United Republic of Tanzania: Staff Report for the 2016 Article IV Consultation and Fourth Review Under the Policy Support Instrument

This 2016 Article IV Consultation highlights that growth in Tanzania has remained strong and inflation moderate during the past two years. Real GDP grew by 7 percent in 2015, with activity particularly buoyant in the construction, communication, finance, and transportation sectors. Inflation remained in single digits throughout 2015, averaging 5.6 percent, despite the significant exchange rate depreciation in the first half of 2015. Inflation in April 2016 was 5.1 percent, close to the authorities' target of 5 percent. The banking system appears sound overall, but there is wide variation within the system. The level of financial development has improved in recent years, though at a gradual pace.

Abstract

This 2016 Article IV Consultation highlights that growth in Tanzania has remained strong and inflation moderate during the past two years. Real GDP grew by 7 percent in 2015, with activity particularly buoyant in the construction, communication, finance, and transportation sectors. Inflation remained in single digits throughout 2015, averaging 5.6 percent, despite the significant exchange rate depreciation in the first half of 2015. Inflation in April 2016 was 5.1 percent, close to the authorities' target of 5 percent. The banking system appears sound overall, but there is wide variation within the system. The level of financial development has improved in recent years, though at a gradual pace.

Context

1. Tanzania has achieved strong growth and macroeconomic stability over the past two decades. This performance was the result of market-oriented reforms and prudent macroeconomic policies. Growth has been driven by construction, services, and basic manufacturing, and the economy has become more diversified. Inflation, while still volatile, has remained moderate. Poverty has decreased but remains high (at 28.2 percent of the population, based on the national poverty line) with a large population of underemployed youth, and despite substantial progress toward the Millennium Development Goals (MDGs), Tanzania is likely to have missed about half the 2015 targets (Table 1).

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Real GDP and Inflation

(Percent Change)

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Source: National Bureau of Statistics.

2. Progress in implementing past Fund policy advice has been mixed (Annex 1). While macroeconomic management has been able to deliver fiscal sustainability and macroeconomic stability, the quality of fiscal management deteriorated until recently in some areas (e.g., expenditure arrears control) and the pace of reform has abated in recent years. The modernization of monetary policy has made only limited progress in the past two years. The business environment remains challenging and the perception of corruption has increased substantially. As a result, program performance under the PSI has been mixed.

3. The new authorities have an ambitious development and reform agenda. The government aims to make Tanzania a middle-income country with a development plan addressing the country’s infrastructure gap and leading to inclusive growth (see below). The new authorities have also sent strong signals on their determination to reform the government, strengthen the work ethics of the public service, and fight tax evasion and corruption.

4. Data provision is adequate for surveillance and program monitoring. The authorities improved the national accounts and inflation data with Fund technical assistance (TA), including rebasing their benchmark years and expanding coverage. The Accountant General is also making progress on preparing consolidated financial statements for the wider public sector. The authorities intend to participate in the Enhanced General Data Dissemination Standard (e-GDDS) initiative to further enhance data dissemination practices. Staff encouraged them to expand the coverage of government finance statistics, as well as adopt the latest standards in this area.

Recent Developments

5. Growth has remained strong and inflation moderate. Real GDP grew by 7 percent in 2015, with activity particularly buoyant in the construction, communication, finance, and transportation sectors. Inflation remained in single digits throughout 2015, averaging 5.6 percent, despite the significant exchange rate depreciation in the first half of 2015. Inflation in April 2016 was 5.1 percent, close to the authorities’ target of 5 percent.

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Inflation

(Annual percentage chage)

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Source: National Bureau of Statistics.

