Economic developments and outlook

The Seychellois economy exceeded expectations over the first three quarters of 2011, despite the marked slowdown in Western Europe (the most important tourism market). Real GDP growth for 2011 was revised upwards to 5 percent from 4 percent, reflecting the buoyant tourism and canned tuna sectors. While inflation has risen sharply to 5.4 percent on the back of higher fuel and electricity prices, there is little evidence of second-round effects. The outlook is for steady medium-term growth, albeit at a slower rate than 2011 and with large downside risks stemming from the slowdown in the Eurozone.

Our authorities’ risk mitigation efforts are starting to bear fruit. In particular, extensive efforts to diversify the tourism sector - by targeting new geographic markets, improving the affordability of transportation and lodging, and attracting additional airline carriers - have reduced Seychelles’ reliance on high-end tourists from Western Europe (Box 3). Similarly, following domestic and international efforts to address piracy risks, trade volumes and activity in the fishing sector are recovering to pre-2008 levels. The authorities’ strong track record in program implementation and steady reduction in public debt is supporting investor confidence and maintaining substantial inflows of foreign capital, particularly in the tourism sector.

Program implementation

Program performance has remained exemplary, with all quantitative targets for end-June 2011 being met and all but two structural benchmarks being delivered. Of the remaining benchmarks, the tariff study for the public utility company has been delayed until end-June 2012, reflecting difficulties recruiting an appropriately qualified consultant. The reinstatement of the electricity tariff adjustment for fuel price variations - which would have reintroduced some automaticity in the adjustment of electricity tariffs in line with fuel prices - will be considered following the outcome of this review. In the meantime, the authorities increased electricity tariffs by almost 30 per cent over August, November and January, bringing tariffs to cost recovery levels, and stand ready to adjust them further as needed.

Fiscal policy

A primary surplus of 4.7 percent of GDP is expected for 2011, slightly above the target of 4.5 percent. This is a remarkable achievement given the unexpected costs of providing support to the national airline, Air Seychelles. The carrier began experiencing financial difficulties at the end of 2010 as a result of its increasingly uncompetitive fleet structure and code sharing arrangements with other airlines. The authorities decided to support the airline temporarily, while orchestrating a restructuring to restore the airline to profitability and limit the Government’s exposure. Following further set-backs in 2011, with the cancellation of a lucrative charter contract and growing competition from international carriers, the authorities acted decisively, notwithstanding domestic political sensitivities, to eliminate all long-haul flights from January 2012 and transform the airline into a regional carrier. This will eliminate the need for budget support by the end of 2012.

The authorities have increased their primary surplus target for 2012 to 4.7 percent of GDP, based on slightly lower revenue projections being more than offset by the unwinding of one off expenditure. To manage the risks of further unforeseen expenses, a contingency of 0.6 percent of GDP has been included in the budget to cover any costs associated with piracy, natural disasters, and further sharp increases in international food and fuel prices. Current expenditures will be tightly contained to accommodate priority capital investment, with a focus on infrastructure bottlenecks and priority social needs.

The delivery of a number of reforms (some of which are structural benchmarks under the EFF) will enhance the fiscal policy framework over 2012 and beyond:

• The introduction of the VAT in July 2012 - the last major step of the overhaul of taxation that began in 2008 - will improve the efficiency of the tax system (while being revenue-neutral).

• Modernizing the Seychelles Revenue Commission, especially in the area of customs administration, will enhance compliance, efficiency and competitiveness in this important area and complement the extensive taxation reforms to date. A new single tax identification number was introduced in October 2011, and the new Customs Management Act becomes operational in June 2012.

• Wide-ranging reforms to public financial management will improve budget preparation, accounting procedures and budget execution. In particular, beginning with the 2013 budget presentation, capital expenditures will be subject to parliamentary approval and project costs will be projected over five years. Program based budgeting will be phased in by 2015, beginning with the two largest ministries - Health and Education - in 2013.

• Higher mandatory contributions to the Seychelles Pension Fund will contribute to its long-term sustainability, while an upcoming independent audit will help to identify further areas for improvement.

Monetary and exchange rate policies

The Central Bank of Seychelles (CBS) tightened monetary policy over 2011 to absorb excess liquidity in the banking system and guard against second-round inflationary effects from external fuel price shocks. Three month T-bill rates rose from 0.5 percent to 5 percent over the year. In a welcomed sign of development of the financial sector, annual credit growth reached 16 percent in September (off a relatively low base). Broad money is projected to grow slightly slower than nominal GDP in 2012 to contain inflation. However, with the government’s call on private capital markets decreasing, there is sufficient room for private credit growth.

Consistent with Fund advice, the authorities are preparing a memorandum of understanding between the CBS and the Treasury to facilitate the issuance of Treasury bills for monetary policy purposes, which will assist the CBS in managing liquidity and reduce the costs of sterilization. Progress on this issue needs to be viewed against the background of the lingering aversion of many policymakers (and Seychellois) to government debt, following the balance of payments crisis in 2008.

Our Seychellois authorities remain committed to a floating exchange rate, which has served their economy well through its reforms and helped to cushion the impact of recent external shocks. The CBS is continuing to accumulate international reserves, with the medium-term target of three moths of prospective import coverage. It is also strengthening reserve management practices, and has initiated discussions with the World Bank to begin using its Reserve Asset Management Program.

Financial sector policies

Seychelles’ banks remain well-capitalised and profitable, and the CBS has continued to strengthen its supervisory arrangements. By the end of the first quarter of 2012 the CBS will have completed a full cycle of onsite examination of all banks and quasi-bank institutions under its modernised supervisory framework, and it is introducing improved mechanisms for offsite data assessment. New guidelines were issued in October 2011 on disclosure requirements for banks’ terms and conditions, which will complement the CBS’ public financial literacy program.

Other upcoming reforms that will enhance the development and operation of the financial system include:

• The launching of a credit information system in early 2012, as a first step towards a (privately run) credit information bureau, to improve transparency and risk-pricing in the financial system.

• The establishment of a commercial court to tackle the backlog of commercial disputes, which is seen as a major weakness in Seychelles’ business environment.

• The introduction of a new mandate for the Development Bank of Seychelles, to target commercially viable but higher-risk small enterprises that commercial banks would normally be reluctant to finance. This will support private lending by eliminating any perceived competition from the DBS.

• The introduction of a new mandate for the House Financing Corporation, consistent with the longer-term objective of focusing state interventions on the most vulnerable households, and supporting a larger role for commercial banks in mortgage financing. Related governance and operational reforms will improve the corporation’s financial viability and risk management.

Debt restructuring and sustainability

The external debt restructuring is close to completion, with less than US$9 million (out of eligible debt of around US$700 million) in agreements yet to be signed. Agreements have been reached with the three remaining creditors, and are expected to be signed shortly.

Total public debt (domestic and external) is projected to fall to 76 percent of GDP at end 2012, and remains on track against the target of 50 percent of GDP by 2018. To ensure progress towards this goal, new external loans or loan guarantees will be limited to the equivalent of US$40 million in 2012, and will mainly be used for infrastructure projects. Additionally, starting in 2012 a committee chaired by the Minister for Finance will review all public projects of a magnitude greater than SR 25 million, with a particular focus on their macroeconomic impact and risks, to inform the Government’s public investment decisions. The new, more robust, arrangements for budgeting for capital expenditure will complement these initiatives.