Disbursements Under the ECF Arrangement, 2010-2012

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Table 8.

Sierra Leone: Millennium Development Goals

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Source: World Development Indicators database, 2009.
Table 9.

Sierra Leone: Financial Soundness Indicators of the Banking System, 2005–10

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Source: Bank of Sierra Leone.

Capital requirement over risk-weighted assets (solvency ratio).

Core capital (Tier I) over total assets.

Calculated taking into account both domestic currency and foreign currency deposits. Liquid assets include domestic currency cash in vault, claims on the BSL, claims on discount houses, and government securities.

Effective November 2007, minimum liquidity includes 40 percent of demand deposits and 20 percent of quasi-money to be held in either cash or treasury bills.

A single large exposure of an institution is any exposure that is 2 percent or more of its capital base.

18. Program performance was satisfactory in the first half of 2010. All quantitative performance criteria for end-June 2010 were met (MEFP Table 1). The two structural benchmarks for end-June (implementing an automatic fuel pricing mechanism and adopting new off-site surveillance guidelines) were implemented but with a delay (MEFP Table 2). Similarly, two of the three structural benchmarks for September were implemented with a slight delay: the commissioner and the deputy commissioner were hired for the Domestic Tax Department (DTD); and amendments to the Government Budget and Accountability Act and the Financial Management Regulation were submitted to the parliament to ensure that only viable capital projects enter into the budget.

IV. Program Issues

19. Consistent with the Agenda for Change, the key program objective is to raise growth by increasing investments in infrastructure and developing the private sector. In order to achieve this objective, the focus will remain on (i) creating fiscal space for improving basic infrastructure and social services while maintaining macroeconomic stability; (ii) strengthening tax performance and improving public financial management (PFM) systems; and (iii) developing the financial sector by making it more accessible and strengthening BSL independence and supervisory role.

A. Policies for the Remainder of 2010

20. Budget expenditures for 2010 are projected to be 1.2 percent of GDP higher than programmed, partly financed by higher revenue collections. Spending is projected to increase in the second half of the year due to additional needs to implement the national development priorities: hiring an additional 3,000 health care workers under the FHCI, maintaining an emergency power project, and investing in additional infrastructure, particularly roads. Moreover, foreign interest payments are projected to increase owing to exchange rate changes. On the financing side, payments for clearing arrears to oil marketing companies are projected to exceed the program by 0.3 percent of GDP stemming from unpaid subsidies accumulated because of delays in implementing a new automatic domestic fuel pricing framework. On the revenue side, the GST is continuing to exceed expectations; therefore, for the year as a whole, domestic revenue has been revised up by 0.6 percent of GDP. As a result, the overall fiscal deficit, excluding grants, is projected to increase to 11.5 percent of GDP, compared to 10.8 percent of GDP in the program. On this basis, there is a need to revise the program target for net domestic bank financing from 2.4 percent of GDP to 3.3 percent of GDP in 2010. In the event that domestic revenue exceeds the revised projection for 2010, the authorities have agreed to reduce net domestic bank financing correspondingly (MEFP ¶10).

21. While recognizing the tremendous needs of the country, staff stressed the importance of maintaining budget discipline and limiting the use of overdrafts in the BSL. Staff raised concerns about the significant use of overdrafts in the BSL to finance the fiscal expansion in the third quarter of 2010.3 The use of direct financing from the BSL, except for smoothing purposes, to finance government spending hinders liquidity management and the overall objectives of monetary policy. Looking forward, the authorities committed to strengthening budget discipline, increasing revenue collection, containing nonpriority expenditures, and reducing overdrafts with the BSL. To this end, the authorities (i) made the increase in diamond royalties to 6.5 percent effective in November 2010; (ii) implemented, by end-October 2010, a new automatic domestic fuel price framework that will eliminate existing subsidies within a few months; and (iii) reduced government overdrafts with the BSL by about Le 30 billion (0.4 percent of GDP) in early November 2010, and committed to amending the BSL Act to limit direct BSL credit to the government, including overdrafts, to 5 percent of the previous year’s domestic revenues (MEFP ¶ 29).

22. Monetary policy will seek to contain inflationary pressures from the introduction of the GST and the fiscal expansion. The monetary program has been maintained as envisaged in the program. Reserve money growth is targeted at 7.5 percent in 2010 to keep inflation below 16 percent by end-2010. The BSL will stand ready to tighten monetary policy further, should inflationary pressures increase. With a stable leone against the US dollar, the amount offered in the foreign exchange auction will remain at a reduced level for the rest of 2010. The program end-December targets for net domestic assets and gross international reserves have been maintained.

23. On the structural program, the two benchmarks for end-December 2010—establishing a credit reference bureau and integrating the GST administration within the Large Taxpayer Office—are on schedule to be met (MEFP Table 3).

B. Policies for 2011

24. The macroeconomic outlook is positive for 2011. The economy is expected to grow by 5.2 percent, while inflation should return to single-digits. This will be supported by an increase in public investment and a monetary policy aimed at achieving single digit inflation and maintaining a flexible exchange rate.

Fiscal policy

25. Fiscal policy in 2011 is to boost infrastructure investment to support sustained economic growth. The authorities are preparing the 2011 budget that envisages higher domestic revenue and a significant increase in capital spending, mainly financed by external grants or concessional loans (MEFP ¶16–19). Fiscal policy will be anchored by keeping domestic financing from banks and nonbank financial institutions close to 2 percent of GDP.

