Sierra Leone: Sierra Leone—Third and Fourth Reviews Under the Extended Credit Facility Arrangement and Financing Assurances Review, Requests for Waivers for Nonobservance of Performance Criteria and Modification of Performance Criteria, and Requests for Rephasing and Augmentation of Access Under the Extended Credit Facility

This paper discusses Sierra Leone's Third and Fourth Reviews Under the Extended Credit Facility Arrangement and Financing Assurances Review, Requests for Waivers for Nonobservance of Performance Criteria (PC) and Modification of PC. Program implementation has been good, notwithstanding the shocks that the economy has experienced. Despite missing several end-2014 PCs, owing to the Ebola outbreak, authorities have placed policies back on track. All end-June 2015 PCs, as well as most structural benchmarks, have been observed. The IMF staff supports the authorities' requests for waivers, as well as for additional financing from the IMF.

Abstract

This paper discusses Sierra Leone's Third and Fourth Reviews Under the Extended Credit Facility Arrangement and Financing Assurances Review, Requests for Waivers for Nonobservance of Performance Criteria (PC) and Modification of PC. Program implementation has been good, notwithstanding the shocks that the economy has experienced. Despite missing several end-2014 PCs, owing to the Ebola outbreak, authorities have placed policies back on track. All end-June 2015 PCs, as well as most structural benchmarks, have been observed. The IMF staff supports the authorities' requests for waivers, as well as for additional financing from the IMF.

Recent Economic Developments

1. The Ebola epidemic continues to exact a heavy social and economic toll (Box 1). The confirmed number of cases reached 8,704 at end-September, including at least 3,589 fatalities. The epidemic disrupted production and distribution channels for basic consumer goods, leading to lost incomes and heightened inflationary pressures. The population of orphans, food-insecure, and the vulnerable has increased significantly, stretching thin the social protection system. The death of many healthcare workers has severely impacted the nation’s healthcare system. With new cases of Ebola down sharply—the country may be declared Ebola-free in November—the authorities have begun to focus on a post-Ebola recovery.

2. The economic environment deteriorated sharply in the second half of 2014 and 2015 (Figure 1, Table 1, and Text Table 1). Real GDP growth is estimated to have decelerated from 20 percent in 2013 to 4.6 percent last year, somewhat slower than the 6 percent projected at the time of the second ECF review. With the collapse of the iron ore industry,1 GDP is expected to decline a dramatic 21.5 percent in 2015. However, non-iron ore GDP is expected to grow modestly (1 percent), as the relaxation of curfews and quarantines, and the resumption of international flights and other economic activities, have buoyed agriculture, manufacturing and trade. This modest recovery could be impacted by mid-September flooding in and around Freetown, which caused significant disruption and resulted in the dislocation of more than 14,000 families.

Figure 1.
Figure 1.

Sierra Leone: Real and External Sectors, 2011–15

Citation: IMF Staff Country Reports 2015, 323; 10.5089/9781513595788.002.A001

*Denotes projections.Sources: Sierra Leonean authorities; and IMF staff estimates and projections.
Table 1.

Sierra Leone: Selected Economic Indicators, 2011–18

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

Refers to projections of EBS/14/116

Refers to reserves in current year and imports in following year.

Excludes import of capital goods and service related to the iron ore project that is externally financed.

Revenue less expenditures and net lending adjusted for interest payments.

Text Table 1.

Sierra Leone: Selected Economic and Financial Indicators

(Percent of non-iron ore GDP, unless otherwise indicated)

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

Ebola Epidemic in Sierra Leone: Developments and Prospects

Sierra Leone is gradually emerging from the Ebola Virus Disease (EVD) epidemic. With more than 3,500 fatalities as of September 2015, the socio-economic impact of the disease is profound. One full school year was lost following closures, as well as restrictions on movements and gatherings at the height of the epidemic. The high fatality rate among health care workers contributed to a more than 80 percent decline in the ratio of skilled health personnel to the population. This loss, coupled with a 21 percent decline in childhood immunization, means that some post-civil war gains in human development indicators have likely been reversed.

The adverse macroeconomic impact of EVD was moderated by increased donor support in the wake of the epidemic. As economic activities slowed in 2014, the momentum that followed the commencement of iron ore mining in 2011 was lost. However, strong external support from development partners, including the Fund, contributed to only a moderate deterioration in the current account balance and exchange rate stability. The gradual decline in EVD infections and resumption of economic activity is now fueling a modest recovery in the non-mining economy. However, the loss of iron ore export receipts, combined with the decline in Ebola related external inflows, is putting pressure on the exchange rate.