6. The external position recorded mixed developments. The current account deficit declined from 10.7 percent of GDP in 2013/14 to a projected 8.6 percent in 2015/16, mainly due to lower oil prices. The capital and financial account surpluses, however, have narrowed, reflecting lower donor support and lower FDI related to natural gas exploration. International reserve coverage has declined somewhat to a projected 3.6 months of imports of goods and services in June 2016, reflecting no accumulation in 2015/16 and the projected large increase in imports in 2016/17. The shilling depreciated sharply against the U.S. dollar in 2014/15 (about 25 percent) and experienced high volatility. While the shilling depreciated a bit further since mid-2015, the situation in the foreign exchange (FX) market has normalized, with improved liquidity and participation by commercial banks. Following the opening of the capital account to East African Community (EAC) investors in 2015, the authorities plan to extend the liberalization to all foreign investors.

Exchange Rates

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Sources: Tanzanian authorities and IMF staff estimates.

7. Unrealistic budgets and weak commitment controls led to the accumulation of large arrears to suppliers and pension funds in recent years. The overall cash fiscal deficit remained relatively low in 2013/14 and 2014/15, at 3.3 percent of GDP. However, once corrected for significant budget expenditure arrears accumulation, the fiscal deficit actually was in the 4–4.5 percent of GDP range.1 Budget execution in recent years was affected by unrealistically high revenue projections and financing shortfalls, which required inefficient intra-year expenditure adjustment mostly falling on investment. Delays in adjusting the budget and weak commitment controls were key factors behind the accumulation of arrears.

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Tax Revenue Collection and Budget Forecast

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Sources: Tanzanian authorities and IMF staff estimates.
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Budget Financing1

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Sources: Tanzanian authorities and IMF staff estimaes.1 Excludes arrears financing and gas pipeline financing.

8. Implementation of the 2015/16 budget has also faced challenges. While the budget was built on ambitious but realistic revenue projections, expenditures still had to be adjusted for external financing shortfalls and to make room for expenditures carried over from 2014/15 and some of the new government’s priorities in education. The revised budget targets a lower overall deficit of about 3¼ percent of GDP (compared with 4.2 percent in the original budget and the program). Available information (on a cash basis) for the first three quarters suggests that this target is well within reach, reflecting a significant slowdown in the execution of capital expenditures. The stock of expenditure arrears decreased during the third quarter of the fiscal year (January-March 2016), reflecting the partial clearance of construction arrears and reversing an increase during the first two quarters.

9. While central government debt has increased to about 38 percent of GDP, debt vulnerabilities remain limited. This increase reflects both fiscal deficits and the impact of the recent depreciation of the shilling on dollar-denominated debt. External borrowing on nonconcessional terms has increased rapidly in recent years, partly to make up for dwindling aid.

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Foreign Aid

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Sources: Tanzanian authorities and IMF staff estimates.

10. The Bank of Tanzania (BoT) has successfully implemented its monetary targeting framework, but there has been little progress in moving to an interest-based framework. Average reserve money growth has been kept within a 10–15 percent range and inflation at single digits. Once exchange rate effects are accounted for, credit and broad money growth, respectively at about 14 and 8 percent at end-April 2016, have picked up modestly.2 Progress on de-dollarization, which stalled in the wake of the shilling’s depreciation, has resumed.3 The BoT is building forecasting and policy analysis capacity, with IMF support, and started focusing more on managing commercial banks’ excess reserves, leading to less volatile interbank rates. However, the move to an interest-based framework has lagged behind, with repeated delays to introduce required reserve averaging, which is a precondition to implementing additional reforms.

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Broad Money and Credit Growth

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Source: Bank of Tanzania.

Outlook and Risks

11. The government’s second Five-Year Development Plan (FYDP II) focuses on economic transformation through industrialization and human development. To facilitate private sector-led growth, the new government aims to address the infrastructure gap, which remains large in Tanzania (see table below for a cross-country comparison), and create a business environment that is conducive to job creation. The government also aims to reduce poverty by improving social services (education, health, housing, water and sanitation), enhancing income security, and promoting social protection. The plan will start being implemented with the 2016/17 budget.

Selected Quantitative and Qualitative Indicators of Infrastructure, 2010–14

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Sources: Country authorities, World Bank and World Economic Forum.