26. The authorities are focused on raising revenues. Domestic revenue is projected to increase to 13.3 percent of GDP from 13 percent of GDP in 2010, reflecting an increase in diamond royalties to 6.5 percent, continued efficiency gains from GST, and benefits from tax administration reforms. Although royalties could begin to be collected from the new iron ore mining projects, the authorities have prudently incorporated only the annual license fees into the budget projection for 2011. Grants remain at 6.8 percent of GDP as the anticipated decrease in budget support by 0.9 percent is offset by an increase in project grants. Privatization proceeds are projected to yield an additional 0.6 percent of GDP.

27. On the expenditure side, the authorities foresee a shift from current to capital spending. To build basic infrastructure, capital spending is projected to increase by 1.8 percentage points of GDP to 10.2 percent of GDP in 2011, mostly financed by external project grants and concessional project loans. Current expenditures are envisaged to decline, reflecting containment of non-priority spending on goods and services, and savings arising from the termination of the emergency power project.4 However, spending for preparations of the 2012 elections will partially offset these savings. The wage bill assumes a 15 percent increase in basic salaries and includes the full year effect of the new hiring in the health sector.

28. Domestic bank financing will decline in 2011, while external project financing and privatization proceeds will increase. The overall fiscal deficit, excluding grants, is projected to increase to 12.5 percent of GDP from 11.5 percent of GDP in 2010. Net domestic financing from banks and nonbank financial institutions is projected to decline to 2.3 percent of GDP in 2011 from 3.5 percent of GDP in 2010. The decline in domestic bank financing and the switch from current to capital spending will support private sector development and help achieve lower inflation in 2011.

Monetary and exchange rate policies

29. Monetary policy will aim to achieve single digit inflation by the end of 2011. Continued tight monetary policy, combined with the reduction in annual inflation because of a base effect stemming from the 7 percent price jump in January-February 2010, is projected to achieve a significant reduction in inflation in 2011. Reserve money is envisaged to grow by 14 percent and broad money by 20 percent; this should accommodate a 31 percent growth in private credit. With constrained government access to direct credit from the BSL and active use of the repo and reserve repo instruments, liquidity management is expected to improve.

30. The authorities are committed to maintaining a flexible exchange rate to facilitate adjustment to external shocks. The BSL will limit its foreign currency sales to absorbing foreign-financed budget spending and smoothing short-term market volatility (MEFP ¶21). With a rebound in exports and prudent macro policy, the volume of BSL’s foreign exchange auctions is expected to remain low in 2011.

Financing assurances

31. The government is making good faith efforts to resolve external arrears to commercial creditors; those are estimated at US$240 million at end-2009. The authorities continue to engage creditors and have made goodwill payments to avoid litigation. They secured a grant to fund the preparatory work for an IDA debt-buy-back program. Once implemented, possibly as early as end-2011, external commercial debt could be reduced by over 90 percent. Government policy is that no creditor will be exempted from participating in the program. Ongoing efforts to resolve these arrears provide sufficient financing assurances for the Fund-supported program.

Structural reforms

32. The authorities are committed to stepping up structural reforms to complement the scaling up of public investment and providing for other development priorities. Reforms will focus on

  • Improving tax administration: To reduce inefficiencies arising from separate tax departments and to enhance tax compliance, the National Revenue Authority (NRA) will integrate GST operations with the Large Taxpayer Office (LTO) and Medium Taxpayer Office (MTO). In addition, the NRA will step up efforts to improve tax compliance by implementing a small taxpayer regime and applying penalties for noncompliance (MEFP ¶23–24).

  • Strengthening PFM: The authorities aim to strengthen the Medium Term Expenditure Framework (MTEF) by enhancing the planning, monitoring and evaluation process for capital projects. They also plan to improve the quality of the workforce in the public sector by implementing a multiyear pay reform. Budget execution will continue to be strengthened by the rolling out of IFMIS to ministries, departments and agencies (MEFP ¶25–27).

  • Strengthening the financial sector: The BSL will enhance the conduct of its monetary policy by establishing a benchmark interest rate. The independence of the BSL will be strengthened, as will its supervisory role in reducing vulnerabilities (with the adoption of new off-site surveillance guidelines for banks). The BSL will also limit its direct credit to the government, which will foster the development of bond markets. Access to credit will be enhanced by establishing a credit reference bureau and strengthening the payments and settlements system. In addition, the Anti-Money Laundering (AML) Act 2005 has been revised to include provisions for combating the financing of terrorism (CFT); these are to be submitted to the parliament by the end of the year (MEFP ¶28–33).

V. Program Risks

33. There are risks to budget implementation in the short and medium term. The pressure to increase wages outside of the health care sector continues and the budget cost of the FHCI could be higher than envisaged if donor support does not come through as projected. The budget will be strained further if revenue collections from higher royalties on diamonds do not materialize, while the authorities have committed to large infrastructure projects. To reduce these fiscal risks, a timely implementation of the public service pay reform will be important. In addition, efforts are required to improve tax performance through reforming tax administration and eliminating discretionary tax incentives. In the medium term, tax revenue from mining may be lower than anticipated if the new mining projects do not fully materialize.

34. Sierra Leone has adequate capacity to meet its financial obligations to the Fund. The country has established a record of timely servicing its obligations to the Fund, and the DSA places Sierra Leone at a moderate risk of debt distress (Table 6). Debt service to the Fund would remain modest in absolute terms, and below 1.5 percent of exports of goods and services throughout the program period.

VI. Ex Post Assessment

35. As Sierra Leone is a member with a longer-term program engagement with the Fund, an Ex Post Assessment (EPA) update has been circulated to the Executive Board (www.imf.org). The EPA focused on program objectives and design, as well as key lessons from the experience. The update found that the authorities and donors agree that the Fund has been an essential advisor on macroeconomic policy. Key EPA recommendations include continued focus on strengthening capacity through technical assistance, setting ambitious but realistic revenue targets, formulating structural benchmarks that are of macro-critical importance, and fostering better coordination among the authorities, donors and the Fund to conduct a more forward-looking discussion of the macroeconomic framework for the following fiscal year, thus reinforcing the budget preparation process.