A01ufig01

Sierra Leone - Dailv EVD Trend since December 1, 2014

Citation: IMF Staff Country Reports 2015, 323; 10.5089/9781513595788.002.A001

Data Source: World Hearth Organization Daily EVD SItrep

A Post-Ebola Recovery Strategy, developed with the support of development partners, aims to put the economy back on a path toward economic growth and stability. The strategy focuses on three elements: getting and staying at zero new cases; implementing immediate recovery priorities; and transitioning back to the Agenda for Prosperity in the medium term; Unfortunately, it has attracted only limited donor funding to date. Government spending in 2015 (0.4 percent of non-iron ore GDP) has focused mainly on getting children back to school, as well as water and sanitation needs. Even assuming future increases in donor commitments, the economic impact of Ebola will linger as foreign investors consider the additional risk factor before committing to projects in the country.

3. Inflation has picked up somewhat, reaching 8.9 percent at end-August 2015. In the second half of 2014, lower agriculture production and disruption in cross border trade with Liberia and Guinea contributed to higher inflation. Reflecting the pickup in non-mining economic activities, inflation is expected to increase further this year, reaching 12 percent by the end of 2015.

4. The fiscal deficit widened in 2014 largely due to the economic slowdown and low iron ore prices (Figure 2, Table 2a, and 2b). The domestic primary deficit is estimated to have been 5.6 percent of non-iron ore GDP, compared to the 4.9 projected at the time of the last review. Revenue was somewhat lower than projected, while domestically financed expenditures somewhat higher, both due mostly to the impacts of Ebola, including unplanned recruitments. For 2015, despite the continued impact of Ebola and the longer than anticipated shut down of iron ore mining, revenues are projected to be slightly higher than at the time of the last review, due to the modest recovery in the non-iron ore economy, as well as administrative measures. However, as capital projects resumed more rapidly than previously anticipated, the overall deficit is projected to be 4.8 percent of non-iron ore GDP, slightly higher than the 4.6 projected at the time of the last review.

Figure 2.
Figure 2.

Sierra Leone: Fiscal Sector, 2011–15

(Percent of non-iron ore GDP)

Citation: IMF Staff Country Reports 2015, 323; 10.5089/9781513595788.002.A001

Sources: Sierra Leonean authorities; and staff estimates and projections.
Table 2a.

Sierra Leone: Fiscal Operations of the Central Government, 2011–18

(Billions of leone)

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

EBS/14/116

Includes foreign financed election spending in 2012, Le 177.5 billion (1.2 percent of non-iron ore GDP).

Transfer to the budget from a maturing EU grant onlent to Sierra Rutile.

For 2014-15, contingent expenditure captures only expenditures related to the Ebola epidemic.

Revenue less expenditures and net lending adjusted for foreign interest payments and foreign financed capital spending.

Staff will clarify during mission what portion of arrears is domestic versus foreign.

Includes private sector donations.

Non-resource revenue less expenditures and net lending adjusted for interest payments

Public domestic debt includes marketable and non-marketable treasury instruments and ways and means, excludes accounts payable.

Fiscal anchor under the program; defined as government financing from the banking system and non-bank financial institutions and kept below 2 percent of non-iron ore GDP.

Table 2b.

Sierra Leone: Fiscal Operations of the Central Government, 2011–18

(Percent of non-iron ore GDP)

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

EBS/14/116

Includes foreign financed election spending in 2012, Le 177.5 billion (1.2 percent of non-iron ore GDP).

Transfer to the budget from a maturing EU grant onlent to Sierra Rutile.

For 2014-15, contingent expenditure captures only expenditures related to the Ebola epidemic.

Revenue less expenditures and net lending adjusted for foreign interest payments and foreign financed capital spending.

Staff will clarify during mission what portion of arrears is domestic versus foreign.

Include private sector donations.

Non-resource revenue less expenditures and net lending adjusted for interest payments.

Public domestic debt includes marketable and non-marketable treasury instruments and ways and means, excludes accounts payable.

Fiscal anchor under the program; defined as government financing from the banking system and non-bank financial institutions and kept below 2 percent of non-iron ore GDP.

5. With the economy weak but inflation rising somewhat, the Bank of Sierra Leone (BSL) kept the policy rate unchanged at 10 percent through March 2015 (MEFP ¶7, 11). It was then reduced to 9.5 percent, to signal that stronger private sector credit expansion was needed to support the post-Ebola economic recovery. Market rates were largely unresponsive to the change, as in the past.

6. The Leone came under increased depreciation pressures starting in the second half of 2014 (Text Figure 1, MEFP ¶12). Since May 2014 the Leone has depreciated by 18.9 percent against the US$ in two episodes. First, in the second half of 2014, during the peak of Ebola outbreak the Leone depreciated by 13.4 percent, reflecting demand pressures generated by Ebola-related imports. To meet this additional demand, the BSL increased its weekly interventions in the foreign exchange market from US$500,000 to US$3 million, made possible by donor inflows. Second, the Leone depreciated by 8.9 percent from June to September 2015, as donor inflows declined and seasonal demand increased from importers who are restocking goods for the year-end festive season. With the reduced donor inflows, BSL weekly sales of foreign exchange have been reduced to US$1–2 million since May 2015.

