Faced with scarcity of resources, Djibouti has pursued a strategy of developing infrastructure to exploit its strategic geographic location so as to foster rapid growth, reduce poverty and create much-needed jobs. Djibouti has had to resort to non-concessional financing, which has raised its external debt. Reform is crucial to generate the revenues needed to return to a sustainable external debt and fiscal path, achieve higher growth, and reduce widespread poverty and unemployment.

Abstract

Faced with scarcity of resources, Djibouti has pursued a strategy of developing infrastructure to exploit its strategic geographic location so as to foster rapid growth, reduce poverty and create much-needed jobs. Djibouti has had to resort to non-concessional financing, which has raised its external debt. Reform is crucial to generate the revenues needed to return to a sustainable external debt and fiscal path, achieve higher growth, and reduce widespread poverty and unemployment.

Despite Strong Investment-Driven Growth, Poverty and Unemployment Remain Widespread

1. Economic activity continued to gather pace in 2014. Economic growth was estimated at 6 percent in 2014, driven by large-scale investments in infrastructure and port facilities. Aggregate investment reached 44.1 percent of GDP in 2014. Public investment spending was about 20 percent of GDP ($320 million), mainly on the Djibouti-Addis Ababa railway project which is expected to be operational in 2016 and on the pipeline that will transport water from Ethiopia to Djibouti. The high investment resulted in a fiscal deficit (commitment basis) of 12.2 percent of GDP which was financed by external borrowing (8.9 percent of GDP) and the drawdown of revenues from the partial privatization of the Djibouti port in 2013. Inflation remained relatively low at 3 percent, mainly driven by tobacco and services price increases. The current account deficit rose to 25.6 percent of GDP, driven by investment goods imports. Net income from abroad rose from $84 million in 2013 to $94 million in 2014, reflecting the increase in rent for the U.S. military base. Currency board coverage was 110 percent. Central bank gross foreign assets fell from $410 million in 2013 to $381 million in 2014 (3.5 months of imports) as privatization revenues were drawn down.

2. However, widespread poverty and unemployment persist. About 22 percent of the population lives in extreme poverty and the unemployment rate is 48 percent. Recent high levels of economic growth have been driven by capital-intensive investment in the ports and port-related activities, with limited trickle-down effects for the rest of the economy. Many of the jobs created have been taken by expatriates, due to a low domestic skills base or preference for foreign labor. Sectors with high growth and employment potential such as fishing and tourism remain underdeveloped. Agricultural activity, the primary source of livelihood in most low-income countries, is minimal due to unfavorable climatic conditions. Access to finance is low, constraining the emergence and growth of smaller enterprises. Only 20 percent of the adult population has access to banking services and only 5 percent of formal-sector enterprises have access to bank financing. The business environment has been challenging and has not created favorable conditions for the expansion of the private sector. The challenges stem in part from high production costs—in particular for electricity, communication and water—and a weak judicial system.

A01ufig1

Total Unemployment vs. Youth Unemployment, 2012

(percent of labor force)

Citation: IMF Staff Country Reports 2016, 248; 10.5089/9781475575200.002.A001

Sources: Djibouti authorities and International Labor Organization.Unemployment data provided by Djibouti authorities may not be comparable to ILO data due to differences in methodology.LIC = Low-Income Countries; MENAP = Middle East, North Africa, Afghanistan, and Pakistan.

3. The external debt stock increased to 53.7 percent of GDP in 2014, from 48.4 percent in 2013, driven by borrowing to finance infrastructure investment. Djibouti has been assessed to remain at high risk of debt distress. The authorities stated that they have cleared all arrears to the Paris Club creditors. Arrears to non-Paris Club creditors stood at $18.5 million (1 percent of GDP) at end-August 2015 and were mainly due to Iran and India. The authorities indicated that they are seeking debt rescheduling from these creditors.