VII. Staff Appraisal

36. After a period of economic slowdown, the outlook for Sierra Leone appears more favorable. Growth is expected to pick up due to strong growth in the services sector and buoyant agricultural production. However, inflation is projected to remain in double digits this year owing to the introduction of the GST, but it is expected to decline to single digits in 2011.

37. A key constraint to economic growth in the medium term is the lack of basic infrastructure. While sustained strong growth is a necessary condition to achieve a significant reduction in poverty, a challenge for the authorities in the coming years will be to strike the right balance between spending on basic infrastructure and on social services. Staff welcomes the authorities’ current effort to accelerate infrastructure investments and encourages donors to expand their support.

38. A sustainable fiscal policy is critical for macroeconomic stability. Mobilizing more domestic revenues and containing nonpriority spending will continue to create fiscal space for investments in infrastructure and human resources. Staff is thus encouraged by the authorities’ resolve to raise royalties on diamond production, strengthen tax administration, and eliminate all subsidies on domestic fuel prices. On the spending side, it is important to contain the wage bill by raising compensation to public servants to more competitive levels only in the context of a multiyear pay reform.

39. Staff welcomes the authorities’ commitment to fully apply the fiscal regime for mining in accordance with the Mines and Minerals Act and current tax legislation. While the fiscal regime in a recent mining lease agreement for iron ore represents an improvement compared to agreements signed in the past, in staff’s view no tax incentives were needed to make the project economically attractive. Notwithstanding these tax concessions, the medium-term revenue potential from this mining agreement could be significant. However, in view of the uncertainty about the exact amounts and timing, staff recommends that new spending decisions should not be made before the increase in revenue materializes.

40. The fiscal expansion in the second half of 2010 has created a challenge for monetary policy. Staff welcomes BSL’s steadfastness to neutralize the liquidity effect of this expansion by significantly stepping up its open market operations. Staff also supports the BSL’s commitment to reduce inflation to single digits in 2011 and to establish a benchmark monetary policy interest rate. The BSL should continue to enhance banking supervision and closely monitor developments of nonperforming loans.

41. There are no concerns about competitiveness and external stability at present. Staff calculations show that the leone is broadly aligned with its fundamentals. The authorities are encouraged to maintain exchange rate flexibility to allow adjustment to exogenous shocks.

42. The DSA for Sierra Leone shows limited room for additional borrowing. Staff recommends that the authorities rely on grants and highly concessional loans for financing their development program. The authorities’ resolve to strengthen debt management is welcomed.

43. Staff supports the authorities’ commitment to accelerate structural reforms. The focus on improving tax administration, strengthening public financial management, and deepening the financial sector is appropriate. The first two reform areas will help create fiscal space for capital and social spending while the latter complements these efforts by encouraging private sector investment and activity.

44. Staff supports the authorities’ request to modify the target on net domestic bank credit to the government, given the measures taken by the authorities to improve revenue collection, constrain nonpriority spending, and reduce the government’s access to overdrafts with the BSL, as well as the authorities’ commitment to a 2011 budget consistent with macroeconomic and fiscal sustainability. Staff recommends completion of the first ECF review and the financing assurances review.

45. Staff recommends that the next Article IV consultation take place in accordance with the 2010 Decision on consultation cycles.

1

Debt Sustainability Analysis (DSA) 2010, www.imf.org.

2

Agreements on the delivery of the HIPC relief are still pending with China, Kuwait, and Saudi Arabia.

3

BSL overdrafts or “ways and means” increased to about 2.5 percent of GDP in the third quarter. Note that “ways and means” are only used as within-budget-year financing and any outstanding amounts need to be settled within 90 days after the end of the fiscal year. In the past, outstanding amounts, generally below 1 percent of GDP, have been repaid by issuing treasury bills to the BSL.

4

Budgeted spending on goods and services is 0.3 percentage points of GDP below the budget for 2010 (excluding the emergency power project). This saving reflects lower allocations for travel, vehicles, office equipment, and other nonpriority goods and services.

Appendix: Sierra Leone—Letter of Intent

November 17, 2010

Mr. Dominique Strauss-Kahn

Managing Director

International Monetary Fund

Washington, D.C. 20431

U.S.A.

Dear Mr. Strauss-Kahn:

The attached Memorandum of Economic and Financial Policies (MEFP) supplements the one attached to my letter to you dated May 18, 2010. It describes recent economic developments and progress in the implementation of the ECF-supported program during the first half of 2010 and presents our policies planned for the remainder of 2010 and 2011.

All June 2010 quantitative performance criteria and indicative targets were met. The two structural benchmarks for June were met, but with a slight delay: the automatic domestic fuel-pricing formula was adopted in October to bring the domestic pump prices in line with international oil prices and the BSL adopted the new off-site surveillance guidelines for banks in November.

Although fiscal policy remained on target in the first half of 2010, spending accelerated in the second half of the year due to unanticipated expenditures on emergency power project, hiring of health care workers, higher interest payments, outlays for road construction, and payments of arrears to oil marketing companies because of delays in implementing full pass-through of international fuel prices. While tax collections are anticipated to exceed program projections, mostly explained by very good performance of the GST introduced in January, additional domestic financing of 0.9 percent of GDP will be required in 2010. Hence, the Government of Sierra Leone (GoSL) requests that the target for end-December 2010 on net domestic bank credit to the central government be modified. To further boost domestic revenue in 2011, we have raised royalties on diamonds to 6.5 percent, in line with the Mines and Minerals Act 2009. The GoSL is committed to present to Parliament a 2011 budget that constrains non-priority spending and target net domestic bank financing of about 2 percent of GDP.