Text Figure 1.
Text Figure 1.

The Official and Parallel Market Exchange Rate

Citation: IMF Staff Country Reports 2015, 323; 10.5089/9781513595788.002.A001

Sources: Sierra Leonean authorities.

7. Banking sector vulnerabilities have increased due to the pressures created by Ebola and the iron ore crisis (Box 2). Compared with 2013, the number of banks that were non-compliant with the minimum liquidity and capital adequacy ratios increased, while loan concentration remains high. In addition, aggregate non-performing loans have grown significantly, reaching 39.6 percent of gross loans at end-June 2015.2 The two largest banks were put under administration in December 2014, and the BSL is working with the staffs of MCM and the World Bank to identify and resolve the underlying problems (MEFP ¶31–32). Nonetheless, at the aggregate level, banks remain profitable,3 with high liquidity, primarily in the form of treasury bills.

Sierra Leone: Financial System Challenges and Non Performing Loans (NPLs)

Financial System Structure. The financial system in Sierra Leone is dominated by the banking system, with 13 commercial banks. Three banks are local (two are state-owned). Assets of the commercial banks represent around 20 percent of GDP. In addition to commercial banks, there are community banks, security dealers, micro finance institutions and mortgage banks. The nonbank financial institutions include insurance companies, a stock exchange, foreign exchange bureaus and a pension fund.

Cash based economy. Transactions in the economy are mainly in cash, with limited use of electronic payments. Banks are engaged mostly in retail business.

A01ufig02

Credit to the private sector

(in percent of non iron ore GDP)

Citation: IMF Staff Country Reports 2015, 323; 10.5089/9781513595788.002.A001

Access to financial services is still at a low level. The capital market is shallow, and the secondary market for government securities almost nonexistent. Banks and other financial institutions invest heavily in short-term government Treasury Bills, and tend to extend only short term credits.

A01ufig03

Capital Adequacy Ratio

(Banking System 2010–14)

Citation: IMF Staff Country Reports 2015, 323; 10.5089/9781513595788.002.A001

The banking system as a whole seems well capitalized, with a large variation across banks. The aggregate capital adequacy ratio is 30 percent as of June 2015. However, the two largest banks continue to have challenges to meet the regulatory required minimum capital adequacy ratio of 15 percent.

A01ufig04

Non-Performing Loans to Gross Loans

(Banking System 2010–14)

Citation: IMF Staff Country Reports 2015, 323; 10.5089/9781513595788.002.A001

Asset quality and capital have deteriorated in recent years. The ratio of nonperforming loans (NPLs) to total gross loans has been steadily rising. As of end June 2015, the NPL ratio stood at almost 40 percent, doubling in 2 years. This rising trend was driven by the two largest banks, whose respective portfolios deteriorated significantly over the period. The impact of Ebola on SME lending and the crisis in the iron ore sector contributed to the NPL increase.

Measures. As part of the resolution of the NPL problem, the two largest banks have been under administration since December 2014, and have received capital injections. In addition, the following actions have been taken by BSL:

  • A cap on lending or a temporary moratorium on lending for some banks.

  • A Loan Write- Off Policy Directive, which would allow banks to clean their balance sheets, and repackage toxic assets for eventual sale. The directive will take effect in December 2015.

  • Adoption of the Lenders and Borrowers Act 2014.

Other planned actions include introduction of Collateral Registry and draft of Credit Administration Bill.

8. The current account deficit deteriorated in 2014, due to the collapse in iron ore prices and the rise in Ebola-related imports. Iron ore export receipts dropped by more than 30 percent in 2014, despite the rise in export volumes, while iron ore related service imports grew more than expected, as freight companies charged a premium due to the Ebola risk. As a result, the net impact of the iron ore sector on the balance of payments (BOP) was negative last year. Ebola related imports of medical goods and services boosted total imports, which were mostly supplied as in-kind transfers.4 The trade deficit was financed by Ebola-related current transfers and strong flows from international donors.

Program Performance

9. Considering the difficult—and not fully anticipated—circumstances, program implementation has been satisfactory (MEFP ¶15; and MEFP Tables 1 and 3). At end-December 2014, performance criteria (PC) on domestic bank credit to the central government, net domestic assets of the central bank, and gross foreign exchange reserves of the central bank were missed, while all other PCs were observed. Spending on poverty-related expenditures modestly exceeded the indicative floor. However, the indicative targets on domestic government revenue and the domestic primary balance were missed because of the impact of Ebola on revenues and expenditures.