4. Commercial banks’ loan portfolio has been deteriorating. The non-performing loans (NPLs) ratio has increased since 2011, with the pace accelerating, increasing recently from 18 percent at end-2014 to 22.5 percent at end-June 2015. Furthermore, provisions for non-performing loans declined from 82 percent in 2012 to 52 percent in mid-2015. Similarly, return on equity and return on assets have reached their lowest levels in 2014–15. This deterioration in the NPLs is mainly concentrated in one bank and can be ascribed to excessive risk-taking as well as weak oversight. However, the authorities imputed the deterioration to a rigorous reclassification of loans and the bankruptcy of two oil companies that failed to repay their debt. To address the situation, an understanding has been reached between the government and other shareholders to recapitalize the bank. Regarding the rest of the banking sector, two small banks are under liquidation. All other banks, but one, have met the new minimum capital requirement. A new investment bank has been authorized to operate.

5. The political climate is dominated by the presidential elections scheduled for April 2016. It is expected that President Ismael Omar Guelleh, in office since 1999, will run for a fourth term.

6. Djibouti is experiencing a large influx of people fleeing the conflict in Yemen. According to the UN and the Djibouti authorities, as of early October 2015, 28,389 people had arrived in Djibouti since the conflict erupted in March 2015, of which 4,895 have been registered as refugees by the UN; the remainder stay with relatives in Djibouti or are expected to relocate to other countries. The international community provides the bulk of the assistance offered to people fleeing the conflict. The Djibouti government indicated that as of end-August it had spent $1.7 million on account of refugees from Yemen.

7. Several recommendations of the 2014 Article IV consultation remain valid. These include: (i) pursue fiscal consolidation to enhance fiscal sustainability; (ii) reform the investment incentive system to increase revenues and level the playing field for enterprises; (iii) avoid non-concessional financing to improve fiscal and debt sustainability; (iv) develop a strategy to manage and reduce the external debt burden; (v) strengthen public investment and debt management capacity; and (vi) promote economic diversification and structural transformation by reducing utility costs, especially the high electricity tariffs, providing training in the skills needed in the labor market, and strengthening contract enforcement.

An Encouraging Outlook Amidst Growing Risks

8. Economic activity is expected to accelerate in the coming years, driven by the investment boom. GDP growth is projected at 6.5 percent in 2015 and 2016, rising to 7 percent in 2017–19. Aggregate investment is projected to peak at about 57 percent of GDP in 2015–16, before declining to 30 percent in 2017–19.1 After peaking at 16.8 percent in 2015, the fiscal deficit is projected to drop to less than 1 percent by 2019, with the completion of the ongoing investment projects triggering a fall in public investment spending from 27.5 percent of GDP in 2015–16 to 11.3 percent in 2017–19. The debt stock is expected to peak at about 80 percent of GDP in 2017, and decline thereafter as disbursements on loans for some infrastructure projects are completed. The inflation rate is projected to stabilize at 3.5 percent in 2016–18. The current account deficit is projected to peak at about 31 percent of GDP in 2015, declining to 14 percent of GDP in 2017–19. Currency board cover is projected at 109 percent throughout 2015–19. Broad money and domestic credit are expected to grow at about 10 percent and 16 percent a year respectively in 2015–19. An agreement signed in June 2015 between Djibouti and China on the establishment of a Chinese naval military base in Djibouti will yield rents of $20 million a year to government revenue.

9. However, the medium-term outlook is exposed to considerable risks, subjecting the baseline growth projections to a high degree of uncertainty. First, Djibouti’s dependence on close trade links with Ethiopia creates risks. A growth slowdown or recession in Ethiopia—the main client of Djibouti’s ports, which are the key engine of the economy—could reduce the use of the ports, adversely affecting growth and fiscal revenues in Djibouti. This risk reinforces the need to diversify economic activity in Djibouti to reduce dependence on a single sector catering largely to a single client. Also, a shock to food production in Ethiopia would impact Djibouti directly which imports the bulk of primary food products from Ethiopia. Second, a sharp slowdown in China, the main source of funding for recent public investment projects, might affect the financing and execution of some of the projects. Third, the risk of political instability in Djibouti could rise in the run-up to the 2016 presidential elections. Fourth, further terrorist attacks in Djibouti—which is exposed to spillovers from the conflict in Somalia—would undermine business confidence, investment and economic activity. Fifth, delays in the implementation of investment projects could increase the fiscal costs for projects for which loans have been disbursed.