On this basis, the GoSL requests that the second disbursement be made available upon completion of the first review under the ECF arrangement.

The GoSL believes that the policies set forth in the attached MEFP and Technical Memorandum of Understanding (TMU) are adequate to achieve the objectives of the new program, but stands ready to take any further measures that become necessary for this purpose, in consultation with the Fund. The GoSL will consult with the Fund in advance of revisions to the policies contained in the MEFP and continue to provide the staff of the IMF the information required to accurately assess Sierra Leone’s progress in executing the policies in the MEFP. The second, third, and fourth reviews under the current program shall take place in June 2011, December 2011 and June 2012, respectively. Furthermore, the GoSL will continue to consult with the IMF on its economic and financial policies, in accordance with the IMF’s policies on such consultations.

The GoSL agrees, in line with its commitment to transparency and accountability, to the publication of this letter, its attachments, and the related staff report in accordance with the procedures for publication.

Very truly yours,

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Attachments

Attachment I. Sierra Leone: Memorandum of Economic and Financial Policies

I. Introduction

1. This memorandum reviews recent economic developments and outlines the macroeconomic policies and structural reforms that the Government of Sierra Leone (GoSL) will pursue under the current Extended Credit Facility (ECF).

II. Recent Economic Developments

2. Economic activity appears to have picked up in 2010. Exports of diamonds have rebounded and indicators point to buoyant agricultural output. Real GDP growth is projected at 4.5 percent in 2010, compared to 3.2 percent in 2009. While lower fuel and domestic food prices eased inflationary pressures during most of 2009, inflation rose in the first half of 2010 due to the depreciation of the leone in late 2009, the introduction of the goods and services tax (GST) in January, and higher domestic fuel prices. The CPI increased by 18 percent in the 12 months through August 2010. However, so far this year, the leone has been stable against the US dollar.

3. Fiscal policy was broadly implemented as programmed through June. Revenue collections were above the target and current spending was close to the program, but the wage bill was higher due to higher than anticipated hiring in the health care sector. Capital expenditures were lower than programmed due to shortfalls in external project support. However, domestically financed capital spending was higher than envisaged.

4. Monetary policy remained tight in the first half of 2010. Growth in reserve money and broad money decelerated significantly in the first half of 2010, as programmed. Private sector credit continued to expand in the first half of 2010, albeit at a slower pace. With a stable value of the leone, the amount offered on the BSL’s weekly foreign exchange auctions fell as envisaged in the program to less than US$1 million by June.

5. Program performance was satisfactory in the first half of 2010. All June 2010 quantitative performance criteria and indicative targets were met (Table 1) and the two structural benchmarks for June have been implemented, though with some delay (Table 2). Moreover, two of the structural benchmarks for September have been implemented, though with a slight delay, and the remaining benchmark is expected to be implemented in November 2010.

Table 1.

Sierra Leone: Quantitative Performance Criteria and Indicative Targets for 2010 1/

(Cumulative change from beginning of calendar year to end of month indicated; Le billions, unless otherwise indicated)

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The performance criteria and indicative targets are defined in the Technical Memorandum of Understanding (TMU).

Indicative targets.

These apply on a continuous basis.

Including grants and loans.

Comprises treasury bills purchased by the National Social Security and Insurance Trust (NASSIT) and the nonfinancial private sector.

Table 2.

Sierra Leone: Structural Benchmarks for 2010

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III. Medium-Term Framework

6. The medium term outlook for the Sierra Leonean economy is favorable. Real GDP growth is expected to recover to 4.5 percent in 2010 and increase to 6 percent by 2012, benefiting from the recent completion of the Bumbuna power station, investment in basic infrastructure, and initiatives to improve the business climate and raise agricultural productivity. The global economic recovery will increase export demand for minerals and cash crops, which should contribute to exchange rate stability. Combined with expanding domestic food production, this should ease inflationary pressures. Monetary and exchange rate policies will also aim at returning to single-digit inflation, with inflation projected to decline from 16 percent in 2010 to 8 percent in 2012. However, import coverage of gross foreign exchange reserves is expected to decline from 6.1 months in 2009 to 4.6 months in 2012, as imports recover with economic recovery and expansion in investment.

7. The economic impact of newly signed mining lease agreements for iron ore could be significant. Assuming full implementation of the planned investments, exports and tax revenue would increase substantially in the medium- and long-term. However, since these projects are still in their infancy and there are uncertainties about the timing and production volumes, they have not been incorporated in the medium-term macroeconomic projections. Moving forward, the government wishes to level the playing field for new mining investments and it will therefore apply the fiscal regime defined in the Mines and Minerals Act (MMA) 2009 and existing tax and custom acts to future mining lease agreements. Also, the government will consider, as stipulated for in the MMA, demanding an equity stake in future larger mining projects to participate in windfalls and to gain insight into the mining business.

8. Consistent with the priorities laid out in the Agenda for Change 2008–12 (PRSP II), the emphasis will be to create fiscal space to improve basic infrastructure while maintaining macroeconomic stability. Since grants and concessional budget financing from donors are likely to decline to pre-crisis levels in the next few years, the government recognizes the urgent need to increase domestic revenue and strengthen the efficiency of public spending. Reflecting efficiency gains from the introduction of GST and improvement in tax administration, the aim is to raise domestic revenue above 13.5 percent of GDP by 2012. To achieve this target, the GoSL will fully apply the fiscal regime stipulated in existing tax and customs acts and will resist issuing discretionary tax exemptions. Fiscal space will further be created by containing non-priority spending, and raising public sector efficiency, especially on project selection and implementation. The GoSL is committed to keeping domestic financing below 2 percent of GDP to maintain debt sustainability and prevent crowding out of the private sector.