12. The macroeconomic outlook is favorable. Growth is projected to remain strong at about 7 percent in 2016, on the back of low oil prices (a positive shock for Tanzania), continued strong growth in certain sectors (e.g., services) and the scaling up of public investment. For the medium term, in the absence of a detailed quantitative macroeconomic framework for FYDP II at the time of discussions, staff designed a baseline scenario assuming public investment scaling up. Noting that many of the authorities’ priority investments would require several years to be implemented, staff assumed that capital expenditures would remain high over a few years. The investment effort would help keep growth at about 7 percent during that period; growth would then revert to its 15-year average of about 6½ percent. Inflation is expected to remain close to the authority’s medium-term target of 5 percent, provided that the BoT maintains a tight monetary policy stance. The external current account deficit is projected at around 9 percent of GDP in 2016/17 and to remain elevated the medium term, as the implementation of FYDP II would lead to high capital spending and imports.

Tanzania: Selected Economic Indicators

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Sources: Tanzanian authorities and IMF staff projections.

13. Risks to the outlook are tilted to the downside. Key external risks include the tightening of global financial conditions, which could result in higher financing costs and/or make external budget financing difficult, and a significant slowdown in China and other large emerging markets, which could affect external demand and the financing of key infrastructure investments and thereby growth (Annex II). Domestic risks include the possibility of fiscal slippages due to spending pressures stemming from FYDP II’s implementation, continued challenges to raise the required revenue and financing for the budget, and in the medium term slow reforms that could affect potential growth.

Authorities’ views

14. The authorities broadly agreed with staff’s assessment of the economy and outlook but were more optimistic about medium-term growth prospects, which would be supported by the implementation of FYDP II. In light of large public investment needs, the government plans to mobilize additional domestic revenue and utilize public-private partnerships (PPPs) for large infrastructure projects to limit government borrowing and risks to debt sustainability.

Policy Discussions

15. Discussions revolved around how to sustain high growth and implement the new government’s priorities while preserving fiscal and external sustainability. This will require mobilizing additional domestic revenue, realigning spending priorities, and creating fiscal space for infrastructure investment, as FYDP II aims to do. At the same time, the targeted transformation of the Tanzanian economy requires administrative and institutional reforms to promote credible policy implementation, higher efficiency of public spending, deeper financial intermediation, and an improved business environment.

A. Raising Public Investment While Mitigating Risks

Background

16. The draft 2016/17 budget envisages a large increase in public investment and revenue and targets a deficit of about 4.5 percent of GDP. The tax revenue to GDP ratio is expected to increase by about 1 percentage point, through a strengthening of tax administration and tax policy measures. The nontax revenue to GDP ratio would increase by about 1.5 percentage point, owing to higher contributions of parastatals to the budget (including a large one-off transfer on account of retained earnings) and higher efficiency in the collection of various fees. On expenditure, the draft budget proposes a large change of the composition of spending in favor of investment. Current expenditure would be contained through a hiring and nominal wage freeze and efforts to significantly reduce the cost of running the government. Capital expenditures would more than double as a share of GDP, bringing development spending to about 11 percent of GDP in 2016/17.4 The budget sets aside about 1.5 percent of GDP to clear budget expenditure arrears. Higher project financing and external nonconcessional borrowing (ENCB) would help finance the investment effort and higher fiscal deficit.

Key Development Projects in 2016/17 Budget

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Source: Tanzanian authorities.

.Exlcudes projects implemented by regions and local governments.