Figure 1.
Figure 1.

Djibouti’s Investment Boom

Citation: IMF Staff Country Reports 2016, 248; 10.5089/9781475575200.002.A001

Sources: Djibouti authorities; and IMF staff estimates.
Figure 2.
Figure 2.

Djibouti: External and Financial Sector

Citation: IMF Staff Country Reports 2016, 248; 10.5089/9781475575200.002.A001

Sources: Djibouti authorities; and IMF staff estimates.
Table 1.

Djibouti: Main Investment Projects Contracted or under Negotiation

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Source: Djibouti authorities.
Table 2.

Djibouti: Risk Assessment Matrix

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Policy Discussions

Discussions focused on: (i) managing the scaling-up of public investment, especially the implications for debt sustainability (ii) fiscal reform, drawing on the recommendations of the June 2015 tax conference; (iii) promoting inclusive growth through poverty reduction and job creation; and (iv) financial inclusion and stability. Selected issues papers have been prepared on fiscal reform, financial inclusion, as well as investment, growth, and debt sustainability.

A. Managing the Scaling-Up of Public Investment, Especially the Implications for Debt Sustainability

10. Public capacity to manage the investment program requires strengthening. The scaling-up of investment to unprecedented levels poses challenges for Djibouti’s limited public management capacity. Staff urged the authorities to strengthen public capacity to evaluate and monitor investment projects, and recommended that a cost-benefit analysis should be conducted before any investment project is undertaken. Staff also proposed that the authorities prioritize the execution of proposed projects, taking into account absorptive capacity and resource constraints. Furthermore, staff encouraged the authorities to speed up plans to set up a committee to assess the macroeconomic implications of the large public investment projects. In view of the accelerated execution of the Djibouti-Addis Ababa railway project, staff urged the authorities to expedite the institutional arrangement for managing the joint railway project with Ethiopia, including the cost and revenue-sharing mechanism. Staff expressed concern over the limited progress on the proposed public enterprise reform emphasizing the need to reform in particular enterprises such as the water and electricity supply companies that will take over the operation of the large investment projects, to ensure their commercial viability. Staff urged the authorities to adopt swiftly a comprehensive public enterprise strategy that is supported by all the stakeholders.

11. Public debt management capacity requires strengthening. Responsibility for planning, monitoring, and negotiating external debt agreements is spread between the Ministry of Economy and Finance, and the Ministry of Budget, and other government institutions, with some overlap and no clear lines of subordination. The limited coordination among these entities undermines debt management, which partly accounts for repeated arrears accumulation. Staff therefore urged the authorities to urgently improve coordination among the government entities involved in debt management.

12. Reducing and managing the growing external debt is an urgent priority. The debt sustainability analysis (DSA) results (see DSA report) reaffirm the high risk of external debt distress. The present value of the debt-to-GDP and debt-to-export ratios as well as all other solvency and liquidity ratios breach the relevant thresholds. The DSA suggests that borrowing space is extremely limited, and any further non-concessional borrowing will exacerbate the already high risk of debt distress. Staff therefore proposed that any public or publicly guaranteed borrowing should be limited to projects with high rates of return. Staff recommended that the projects should be run on a commercial basis so that they can be profitable and generate the revenues needed to service their debt. Furthermore, staff stressed that: (i) the authorities should remain current on all debt service obligations; (ii) debt service capacity should be integrated into the budget planning process; (iii) the budget should provide for sufficient liquidity buffers to cover volatile debt service costs on variable-interest-rate debt and avoid accumulating arrears; and (iv) monitoring and management of government contingent liabilities, including debt contracted by public enterprises without government guarantees, should be tightened.

13. Authorities’ views: The authorities acknowledged the need to strengthen public capacity to manage the investment scaling-up, and underscored the importance of technical assistance to this end. They also acknowledged the high risk of debt distress but pointed out that the investment projects are vital for Djibouti’s development. The authorities are therefore of the view that, in the absence of other financing options, external borrowing to finance the projects is justified. They reiterated their confidence that the investment projects would be profitable in the longer run and generate the revenues needed to service the associated loans. They nevertheless stated that to alleviate the burden of the debt service, they have approached creditors to renegotiate the terms of loans contracted for certain projects.