9. Debt sustainability will remain a priority. The GoSL is committed to a conservative strategy of external borrowing on concessional terms. A comprehensive national debt law and procedures manual will be adopted in 2010. In collaboration with the Public Debt Unit of Ministry of Finance and Economic Development (MOFED), government agencies are working on improving the quality of debt data and reporting in order to better monitor commitments, disbursements, and debt service obligations. The Commonwealth Secretariat Debt Recording and Management System (CS-DRMS) will be electronically linked with IFMIS. In order to further improve on debt management, the Government is requesting assistance from the World Bank and the Fund with respect to developing a comprehensive Medium-Term Debt Management Strategy (MTDS).

IV. Policies for the Remainder of 2010

10. The fiscal deficit is projected to be higher than programmed in 2010. Fiscal spending has accelerated in the second half of 2010 due to the hiring of an additional 3,000 health care staff, unanticipated outlays for the emergency power project that was supposed to expire in June, payments of arrears on fuel subsidies, and additional infrastructure projects particularly on roads. For the year, total expenditures, including payments of arrears, are projected to be 1.5 percentage points of GDP higher than programmed. On the revenue side, the GST continues to perform better than anticipated and revenues are therefore projected to exceed the program target by 0.6 percentage points of GDP. With unchanged program budget support grants and loans, domestic bank financing is projected to increase to 3 percent of GDP from 2.1 percent as envisaged in the program. The overall fiscal deficit, excluding grants, is projected to increase to 11.5 percent of GDP from 10.8 percent of GDP in the program. In case domestic revenues, including any prepayment of taxes, exceed Le 988 billion, the additional revenue will be used to reduce domestic bank financing in 2010.

11. The GoSL has consolidated several existing tax incentives from a number of sector-specific acts into the tax and customs acts. The aim is to maintain the current incentives without introducing new ones, while working towards eliminating all discretionary tax incentives and exemptions. To this end, the GoSL has submitted the Revenue Management Act 2010 to Parliament for enactment. The purpose of the act is to regulate the granting of tax incentives and discretionary duty waivers. Furthermore, to evaluate the costs and benefits of this policy, the GoSL will prepare a policy review by March every year covering the previous calendar year. This review will contain a list of all projects that have benefited from the catalogue of incentives, specify the purpose of the projects, and report foregone revenue. The review will be made publicly available and submitted to the Parliament.

12. A new Mines and Minerals Act came into effect on January 1, 2010. In line with the act, a 6.5 percent royalty for diamond mining became effective in November 2010. The annual revenue effect is estimated at 0.2 percent of GDP.

13. Monetary policy will remain tight to prevent the second round effects of the increase in inflation from the introduction of the GST earlier this year and from higher domestic fuel prices. Reserve money is targeted to grow by 7.5 percent in 2010, consistent with 14 percent growth in broad money. Despite higher domestic financing of the budget, private sector credit is still anticipated to expand by a healthy 26 percent in 2010. The BSL will stand ready to tighten monetary policy further, should inflationary pressures increase. With a stable leone against the US dollar, the amount offered in the foreign exchange auction will remain at a reduced level.

14. Direct credit from the BSL to the government increased significantly in the second half of the year to finance accelerated budgetary spending. In September, government overdrafts in BSL amounted to about 2.7 percent of GDP. However, almost immediately, the BSL was able to withdraw liquidity by selling significant amounts of its holding of treasury bills to keep monetary policy on course. The GoSL recognizes shortcomings of relying on central bank financing. Hence overdrafts in BSL was reduced to about Le 175 billion in early November 2010 and will be further reduced to Le 150 billion (2 percent of GDP) by end-November 2010. In line with the BSL Act, all direct credits provided in 2010 will be repaid no later than 93 days after end-2010. Also, the GoSL is committed to revise the BSL Act to limit the use of direct credit to government in the future (see section VI).

V. Policies for 2011

15. Macroeconomic policies for 2011 will aim at improving basic infrastructure and social services while maintaining macroeconomic stability. This should help facilitate higher economic growth and lower inflation.

Fiscal policy

16. The 2011 budget envisages higher domestic revenue, a significant increase in capital spending, mainly financed by external grants or concessional loans, and a moderate domestic financing need.

17. On the revenue side, domestic revenue is projected to increase to 13.3 percent of GDP from 13 percent of GDP in 2010, reflecting an increase in diamond royalties to 6.5 percent and continued efficiency gains from GST. This projection does not incorporate any revenue from ongoing iron ore investment projects, except for the annual license fee. Grants remain at 6.8 percent of GDP as the decrease in budget support by 0.9 percentage points is compensated by an increase in project grants. Privatization proceeds are projected at 0.6 percent of GDP, reflecting sales of shares in Rokel Bank and Sierra Leone Commercial Bank, as well as proceeds from the concession of the port in Freetown.

18. On the expenditure side, a shift from current to capital spending is envisaged. In line with the priorities laid out in the Agenda for Change to build basic infrastructure, capital spending will increase from 8.4 percent of GDP in 2010 to 10.2 percent in 2011, financed by external grants and concessional project loans (7.5 percent of GDP) and domestic sources (2.7 percent of GDP). Wages and salaries are envisaged to decrease from 6.8 percent of GDP in 2010 to 6.5 percent in 2011, reflecting a 15 percent increase in basic salaries and savings accruing from the pay reform that would start implementation in the second half of the year. In order to conduct fair, peaceful and democratic elections in 2012, current expenditures will include Le 20 billion (0.3 percent of GDP) on elections, with additional donor support of Le 44 billion.