Staff’s views

17. To reduce the risk of further arrears accumulation and absorption capacity problems, staff recommended basing the budget on lower revenue projections. Based on available information, staff’s estimates for tax revenue and nontax revenue are below the authorities’ targets by about ½ percent of GDP each.5 Most of the difference is explained by the estimated impact of administrative measures. Staff underscored that excessively optimistic revenue and financing projections were one of the main reasons behind the accumulation of expenditure arrears in recent years. Staff suggested lowering revenue projections by 1 percent of GDP in the budget and treating any excess revenue, should it materialize, in a supplementary budget in the course of next year. Lowering revenue would require reducing expenditure commensurately to stick to the deficit target. Staff also noted the importance of subjecting large capital expenditures to proper cost-benefit analysis. In this regard, it expressed concerns about the envisaged purchase of planes for Air Tanzania, at a time when a strategy on what to do with the financially distressed airline has not been adopted yet. Staff otherwise strongly supported the planned reorientation of spending toward capital spending, but noted that the envisaged compression of current expenditure was very ambitious and would require broad-ranging measures and sustained efforts. Staff also stressed that the external financing assumptions were ambitious and would require overcoming the issues that have led to ENCB shortfalls in recent years.

18. The debt sustainability analysis (DSA) suggests that Tanzania could afford a somewhat higher deficit than programmed for a few years and still keep its low risk of debt distress. In the baseline scenario designed by staff, the investment scaling up leads to higher fiscal deficits for a few years (about 4.5 percent of GDP, as in 2016/17). The completion of the main infrastructure projects would then lead to a reduction of capital expenditures, and with it of the fiscal deficit to slightly below 3 percent of GDP by 2022 consistent with regional commitments to converge toward the East African Monetary Union (EAMU). In line with its medium-term debt management strategy and ongoing discussions with the concerned creditors, Tanzania would rely more than assumed in the previous DSA on borrowing from the regular windows of the World Bank and African Development Bank, whose terms remain much more favorable than international markets’, and on domestic borrowing.6 Under these relatively prudent assumptions, the updated DSA suggests that while debt vulnerabilities would increase somewhat, the risk of debt distress would remain low.7

19. Fiscal risks and debt management needs to be strengthened. Having realistic budgets (including with regard to recurrent costs associated with capital expenditures) and contingency measures should be the first line of defense against fiscal risks. Utilizing PPPs for large infrastructure projects would reduce government borrowing but the related fiscal risks need to be carefully evaluated and reported; this would also require a strengthening of the capacity to manage PPPs. Staff supported the efforts of the authorities to better monitor and manage parastatals and encouraged further disclosure of information in this area. The publication of the Fiscal Transparency Evaluation and annual updating of the fiscal risks statement would also be welcome.

Authorities’ views

20. The authorities were confident that the projected revenue increase in the draft 2016/17 budget would materialize. They noted that the pickup in tax revenue collection from December 2015 was a sign that taxpayers took the fight against tax evasion seriously, and expected revenue buoyancy to continue. They also expected a number of tax administration measures, including the implementation of an action plan following the recent Tax Administration Diagnostic Assessment and the rollout of Electronic Fiscal Devices, to lead to a significant improvement in compliance. On nontax revenue, they reported that the increased contributions to the budget had been discussed and agreed with the concerned parastatals.

21. The authorities reiterated their commitment to fiscal discipline and indicated that some large projects would be started only after confirmation in the mid-year budget review of adequate preparation and availability of revenue. This would be the case, in particular, for the standard gauge railway for the “central corridor”8 and the renovation of the Dar es Salaam port. They also underscored that some expenditures would be executed only if the financing could be raised. This was particularly the case for certain capital expenditures, which would be financed through project financing or PPPs. Actual spending might therefore turn out lower than budgeted, which could lead to a lower fiscal deficit than envisaged in the draft budget. The efforts to better monitor parastatals were also an attempt to better manage public resources. The commitment to strengthen debt management capacity remained intact; adoption by cabinet of the new policy and legal framework for debt management was expected by end-July 2016, with the delay of a few months from original plans only due to changes in the structure of the Ministry of Finance and Planning.

B. Mobilizing Additional Revenue

Background

22. Tanzania’s tax revenue, at about 13 percent of GDP in 2015/16, is low by international standards. This reflects to a significant extent poor VAT performance. Staff analysis suggests that the tax revenue gap in Tanzania was about 4 percent of GDP in 2009–13, and assuming an unchanged tax potential would still be about 2–3 percent of GDP presently (Box 1).