B. Fiscal Reform

14. The present fiscal path appears unsustainable. To satisfy its inter-temporal budget constraint without default, a government must achieve primary surpluses whose present value should be sufficient to cover the present value of debt service. For Djibouti, over the period 2015–34, primary balances, based on current policy assumptions, are almost always negative and lie way below debt service requirements. For instance, starting in 2021, the shortfall in the primary balance relative to debt service requirements exceeds, on average, 6 percentage points of GDP a year. Given the limited scope for domestic borrowing, the debt service requirements would have to be met through continued foreign borrowing, if available. This raises the prospect of abrupt and large adjustments to government spending or large tax hikes.

A01ufig2

Djibouti: Primary balance and Debt Service Requirements, 2015–34

(in percent of GDP)

Citation: IMF Staff Country Reports 2016, 248; 10.5089/9781475575200.002.A001

Sources: Staff projections

15. Fiscal reform is needed to enhance fiscal sustainability and achieve inclusive growth. Additional revenues will be needed to ensure that the government is able to meet its financial obligations, which are growing rapidly as a result of the on-going debt-financed investment boom. Projections suggest that, given widespread tax exemptions under the current tax regime, fiscal revenues would decline as a percent of GDP over the medium term.2 Djibouti’s growth strategy, based on attracting foreign investment through generous tax concessions, is widely perceived to have sacrificed fiscal revenue without generating commensurate benefits in terms of employment. Furthermore, current fiscal policy could undermine pro-poor inclusive growth. Tax exemptions have created an uneven playing field for investors, sidelining smaller domestic, typically labor-intensive enterprises. Also, implicit subsidies on energy products through reduced taxes—which were intended to cushion the impact of rising international prices—have resulted in forgone fiscal revenues, while benefiting higher-income groups disproportionately. The fiscal situation could be exacerbated by a reduction in aid inflows, which could lead to difficulties in funding planned expenditures: about 10 percent of government expenditure was financed through grants in 2014, and a further 23 percent through loans. In addition, delays in implementing public investment projects for which loans have already been contracted would generate costs to the budget. This has been the case for the water pipeline project which carries a 0.5 percent commitment fee on the undisbursed loan amount. Large-scale external borrowing by public enterprises also poses contingent liabilities to the budget. Lastly, an increase in global oil prices could generate fiscal costs if the authorities do not adjust domestic prices.

16. The government-sponsored June 2015 tax conference is a key step towards a comprehensive reform of the tax regime. The conference launched a broad consultative debate involving the tax administration, the business community, academia, and civil society on the main pillars of tax reform. The guiding themes were: (i) simplifying the fiscal regime; (ii) enhancing fiscal equity; (iii) improving tax efficiency; and (iv) securing fiscal revenues. The conference generated support for reform and promising short, medium, and long-term reform proposals. During the mission, in response to the authorities’ request for Fund technical assistance, an FAD expert worked closely with the authorities to synthesize the conference recommendations. Below are the main recommendations made by the expert, drawing on the wider set of conference recommendations. Some recommendations with modest revenue implications might be introduced in the 2016 budget. Staff urged the authorities to expedite the initiation of measures with stronger revenue prospects since these would take longer to produce the expected revenues.

  • Reduce tax exemptions for the free zone. All new companies would be exempt from income tax in the first ten years of operation, and subject to an income tax of 15 percent starting in the 11th year. Existing companies would be exempt from income tax in the first ten years of operation, and subject to an income tax of 5 percent starting in the 11th year, 10 percent starting in the 15th year, and 15 percent after 20 years. Enhance efforts to ensure that companies meet their tax obligations including the requirement to submit income statements, and pay the 5 percent dividend tax introduced in 2015.

  • Repeal the investment code, one of three channels through which tax concessions have been granted. The other channels are the free zone, and discretionary exemptions granted by the authorities. It is recommended that existing exemptions be honored and, starting in 2017, no new exemption should be issued under the investment code.

  • Remove the domestic consumption tax on investment goods (and raw materials). This tax penalizes investment because it is due at the time of investing, before the returns on investment are realized, and without any refund in the event of a loss.