19. The overall fiscal deficit, excluding grants, is envisaged to increase to 12.5 percent of GDP from 11.5 percent of GDP in 2010. However, domestic bank financing is projected to decline to 1.8 percent of GDP from 3.3 percent of GDP in 2010, reflecting an increase in external project financing and privatization proceeds.

Monetary and exchange rate policies

20. Monetary policy will aim to achieve single digit inflation by the end of 2011. Reserve money is envisaged to grow at 14 percent that will imply a 20 percent growth in broad money and will accommodate a 31 percent growth in private credit. With a constrained access to direct credit from the central bank by the GoSL, liquidity management will be eased.

21. The authorities are committed to maintaining a flexible exchange rate to facilitate adjustment to external shocks. The BSL will limit its foreign currency sales to absorb foreign-financed budget spending and smooth short-term market volatility.

VI. Structural Reforms

22. The structural reform program will complement macroeconomic policies to promote an efficient public sector and higher sustainable private sector-led economic growth. Structural policies will continue to focus on improving tax administration, strengthening public financial management, and developing the financial sector (Tables 2 and 4). Policies for the two latter areas will be based on the Integrated Public Financial Management Reform Program (IPFMRP) and the Financial Sector Development Plan (FSDP), respectively.

Table 3.

Sierra Leone: Quantitative Performance Criteria and Indicative Targets for 2011 1/

(Cumulative change from beginning of calendar year to end of month indicated; Le billions, unless otherwise indicated)

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The performance criteria and indicative targets are defined in the Technical Memorandum of Understanding (TMU).

Indicative targets.

These apply on a continuous basis.

Including grants and loans.

Comprises treasury bills purchased by the National Social Security and Insurance Trust (NASSIT) and the non financial private sector.

Table 4.

Sierra Leone: Proposed Structural Benchmarks for 2011

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Improving tax administration

23. The GoSL will further step up efforts to improve tax administration and broaden the tax base. The current tax administration suffers from inefficiencies arising from separate tax departments for GST and income and it is not conducive to enhance tax compliance. To this end, the National Revenue Authority (NRA) will integrate GST operations (taxpayer services, filing and returns processing, and coordinated audit operations) with the Large Taxpayer Office (Structural Benchmark for December 2010). Moreover, NRA will transfer all eligible taxpayers to the Medium Taxpayer Office (MTO) and integrate the GST administration with MTO to improve the efficiency of tax collections (Structural Benchmark for September 2011).

24. The NRA will step up efforts to improve tax collection and compliance. Measures include applying penalties for non-filing of returns and underestimation of quarterly installment payments; and levying and collecting interest on late payment of tax. In a similar vein, a new small taxpayer regime will be implemented to improve voluntary compliance (Structural Benchmark for December 2011).

Strengthening public financial management

25. The GoSL will strengthen the Medium-Term Expenditure Framework (MTEF) by enhancing the planning, monitoring and evaluation process for capital projects. The government will fully integrate a three-year public investment plan with the budget process for 2012 budget in line with the amendments to the Government Budget and Accountability Act (Structural Benchmark for December 2011).

26. The GoSL is committed to building a high quality workforce in the public sector. To improve working conditions for the public service and to attract staff of high caliber, the government will develop and start implementing a multiyear pay reform (Structural Benchmark for June 2011). The reform will (i) realign current discrepancies in qualifications and grade placements; (ii) decompress the wage structure; (iii) retrench redundant staff; and (iv) gradually raise compensation to competitive levels financed partly from the restructuring and, if necessary, a moderate increase in the total public sector wage bill.

27. The roll out of IFMIS to MDAs will continue to strengthen budget execution. So far, IFMIS has been rolled out to 11 key MDAs with 2 additional MDAs in the process, accounting for about 65 percent of expenditures. The MOFED will continue to provide training and support to IFMIS users across MDAs to ensure that activities are properly and adequately captured within the system.

Financial sector measures

28. The independence of the BSL will be strengthened by amending the BSL and Banking Acts (Structural Benchmark for June 2011). The amendments will enhance the independence of the BSL and align the acts with the Basel Core Principles for Effective Supervision, as recommended by recent IMF TA missions.

29. There is a need to limit the use of BSL direct credits to the government. This will encourage the government to improve its cash flow management and support the development of securities market. Also, the amendments to the BSL Act will (i) set a limit of the annual flow of direct credits to the government (loans and advances) to 5 percent of the actual domestic revenue in the previous budget year; (ii) require that such direct credits are repaid within 93 days from the end of the financial year (repayments may be made with marketable treasury bills that mature before the 93 day deadline); and (iii) stipulate that the BSL may purchase government securities strictly for monetary policy purposes and provided that such purchases are only made in the secondary market. While these amendments are not likely to be approved before mid-2011, the government and the BSL are committed to adhere to the above principles for BSL direct credits to the government from the beginning of 2011.

30. The BSL will strengthen its supervisory role to reduce the vulnerabilities arising in the financial sector from NPLs. This will be achieved by developing a new IT platform and filling open staff positions in the Banking Supervision Department of the BSL. Also, the BSL will gradually move to a risk-based supervision system. In addition, the BSL has aimed to increase the minimum capital requirement from Le 15 billion to Le 30 billion over a five-year period, starting in 2010.