Tax Revenue Gap in Tanzania

Tanzania’s tax revenue performance lags behind that of comparable countries. Tanzania had a tax to GDP ratio of 11.9 percent of GDP in 2011–13, well below the average of EAC countries (13.1 percent of GDP) and that of LICs (14.7 percent of GDP). This reflects to a significant extent poor performance in VAT collection. While EAC countries collected an average of 4.4 percent of GDP in VAT revenue in 2011–13, Tanzania only managed to achieve 3.3 percent of GDP. The VAT revenue underperformance appears to be driven by a low tax productivity associated with administrative inefficiency, low taxpayer compliance, and policy gaps.

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Tax revenue to GDP Ratio, 2011–13

(percent)

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

The estimation of the tax capacity suggests that there is a considerable scope to raise revenue in the medium term. Using the peer analysis and the frontier approach on a sample of 32 LICs with data during 1994–2013, Tanzania’s tax capacity is estimated at 15–16 percent of GDP in 2009–13, that is about 4 percent of GDP above the average tax revenue ratio during the same period. Assuming an unchanged tax capacity, and in light of the increase in the tax revenue ratio in 2015/16, the gap has been reduced to 2–3 percent of GDP.

Staff’s views

23. Raising more revenue will be critical to reconcile the government’s investment priorities with fiscal sustainability. Closing the tax revenue gap will require sustained and deep reforms, both in tax policy and tax administration. Although the new VAT law implemented from July 2015 is a good step forward, more needs to be done to further streamline exemptions and improve the refund mechanism. There is also significant revenue mobilization potential through the elimination of corporate income tax holidays and exemptions, the regular adjustment of specific excise rates, and development of property taxation. In the areas of tax administration, the need to step up reforms is pressing. Areas for policy actions include cleaning up the taxpayer registration and accounting, upgrading the IT system and strengthening compliance risk management.

Authorities’ views

24. The authorities agreed with the need to raise revenue collection and pointed to ongoing initiatives in this area. FYDP II aims to increase domestic revenue by fighting tax evasion, streamlining exemptions, widening the revenue base, and strengthening the capacity of revenue collecting agencies. In the area of tax administration, a plan was prepared following the recent diagnostic mission. The authorities have also started considering tax policy reforms in a broad range of areas (including VAT, corporate income tax, excises, and property taxation), and discussions are expected to continue in the coming months before a strategy is adopted by end-2016.

C. Enhancing Public Spending Efficiency

Background

25. Weak revenue collection has affected the level of expenditure, and spending efficiency has been low in certain sectors. Tanzania’s public expenditure was below the average for LICs in recent years, with the gap being larger for investment spending. As mentioned above, weak commitment controls and unrealistic budgets in recent years have led to intra-year expenditure adjustments affecting investment and arrears accumulation. Staff analysis suggests that Tanzania performs poorly in education and investment spending efficiency while health spending efficiency appears to be in line with the average for LICs (Box 2).9

Staff’s views

26. Improving spending efficiency would help reduce spending pressures. Better outcomes could be obtained with the same amount of spending. As discussed in Box 2, possible reforms include improving resource allocations in the education and health sectors and linking them to performance. Improving the efficiency of public investment becomes even more critical in a context where the authorities plan to raise capital expenditure substantially. An initial assessment of the public investment management process suggests a need to strengthen project appraisal and implementation capacity.

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Government Total Expenditure, 2010–14

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

27. Arrears prevention requires sustained reforms in public financial management (PFM) in addition to credible budgeting. More realistic budgets, tighter commitment controls, and improved cash management are critical to avoid arrears accumulation and budget adjustments in the course of the fiscal year.10 Staff also urged the authorities to settle arrears to pension funds as soon as possible.