  • Raise the lump sum minimum tax from 1 percent to 1.5 percent. All enterprises (including those benefiting from exemptions) are subject to this tax on their business turnover.

  • Increase the threshold for the tax on wages and salaries from DF 5,000 ($28) a month to DF 50,000 ($280).

  • Set up a system of electronic tax filing and payment.

17. Fiscal consolidation is imperative to return the economy to a sustainable fiscal and debt path. Over the medium term, given the restraint already imposed on current spending and the authorities’ determination to pursue their investment plans, there is little scope for cutting aggregate spending. While information is insufficient for a full assessment of the likely quantum of additional revenues from the new investment projects, much of the prospective additional revenues are expected over the longer term. Thus, prospects for additional revenues from this source over the medium term are limited. Scope does exist, however, for increasing tax revenues by broadening the tax base, revising the investment incentive framework (discussed above), and strengthening tax administration by reinforcing human resources and modernizing tax collection processes. Furthermore, improving the performance of public enterprises would enhance their fiscal contribution. Opening up the monopoly telecommunications sector could also generate revenue, and improve efficiency, as experience from other countries shows. Ultimately, cutting investment spending may be necessary to return the economy to a sustainable fiscal and external debt path.

18. The fall in international oil prices offers an opportunity to introduce a market-based pricing mechanism for energy products without increasing domestic prices. Implicit subsidies on kerosene, gasoline and diesel in the form of a reduction of pre-existing tax rates were introduced in the wake of the 2007–08 global financial crisis to cushion the impact of high international oil prices on domestic consumers. The forgone revenues were estimated at about 2 percent of GDP in 2011. The authorities have kept domestic prices largely unchanged while international oil prices have dropped by over 50 percent since the end of 2014, resulting in a de facto elimination of the implicit subsidies. Staff advice has been to introduce a price adjustment mechanism that allows a full pass-through of international prices together with safety nets to protect the welfare of the poor and vulnerable population. During the mission, staff advised that the fall in international oil prices offers an opportunity to introduce the market-based pricing mechanism without increasing domestic prices.

19. Strengthening fiscal and public financial management remains a priority. Several key past staff recommendations are yet to be fully implemented. These include the transition to a medium-term budget framework, and merging the VAT administration and that of other taxes into a large tax payers’ unit which will administer all taxes for large taxpayers: VAT, income tax, etc. The authorities have indicated that work with the large taxpayers’ unit is progressing. New staff are being recruited and the unit is expected to be operational in 2016.

20. Authorities’ views. The authorities acknowledged the need for a far-reaching tax reform to return the economy to a sustainable fiscal and debt path, and foster inclusive growth. They indicated their intention to start implementing the recommendations of the tax conference in the 2016 budget and highlighted the measures implemented to restrain public spending such as the hiring freeze in the public service outside of the health and education sectors. The authorities reiterated their willingness to revise the pricing formula for energy products to eliminate implicit subsidies, but underlined the need to develop beforehand a registry of the poor and vulnerable population which is required for the safety net program.

C. Promoting Inclusive Growth, Job Creation, and Poverty Reduction

21. Eradicating widespread poverty and unemployment remains Djibouti’s fundamental development challenge. In addition to a stable macroeconomic framework and fair tax regime, the following reforms are critical:

  • Improving the business environment: Djibouti ranked 171st out of 189 countries on the World Bank Doing Business Index 2016, reflecting a difficult business environment. A key priority is reforming the judicial system to improve contract enforcement and property rights protection and strengthen anti-corruption efforts.

  • Lowering the cost of utilities and improving the quality of service delivery: Improving the supply of basic utilities and reducing their cost would stimulate investment and boost competitiveness. Electricity tariffs are among the highest in the region, while telecommunications costs are high and service quality relatively poor.

  • Investing in human capital: To equip Djibouti nationals for the job opportunities created by the investment boom, reforms to the educational system and professional training are needed to improve the match between the available skills and needs of the labor market.

  • Economic diversification into labor-intensive sectors like fishing and tourism would reduce the risks associated with reliance on the ports while creating jobs and generating fiscal revenues. The reforms proposed in this section would help promote diversification.