31. To develop a long-term capital market, the MOFED and the BSL will engage market participants, including the commercial banks, NASSIT and other non-bank financial institutions, to develop a long-term bond market consistent with the government’s financing need. The GoSL will also strengthen the capital market regulatory structure and governance by enacting the Securities and Exchange Commission’s (SEC) Act and implement associated regulations, and deepen the long-term capital market with the privatization and divestiture of slated public enterprises.

32. Private sector development is constrained by limited access to financial services. Lack of financial development is evident in low credit to the private sector. Access to credit will be enhanced by strengthening information structure through establishing a credit reference bureau (Structural Benchmark for December 2010). To improve efficiency of transactions in the economy, the BSL is working towards strengthening the payments and settlement systems. In this context the AfDB is financing the automation of the payment system, which includes: (i) Real Time Gross Settlement; (ii) Automated Cheque Processing and Automated Clearing House; (iii) Scriptless Securities Settlement System; (iv) Core Banking Application; and (v) Infrastructure Upgrade. Contracts have been awarded to solution providers for all components and studies to gauge the scope have been conducted for most of them.

33. To prevent opportunities for money laundering, by the end of this year the government will submit to the parliament a new law on Anti-Money Laundering and Combating the Financing of Terrorism.

other reforms

34. The GoSL has committed to the principles of Extractive Industries Transparency Initiative (EITI). The first EITI Report (covering mining for 2006–07) was published in March, and the final validation report was submitted on August 9, 2010. The validation report recommends a number of improvements to the governance and management of the process which are being considered. Furthermore, there are on-going efforts to disseminate the first Sierra Leone EITI report.

35. There is a need to strengthen Sierra Leone’s capacity to collect and disseminate economic statistics. The GoSL is seeking technical assistance from the IMF to improve the reporting of national account and price statistics. There is a particular need to improve collection of data on agriculture output and to compute one single reliable consumer price index.

VII. Program Monitoring

36. The program will be monitored based on quantitative performance criteria for end-December 2010, end-June 2011 and end-December 2011 (Tables 1 and 3), and structural benchmarks for 2010 and 2011 (Tables 2 and 4).

Attachment II. Sierra Leone: Technical Memorandum of Understanding

November 17, 2010

I. Introduction

1. This memorandum sets out the understandings between the Sierra Leonean authorities and the International Monetary Fund (IMF) regarding the definitions of the quantitative performance criteria (PCs) and structural benchmarks (SBs) for the program supported by the Extended Credit facility (ECF) arrangement, as well as the related reporting requirements. Unless otherwise specified, all quantitative PCs and indicative targets will be evaluated in terms of cumulative flows from the beginning of the period, as specified in Table 3 of the Memorandum of Economic and Financial Policies (MEFP).

2. Program exchange rates. For the purpose of the program, foreign currency denominated values in 2010 and 2011 will be converted from their U.S. dollar denominated value into Sierra Leonean currency (leones) using a program exchange rate of Le 3,990/US$.

II. Quantitative Performance Criteria

A. Gross Foreign Exchange Reserves of the Bank of Sierra Leone (BSL)

3. Definition. Unless otherwise noted, gross foreign exchange reserves of the Bank of Sierra Leone (BSL) are defined as reserve assets of the BSL. Reserve assets are defined in the IMF’s Balance of Payments Manual (5th ed.) and elaborated in the reserve template of the Fund’s International Reserves and Foreign Currency Liquidity: Guidelines for a Data Template. They exclude foreign assets not readily available to, or controlled by, the monetary authorities.

Adjustment clauses

4. The floor on the change in gross foreign exchange reserves will be adjusted (a) downward (upward) by the amount in U.S. dollars of the shortfall (excess) in programmed external budgetary assistance1—the downward adjustment will be capped at the equivalent of US$20 million; (b) downward (upward) for any shortfall (excess) in the U.S. dollar value of disbursements from the IMF under the ECF arrangement; and (c) upward (downward) for any increase (decrease) in BSL short-term (one year or less in original maturity) foreign currency-denominated liabilities (to residents and nonresidents).

B. Net Domestic Assets of the BSL

5. Definition. Net domestic assets (NDA) of the BSL are defined as the end-period stock of the reserve money less the end-period stock of net foreign assets calculated at the program exchange rates. Reserve money includes currency issued (equal to currency outside banks plus cash in vaults), deposits of commercial banks with the BSL and the BSL liabilities to other private sector. Net foreign assets of the BSL are defined as gross foreign exchange reserves (defined above) minus foreign liabilities. Foreign liabilities are defined as foreign currency-denominated liabilities of the BSL to nonresidents and the outstanding use of Fund credit. For program purposes, foreign liabilities exclude SDR allocation.

6. Adjustment clauses. The ceiling on changes in NDA of the BSL will be adjusted upward (downward) by the leone value of the shortfall (excess) in the external budgetary assistance at the test dates—the upward adjustment will be capped at the equivalent of US$20 million.

C. Net Domestic Bank Credit to the Central Government (NCG)

7. Definition. NCG refers to the net banking system’s claims on the central government as calculated by the BSL. It is defined as follows:

  • the net position of the government with commercial banks, including: (a) treasury bills; (b) treasury bearer bonds; and (c) loan and advances of commercial banks to the government; less government deposits in commercial banks;

  • the net position of the government with the BSL, including: (a) treasury bills; (b) treasury bearer bonds, excluding holdings of special bonds provided by government to cover the BSL losses; (c) the stock of non-interest bearing non-marketable securities (NIBNMS); (d) the difference between converted NIBNMS into treasury bills and proceeds from their sales; and (e) ways and means; less (a) central government deposits; and (b) HIPC and MDRI relief deposits.