Authorities’ views

28. The authorities broadly concurred with the assessment and stressed that a number of reforms were underway. They noted that expenditure efficiency during the implementation of FYDP I was affected by inadequate prioritization and stressed that FYDP II addressed this issue. The authorities also reported the recent launch of the comprehensive public investment management manual, which is expected to help improve the efficiency of capital expenditure. On expenditure arrears, they underscored that recent data suggest a much better outcome so far than in past years. Arrears will continue to be settled next year, thanks to significant budget allocations for this purpose. An expert has been hired to enhance the IFMIS, which will enable to track multi-year commitments over the life cycle of the budget. This will ensure proper budgeting of the required resources, and further improve the integration of the medium-term expenditure framework into the annual budget process. A new public awareness campaign will be launched to warn suppliers that orders not generated through IFMIS will not be honored. The settlement of arrears to pension funds has been postponed to end-2016 to ensure the legitimacy of arrears to be cleared, in light of the very large amounts involved. The principle of clearing these arrears, however, remains.

Benchmarking and Efficiency of Public Spending in Tanzania

Public spending has broadly stabilized in the recent years and remained below the level of comparator countries. A lackluster revenue performance, combined with declining donor assistance and difficulties in securing external financing, has constrained public spending growth. Further, the need to maintain fiscal discipline in the face of revenue and financing shortfalls led to expenditure cuts that fell disproportionally on capital expenditure, thus weakening the composition of spending. Total public expenditure in Tanzania stood at 19.5 percent of GDP on average in 2010–14, well below the EAC average (24.5 percent of GDP), while capital expenditure was the lowest in the region.

There is a significant room to improve public spending efficiency. The latter was assessed using the data envelopment analysis (DEA) approach on a sample of 34 LICs with data for the period 2010–14. The efficiency score of Tanzania for health spending is estimated at 0.86 close to the sample average, using the health-adjusted life expectancy (HALE) to measure the health outcome. Eliminating remaining inefficiencies (i.e., bringing the score to 1) could raise HALE from 53 to 60 years with the same level of spending. Using school enrollment rates as the education outcome, the efficiency of education spending in Tanzania is about a third lower than in the most efficient LICs. Similarly, Tanzania ranks low in the efficiency of public investment, with the efficiency gap estimated at about a third for overall infrastructure quality.

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Efficiency Scores of Health, Education and Infrastructure Spending, 201–141

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Source: IMF staff estimates.1 The efficiency score varies from 0 to 1, with 1 being the score for the most efficient countries.

Reforms to improve the allocation of resources in the health and education sectors and strengthen public investment management institutions would help Tanzania improve public spending efficiency. In the health sector, existing reports highlight the need to align staffing of healthcare centers and the provision of drugs to demand and performance, address the shortage of skilled staff, tackle low productivity of staff and the high degree of absenteeism, and strengthen the information management system to better monitor health indicators and performance of healthcare centers. In the education sector, reducing the large disparities of students to teacher ratios across districts, improving the quality of primary education, and improving teachers’ skills are essential. It is important that spending on tertiary education does not crowd out that of lower education levels, whereas student loans should be better targeted and their repayment enforced. Strengthening public investment management institutions would be critical to improve the selection, appraisal, management and evaluation of projects.

D. Monetary and Financial Sector Policies: Promoting Growth While Preserving Stability

Background

29. The financial system in Tanzania is dominated by banks.11 Financial markets, on the whole, are shallow and less developed though a few markets (the interbank and foreign exchange markets) exhibit greater liquidity and depth. Banks are generally well-capitalized and profitable. However, there is wide variation within the system: a few large banks have shown strong financial performance but other banks, primarily smaller foreign-owned banks and community banks, exhibit low profitability and poor asset quality. State-owned banks also have relatively high non-performing loan (NPL) ratios. Tanzania stands out in its large number of banks (57).

30. The level of financial development has improved in recent years, though at a gradual pace. A broad measure of financial development suggests that the development of institutions has improved over time but that of markets has lagged. Among institutions, there has been notable improvement in access, particularly for households. The expansion of mobile money and banking is a key driver of this positive development.12 While nearly two-thirds of adults now have access to formal financial services, the picture for firms is less positive: in the 2013 World Bank enterprise survey, almost 44 percent of firms in Tanzania claimed to face difficulties in accessing finance, the highest proportion in the EAC, with small and medium enterprises facing particularly acute challenges. Further, the level of financial development in Tanzania is lower than might be expected for a country at its current level of income and similar fundamentals, with market development particularly lagging. Finally, financial efficiency is relatively low in Tanzania, with for instance high lending rates.

