Recent Economic Developments and Program Performance

4. Preliminary estimates suggest that growth slowed down slightly in 2011 to reach about 5 percent, as the external environment deteriorated largely on account of the Eurozone crisis. While tourism and public investment largely maintained their contribution to growth, FDI declined significantly and official transfers were lower than expected. Higher global food and fuel prices fueled inflation and contributed to widening the current account deficit. Reflecting these unfavorable circumstances, the external position of the country weakened, with a notable decline in international reserves. Delayed disbursement of donor assistance aggravated these reserve losses by leading to a reduction of government deposits at the BCV.

5. Performance under the fiscal program was satisfactory as all quantitative targets for end-September 2011 were met. However, on the monetary front, the two quantitative criteria related to net domestic assets (NDA) and net international reserves (NIR) were missed owing largely to deteriorating external conditions, particularly in the euro area.

6. To mitigate the adverse impact of external developments, the authorities were able to strengthen the external position in the second half of 2011 through a tighter fiscal and monetary policy stance. On the fiscal side, the deficit was kept under budgeted levels, as the authorities took steps to significantly cut spending and sustain strong tax revenue performance. A number of measures were adopted that notably aimed to increase the efficiency of public administration, streamline public agencies, and ensure stricter control over the wage bill for civil servants. At the same time, there was limited recourse to domestic budget financing.

7. On the monetary side, the BCV broadened the scope of reserve requirements in July 2011 to include government deposits. In parallel, it took necessary steps to constrain the growth of credit as well as reserve and broad money notably through the resumption of open-market operations. As a result of the abovementioned policy measures, year-end preliminary estimates show that reserve losses were contained and the growth of net domestic assets of the central bank was significantly curtailed.

8. In view of the corrective actions taken, the authorities are requesting waivers of nonobservance of end-September 2011 assessment criteria related to net domestic assets and net international reserves.

9. On the structural front, program performance was strong with five out of seven benchmarks set for the review being met, including the signing of memoranda on fiscal and monetary coordination and the setup of a financial stability committee; the establishment of a framework for the issuance of fungible treasury bonds; the establishment of a medium-term debt strategy, and the inclusion of cross-debt between state-owned enterprises in the report on contingent liabilities. Work toward completing the missed structural benchmarks which entail the submission of the draft income tax bill and new banking law to the parliament is underway and expected to be completed early in 2012.

Policies for 2012 and Onwards

10. As indicated above, the authorities promptly took actions in the face of the weakening external environment to mitigate the subsequent adverse impact on macroeconomic fundamentals. In light of Cape Verde’s exposure to the current Eurozone crisis, they will remain vigilant, standing ready to take necessary actions to cope with external shocks.

11. In this connection, it is the authorities’ intention to keep the stance of fiscal and monetary policies tight so as to preserve fiscal and debt sustainability and safeguard the external position.

12. On the fiscal front, the authorities underscored their medium-term objective of containing the fiscal deficit and minimizing recourse to domestic financing. In the short run, they plan to keep a tight control over public spending. However, care will be taken to implement austerity measures in consultation with social partners with a view to preserving social stability, sustaining economic growth, and securing further progress toward poverty reduction.

13. The authorities agree that the existing social safety net provides good protection to the poor and the vulnerable, as noted in the staff report. Under these circumstances, they believe that any proposed change in the social safety net should be supported by a comprehensive analysis so as not to jeopardize its adequacy. In this respect, they are of the view that more work needs to be conducted to support staff’s proposal to reduce the social security fund’s tax rate on wage income and restructure the benefit side to ensure the fund’s long-term fiscal solvency. They are concerned that the implementation of such measures would ultimately contribute to reversing hard-won gains in poverty reduction.

14. On its part, the BCV has continued to tighten the stance of monetary policy. Earlier this month, the central bank raised the policy rate and reserve requirements on deposit liabilities, thereby increasing the prospects for further improvements in monetary aggregates and the balance of payments. At this current juncture, keeping the monetary policy stance tight will help achieve the key immediate monetary policy goal which is to stabilize reserve coverage at around 3 months of imports and thus protect the peg.

15. While the fiscal and monetary authorities will work toward achieving their respective policy goals, they will also continue to attach great importance to further strengthening monetary and fiscal policy coordination. Such coordination was tellingly illustrated by the concerted actions taken recently by the fiscal and monetary authorities to support monetary adjustment and strengthen the external position.

16. In view of the risks to financial sector stability stemming from domestic and external factors, strict supervision and regulation of the financial sector will continue to be exercised. At the same time, ongoing efforts to strengthen the supervisory and regulatory framework for onshore and offshore banks will be pursued and adequate use of the newly-established financial stability committee will be made.

17. The authorities see merit in developing a consolidated view of public accounts, integrating the social security fund (INPS), local administrations, and state-owned enterprises (SOEs). SOE reform will be carried forward, notably with a view to generating more efficiency gains in the functioning of public administration. In particular, work is underway to improve the financial situation of the electricity and water company (Electra) and airline company (TACV). In this connection, substantial progress has already been made in recent months in reforming Electra, including the adoption of an action plan for the second phase of Electra’s institutional restructuring, the design of a comprehensive approach to the financial reform of Electra, the adoption of a new regulatory tariff-adjustment model, and the signature of a results-based management contract between Electra and the government of Cape Verde.¹

18. In conclusion, I would like to reiterate that the authorities highly value the advice they have received from the IMF in the context of the successive PSIs and they continue to attach great importance to maintaining a close relationship with the IMF.

19. In light of Cape Verde’s broadly satisfactory performance under the Policy Support Instrument, I would appreciate Directors’ support for the conclusion of the second review of Cape Verde’s PSI program.