10. Despite the continuing challenges, all PCs and indicative targets for end-March and end-June 2015 were met, except for the end-March indicative target on BSL gross foreign exchange reserves and the end-June target for poverty related spending. The end-March 2015 gross reserve accumulation target was missed by a small margin (about US$7 million) due to lower minerals export receipts. At the time of the second review, the targeted 2015 overall spending was reduced 17 percent, rendering the accommodation of the planned poverty related spending extremely difficult. The authorities missed the June indicative target on poverty expenditure by just over 30 percent.

11. On structural benchmarks, there was limited progress in the implementation of measures programmed for the second half of 2014, largely due to Ebola-related delays in TA (MEFP ¶17; MEFP Table 2). The monthly rolling Treasury cash flow table consistent with the revised 2014 budget; the semi-annual report on the execution of the public investment program; and the quarterly report on external debt commitments, agreements and disbursements were prepared; and a three-year Public Investment Program integrated with the budget process and the revised Medium-term Expenditure Framework for 2015–17 was completed. Pilots of the wholesale foreign exchange auction were held starting in September 2014, and have been used exclusively since March 2015. The remaining structural reforms programmed for the second half of 2014 (MEFP Table 2) have yet to be implemented. For 2015, the PFM bill was submitted to Parliament in August 2015, (MEFP Table 2) only slightly later than called for in the program. The remaining major structural benchmarks on revenues—the establishment of the Treasury Single Account (TSA) and the introduction of the Tax Administration Act—are expected to be completed before year-end.

Economic Outlook and Risks

12. The outlook is highly uncertain and subject to significant downside risks (Text figures 25; Text Table 1).

  • Output and inflation. Under the baseline projection, GDP will decline 21.5 percent in 2015, and be virtually unchanged in 2016, before gradually recovering in 2017. This path reflects assumptions that the non-iron ore sectors of the economy will recover gradually, while iron ore production will resume starting in 2017. It is possible iron ore production could resume before that date—indeed, the new owner of the largest mine indicates that, if appropriate agreements can be reached with their subcontractors, production could resume this year. However, given the likelihood of continued low prices for iron ore on the international market, staff believes this to be unlikely (see Appendix II for the DSA impact of losing iron ore sector permanently). Going forward, staff will work with the authorities and the staff of the World Bank to try to identify measures the authorities can take to reduce the cost of iron ore mining, so as to enhance the sector’s recovery prospects. Inflation is expected to decline only modestly, as Ebola-related supply constraints gradually ease.

  • The external position. The significant downward revisions to historical export data, and thus large historical errors and omissions in the BOP, render BOP projections highly uncertain. Notwithstanding the loss of the remaining iron ore exports, staff projects a significant improvement in the current account in 2015, in part because iron ore was a net negative factor for the BOP in 2014. The current account balance is expected to improve gradually over the medium-term, helped by the expected resumption in iron ore exports and a slower growth in goods and services imports, which will be driven by moderate oil price growth and iron related services growth. Reserve coverage is projected to be 4.7 months of non-iron ore imports at end-2015, gradually increasing to 5.2 months by 2018.

Text Figure 2.
Text Figure 2.

Sierra Leone: Real GDP Growth

(percent)

Citation: IMF Staff Country Reports 2015, 323; 10.5089/9781513595788.002.A001

Source: Sierra Leone authorities and IMFStaff.
Text Figure 3.
Text Figure 3.

Sierra Leone: Inflation

(year-on-year percent change)

Citation: IMF Staff Country Reports 2015, 323; 10.5089/9781513595788.002.A001

Source: Sierra Leone authorities and IMFStaff.
Text Figure 4.
Text Figure 4.

Iron Ore Price 1/

(US$ per ton)

Citation: IMF Staff Country Reports 2015, 323; 10.5089/9781513595788.002.A001

Source: WEO and Sierra Leone authorities1/ Sierra Leone price is a weighted company average based on realized 2013-14 prices and WEO price projections.
Text Figure 5.
Text Figure 5.

Sierra Leone: Exports

(percent of non- iron ore GDP)

Citation: IMF Staff Country Reports 2015, 323; 10.5089/9781513595788.002.A001

Source: Sierra Leone authorities and IMF Staff.

13. Risks to the outlook are to the downside (Text Table 2). Key domestic risks arise from the uncertainty in the duration and impact of the Ebola epidemic, and in the resumption of iron ore production; increased fragility in the fiscal position; and heightened vulnerability in the financial sector. Externally, further decline in iron ore prices is a major risk for the projected growth and external position.5 The authorities concurred with this assessment, stressing that the post-Ebola recovery would be gradual in view of lost incomes and eroded capital base for households and businesses.

Text Table 2.

Sierra Leone: Risk Assessment Matrix (RAM)1

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The RAM shows events that could materially alter the baseline path (the scenario most likely to materialize in staff’s view). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent; “medium” a probability between 10 and 30 percent; and “high” a probability of 30 percent or more). The RAM reflects staff’s views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.