  • Social safety nets are needed to protect the poor and vulnerable population.

  • Encouraging small businesses. These tend to be labor-intensive, relying on domestic labor. Yet, they have been disadvantaged by the current development strategy of according tax concessions to attract foreign investment, and face additional obstacles, such as limited access to credit.

Figure 3.
Figure 3.

Djibouti: Business Environment and Governance Indicators

Citation: IMF Staff Country Reports 2016, 248; 10.5089/9781475575200.002.A001

Sources: Worldwide Governance Indicators 2014 (government effectiveness, regulatory quality, rule of law, and control of corruption); the line is the OLS trend for all countries.

22. The authorities launched in 2015 the Accelerated Growth Strategy for Promoting Employment (SCAPE). The SCAPE, which encompasses ongoing public investment projects, translates “Vision Djibouti 2035” into five-year rolling plans. Vision 2035, the authorities’ long-term development vision, envisions Djibouti as Africa’s commercial and logistics hub, and aims to triple per capita income by 2035. The SCAPE aims to enhance diversification of economic activity through a wide range of projects, for which funding has been secured, including: (i) port and transportation facilities: the ongoing Addis-Ababa Djibouti railway project, and construction of new ports and expansion of existing ports; (ii) energy: a second electricity supply line with Ethiopia, a geothermal project involving a consortium of seven donors, and construction of a new power plant close to Djibouti-ville, the capital city (iii) water supply: the ongoing construction of a water pipeline between Djibouti and Ethiopia, and a desalination plant funded with an EU grant. Funding for some of the other projects is yet to be secured.

23. The authorities have launched initiatives to protect the welfare of the poor. Some 16,400 low-income households are scheduled to receive allowances of DF 18,000 ($101) per quarter over twelve months under a cash transfer program.3 The universal health insurance scheme, which was initially limited to the public sector, has been extended more widely. Other support programs include free vaccination for children from poor households, and allowances to university students from outside the capital city.

24. Authorities’ views. The authorities are aware of the challenges facing them in the area of job creation and poverty reduction. They concurred with staff on the reform priorities and expressed confidence that the ongoing investment projects would foster inclusive growth by generating jobs and hence income, and meeting the basic needs of the population, such as access to water supply, health facilities, and education.

D. Financial Inclusion and Stability

25. Access to financial services remains low in Djibouti despite the increase in the number of banks from four in 2006 to ten today. Less than 20 percent of the adult population possesses a bank account. Some banks require a relatively large minimum deposit to open a bank account. Only 4 percent of adults could obtain a loan from a formal-sector financial institution in 2011, while 18 percent of adults had obtained credit from their circles of family or friends. Certain requirements constrain access to credit such as the 2 percent tax for the registration of collateral for mortgage loans, and another 2 percent tax for the release of collateral. Credit to small and medium enterprises represents only 12 percent of total bank credit to enterprises. High-risk premia undermine financial inclusion and development: Lending-deposit rate differentials exceed 10 percentage points. Djibouti banks require high levels of collateralization: 228 percent of the loan amount, compared with 190 percent in other MENA countries and 179 percent in Sub-Saharan Africa. Such low levels of financial inclusion in Djibouti suggest that the economy may be operating well below its potential because productive activity by a large share of the population would be constrained by limited access to financial services.

26. Management problems have stymied the development of microfinance since its emergence in 2008. The Caisse populaire d’Epargne et de Crédit, the leading microfinance institution was under central bank receivership from 2012 to 2015 because of management problems. This institution, with a membership of over 14,000 (about less than 3 percent of the adult population), accounted for less than 0.12 percent of bank credit. Its lending interest rate was 26.8 percent a year, which is almost 10 percentage points higher than the average of commercial banks’ rates. The microfinance institution did not pay interest on deposits.

27. The central bank is pursuing measures to enhance financial inclusion and development. It has set up a guarantee fund to facilitate access to finance for small companies and established a Sharia Board for Islamic banking. It is also pursuing plans to modernize the payment system, develop the electronic payment system, and modernize the credit information system, with support from the World Bank.