8. Adjustment clauses. The ceiling on changes in NCG will be adjusted (a) upward (downward) by up to the leone value of the shortfall (excess) in external budgetary assistance—the upward adjustment will be capped at the equivalent of US$20 million; (b) downward (upward) by the excess (shortfall) in the leone value of net issues of government securities to the nonbank private sector vis-à-vis the program assumption (as specified in the memorandum items in Table 3 of the MEFP).

9. Data source. The data source for the above will be the series “Claims on government (net)”, submitted to the IMF staff and reconciled with the monthly monetary survey prepared by the BSL.

10. Definition of Central government. Central government is defined for the purposes of this memorandum to comprise the central government and those special accounts that are classified as central government in the BSL statement of accounts. The National Social Security and Insurance Trust and public enterprises are excluded from this definition of central government.

D. External Payment Arrears of the Public Sector

11. Definition. External payment arrears of the public sector are defined as the stock of new external overdue debt-service payments by the public sector. For the purposes of this PC, the public sector comprises the central government, regional government, all public enterprises and the BSL. The nonaccumulation of external arrears is a performance criterion during the program period. Excluded from this PC are those debts subject to rescheduling. This PC will apply on a continuous basis.

E. New Nonconcessional External Debt Contracted or Guaranteed by the Public Sector with an Original Maturity of One Year or More

12. Definition. Those are defined as all forms of new debt with original maturity of one year or more contracted or guaranteed by the public sector (see paragraph 11 for definition of public sector) based on the residency criterion. This PC applies not only to debt as defined in the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274 (00/85), August 24, 2000, Point 9, as revised on August 31, 2009, (Decision No. 14416-(09/91)) but also to commitments contracted or guaranteed for which value has not been received. Excluded from this PC are disbursements from the IMF and those debts subject to rescheduling. For the purposes of this PC, the “public sector” is as defined in ¶11 above. This PC will apply on a continuous basis.

13. Any external debt of which the net present value, calculated with the reference interest rates mentioned hereafter, is greater than 65 percent of the nominal value (grant element of less than 35 percent) is considered nonconcessional, with the exception of IMF lending. For debt with a maturity of more than 15 years, the average of the ten-year commercial interest reference rates (CIRRs) published by the OECD is used to calculate the grant element. The average of the six-month CIRRs is used for debt with shorter maturities. For loans in foreign currencies for which the OECD does not calculate a CIRR, calculation of the grant element should be based on the CIRR in SDRs. The Government will report any new external borrowing and its terms to Fund staff as soon as external debt is contracted or guaranteed by the government.

F. External Short-Term Debt Contracted or Guaranteed by the Public Sector

14. Definition. External short-term debt is defined as external debt stock with a maturity of less than one year contracted or guaranteed by the public sector (see paragraph 11 for definition of public sector). Debt is defined in Annex I of this TMU. For this purpose, short-term debt will exclude normal trade credit for imports. For the purposes of this PC, the public sector is as defined in ¶11 above. This PC will apply on a continuous basis.

III. Quantitative Indicative target

A. Domestic Revenue of Central Government

15. Definition. The floor on total domestic central government revenue is defined as total central government revenue, as presented in the central government financial operations table, excluding external grants.

B. Poverty-Related Expenditures

16. Definition. Poverty-related expenditures refer to those expenditures in the areas identified in Table 2 of the Sierra Leone HIPC Decision Point Document.

IV. Program Monitoring

17. The Sierra Leonean authorities shall maintain a program-monitoring committee composed of senior officials from the MoFED, the BSL, and other relevant agencies. The committee shall be responsible for monitoring performance under the program, recommending policy responses, informing the IMF regularly about the progress of the program, and transmitting the supporting materials necessary for the evaluation of PCs and benchmarks. The committee will provide monthly reports to the IMF on progress in implementing the program’s quantitative targets and structural benchmarks.

Annex 1: Implementation of the Revised Guidelines on Performance Criteria with Respect to Foreign Debt

The term “debt” has the meaning set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted on August 24, 2000, which reads as follows: “(a) For the purpose of this guideline, the term “debt” will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows: (i) loans, i.e., advances of money to obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans, and buyers’ credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements); (ii) suppliers’ credits, i.e., contracts where the supplier permits the obligor to defer payments until sometime after the date on which the goods are delivered or services are provided; and (iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair, or maintenance of the property. (b) Under the definition of debt set out above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt”. (c) Excluded from this performance criterion are normal import-related credits, disbursements from the IMF, and those debts subject to rescheduling arrangements.”

Sierra Leone: Summary of Data to be Reported to IMF Staff

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External budgetary assistance is defined as program grants and program loans, excluding HIPC assistance.

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Cover IMF Staff Country Reports
Sierra Leone: 2010 Article IV Consultation and First Review Under the Three-Year Arrangement Under the Extended Credit Facility, Request for Modification of Performance Criterion, and Financing Assurances Review-Staff Report; Public Information Notice and Press Release on the Executive Board Discussion; and Statement by the Executive Director for Sierra Leone
Author:
International Monetary Fund
Volume/Issue:
Volume 2010: Issue 370
Publisher:
International Monetary Fund
ISBN:
9781455212934
ISSN:
1934-7685
Pages:
87
DOI:
https://doi.org/10.5089/9781455212934.002

Real GDP per capita, index

(1990=100)

Sierra Leone: Total Expenditure on Health, 2008-12

Sierra Leone: Recent Development of REER and NEER January 2000-June 2010

Sierra Leone: Monthly NEER Disequilibrium in PPP Model (Percent) January 2002-June 2010

Ease of Doing Business

Paying Taxes
Figure 1.

Sierra Leone: Selected Macroeconomic Indicators, 2006-10

(Percent changes, unless indicated otherwise)

Sierra Leone: External Trade, 2006-10