28. Developing the financial infrastructure is crucial for financial development:

  • The credit information system needs to be strengthened and developed. An effective information system that enables real-time access to information on credit applications reduces risks emanating from information asymmetries between lenders and borrowers.

  • Implementation of the credit guarantee fund for SMEs needs to be accelerated. The fund would enable partial risk sharing, which should encourage financial institutions to lend to perceived high-risk groups such as small businesses.

  • Technological innovation would promote financial inclusion. Mobile telephony—more than half of the adult population are subscribers—can offer low-cost financial services relative to traditional banking.

29. The central bank’s banking supervision capacity and commercial banks’ risk management capacity require strengthening to enhance financial stability, in light of the expansion of the banking system and the high level of NPLs in commercial banks’ loan portfolio. Rising NPLs in recent years combined with declining provisions to NPLs and banks’ profitability suggest that the banking sector may be facing a deeper problem and therefore strengthened banking supervision is required.

30. Persistently high NPLs could undermine financial and economic stability. A continuing deterioration in asset quality could adversely affect banks’ profitability and result in a tightening of credit to the private sector. This would hurt economic activity at a time when banks are solicited to support private sector development and economic diversification. The September 2015 follow-up reserves management TA mission made concrete proposals to bolster central bank reserves management. The ultimate aim of the proposals is to enhance central bank independence by increasing its income from reserves. In recent years, low international interest rates have reduced significantly central bank income from reserves. The proposals are focused on writing an investment policy, drafting a framework for risk management, implementing a decision-making process for reserves management, and strengthening institutional capacity through training.

31. A review of mortgage procedures and conditions is warranted. The authorities should consider reducing or eliminating the 2 percent tax for the registration of collateral for mortgage loans and the other 2 percent tax for the release of collateral.

32. Authorities’ views. The authorities agreed with staff on the need to improve access to financial services for the majority of the population. They expect that the reformed Caisse populaire d’Epargne et de Crédit, the main microfinance institution, and ongoing projects such as the modernization of the credit information and payment systems, would play a key role in promoting financial inclusion in Djibouti.

Other Issues

33. The currency board arrangement has served Djibouti well and should be maintained. It has helped instill confidence in the economy and improve predictability in managing international transactions. Given that the currency board precludes exchange rate adjustment, competitiveness should be pursued by reducing the high cost of utilities—electricity, telecommunications and water supply—and improving human resource productivity through skills training.

34. The medium-term outlook for the balance of payments will, among other things, depend on commodity prices and the performance of the Ethiopian economy. Given the high dependence on imports of food and fuel, changes in commodity prices could have significant implications for the balance of payments, household welfare, and government finances. No major changes are expected to the rents from the military bases, as the current contracts with the main countries using the bases are valid for the coming years. The demand for port services by Ethiopia, the principal client, is driven by the performance of the Ethiopian economy

35. The authorities informed staff that there had not been any changes in Djibouti’s exchange system and related legal framework since the last Article IV consultation. The authorities also stated that since Djibouti’s last notification to the Fund pursuant to Decision No. 144, security concerns had not caused them to impose any exchange measures.

Staff Appraisal

36. The ongoing debt-financed investment boom will boost economic growth, but also aggravates Djibouti’s high risk of debt distress, raising concerns for fiscal sustainability. Deep, wide-ranging reforms are critical to mitigate the risks and ensure the investment boom helps reduce widespread poverty and creates a large number of jobs for Djibouti nationals.

37. Public capacity to manage the investment scaling-up requires strengthening. It is essential to strengthen public capacity to evaluate and monitor investment projects, prioritize proposed projects based on absorptive capacity and resource constraints, and conduct cost-benefit analysis before any project is undertaken. Coordination among the government entities involved in debt management should be improved. Public enterprises that will manage the large investment projects should be reformed to ensure their commercial viability and reduce contingent liability for the budget.

38. A well-defined arrangement for managing the Djibouti-Addis Ababa railway should be finalized, given that the project is at an advanced stage. The arrangement should include finalizing the agreement on the company that will manage the railway project between the two countries.

39. Reducing and managing the growing external debt is an urgent priority. With Djibouti already at high risk of debt distress, borrowing space is extremely limited. Public and publicly guaranteed non-concessional borrowing should be limited. Debt service capacity should be mainstreamed into the budget process, and the monitoring and management of government contingent liabilities should be tightened.

40. Fiscal reform is needed to enhance fiscal sustainability and inclusive growth. Additional revenues will be needed to ensure the government is able to meet its financial obligations, which are growing rapidly as a result of the ongoing debt-financed investment boom. Against this background, a rapid implementation of a comprehensive tax reform on the basis of the recommendations of the June 2015 Tax Conference is crucial. The goal should be to strive for a simple and transparent tax regime that reduces tax exemptions and level the playing field between onshore and offshore companies with the ultimate goal of promoting investment, economic growth, and job creation.

41. Staff urges the authorities to accelerate the reform of public enterprises. This reform is critical as it would improve the financial situation and efficiency of these enterprises, boost their capacity to manage the large investment projects, and reduce production costs for water and energy.

42. Other structural reforms are needed for poverty reduction and job creation. The reforms should aim to improve the business environment, lower the cost of utilities and improve the quality of service delivery, and equip Djibouti nationals with the skills needed to take the jobs created by the investment boom.

43. Financial stability. Staff exhorts the authorities to swiftly adopt and implement corrective measures to address the problems of banks in difficulty. Reinforcing banking supervision and putting in place appropriate bank resolution mechanisms would enhance the central bank ability to address financial vulnerabilities. Furthermore, the central bank should also take the necessary measures to strengthen its income position, based on the recommendations made by Fund technical assistance, to improve its financial position and safeguard its independence.

44. Access to financial services remains low in Djibouti despite the expansion of the banking system. The establishment of the envisaged guarantee fund and a sustained development of microfinance, together with the development of financial infrastructure and use of innovative technology such as mobile banking, would foster financial inclusion.

45. The currency board arrangement has served Djibouti well and should be maintained at an unchanged parity, despite indications of real exchange rate overvaluation. It has helped instill confidence in the economy and improve predictability in managing international transactions. Competitiveness should be pursued by reducing the high cost of utilities and improving human resource productivity through skills training.

46. Staff recommends that the next Article IV consultation with Djibouti be held on the standard 12-month consultation cycle.

Table 3.

Djibouti: Selected Economic and Financial Indicators, 2013–20

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Sources: Djibouti authorities; and IMF staff estimates and projections.

Public sector includes central government only.

Table 4.

Djibouti: Central Government Fiscal Operations, 2013–20

(In millions of Djibouti francs)

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Sources: Djibouti authorities; and IMF staff estimates and projections.

Annual leasing fees from French, U.S. and Japanese military bases.

Excludes housing subsidies.

For 2013 includes a US$28.9 million participation in railway project.

Privatization revenues were lodged at central bank in 2013. After 2013, financing from this source is recorded as central bank financing.

Table 5.

Djibouti: Central Government Fiscal Operations, 2013–20

(In percent of GDP)

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Sources: Djibouti authorities; and IMF staff estimates and projections.

Annual leasing fees from French, U.S. and Japanese military bases.

Excludes housing subsidies.

For 2013 includes a US$28.9 million participation in railway project.

Table 6.

Djibouti: Balance of Payments, 2013–20

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

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Sources: Djibouti authorities; and IMF staff estimates and projections.

Includes the French and U.S. contributions for the military bases and outflows of interest due on Paris Club and non-Paris Club debt.

Excludes exceptional financing.

Table 7.

Djibouti: Monetary Survey and Banking Sector Indicators, 2013–20

(End-of-period, in millions of Djibouti francs, unless otherwise indicated)

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Sources: Djibouti authorities; and IMF staff estimates and projections.
Table 8.

Financial Soundness Indicators, 2001–March 2015

(In percent, unless otherwise indicated)

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Sources: Central Bank of Djibouti; and IMF staff estimates.

Nonperforming loans (NPLs) include three loan classifications: watch, doubtful, and loss. Revised from 2006 to exclude old NPLs of a liquidated bank.

Maximum single borrower limit is defined as 25 percent of capital (K3-1).

Based on minimum capital.