31. Improving financial development would likely yield higher growth and greater stability. Based on recent cross-country empirical work done at the IMF,13 Tanzania stands to benefit substantially from greater financial development. By bringing the level of development up to expected levels given Tanzania’s economic and demographic characteristics, empirical estimates suggest that growth could be higher by up to 1 percent and less volatile.

32. Improving financial market development in Tanzania would also facilitate macroeconomic policy implementation. The monetary transmission mechanism is weak and seems to have weakened, rather than strengthened, in recent years. There appears to be little correlation between short-term (market) rates and longer-term retail rates, probably reflecting interest rate volatility in the interbank market. The lack of market development also adversely affects fiscal policy by reducing the authorities’ capacity to raise domestic financing at a reasonable cost and run counter-cyclical policies in response to shocks, and raises risks such as rollover risks.

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Financial Inclusion

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

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Mobile money transactions

Percent of GDP

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Source: IMF Financial Access Survey.
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Tanzania: Estimated Gap in Financial Development and Impact of Closing the Gap

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Sources: Sahay and others (2015); IMF (2016)

Staff’s views

33. Achieving further financial development supporting growth will require prudent credit expansion and other measures. While the short-term relationship between economic growth and credit appears relatively weak, the link may be stronger in the long run. Further, as the financial system deepens, the link is expected to strengthen. Rapid credit growth, while likely a needed ingredient of financial development, may lead to potential vulnerabilities in the financial sector. So far, the recent rapid rise in credit appears to be well-supported by economic conditions: The credit-to-GDP ratio, while rising, has not deviated from historical trends. Nevertheless, there are developments in some sectors that bear monitoring. In particular, lending to real estate (reflecting lending to activities related to commercial properties), while small, has been growing rapidly. Further, some lending for property-related activities is not adequately captured by the data as it is classified as personal loans by commercial banks. Mortgages, which are a new and small part of overall lending, have increased in recent years. While risks appear to be contained, the BoT should monitor the situation closely and stand ready to take swift action, including imposing or adjusting prudential limits.14 Beyond credit growth, financial development will require improving further access, particularly for businesses, and reducing high borrowing costs, which reflect a range of issues typically found in LICs (e.g., imperfect information and slow resolution of disputes by the judicial system).

34. Micro- and macro-prudential oversight needs to be further strengthened, in parallel with the development of the financial system. Moving forward with the planned increase in capital requirements may support a gradual consolidation amongst banks. Some banks continue to have high levels of NPLs. A more proactive approach is required from the supervisory authorities to work with commercial banks on reducing NPLs. The overall stability of the banking system would be enhanced by the BoT tackling more forcefully the two small banks reporting negative capital. Enhanced AML/CFT supervision of banks could help address risks from potential loss of correspondent banking relations. With regard to mobile money, the BoT should continue to work on achieving full pass-through of deposit insurance coverage for individual mobile money accounts, addressing operational risks, and stepping up contingency planning.

35. A key first step to develop financial markets is for the BoT to further increase its emphasis on short-term interest rates. By more directly focusing on stabilizing short-term rates, including through open market operations and implementing structural reforms (e.g., required reserve averaging, ensuring that the Lombard window can always be accessed and at a rate that does not follow short-term market fluctuations), the BoT could reduce interbank rate volatility, foster the development of the interbank market, and strengthen the interest rate channel of monetary policy transmission. The eventual move to an interest-based monetary policy would complete this process. Forecasting and policy analysis capacity needs to be further developed and integrated more systematically into the decision-making process. Further work is needed to improve liquidity forecasting at the BoT and commercial banks, for instance to better anticipate seasonal patterns in government flows, which would be helped by reducing and eventually eliminating central bank advances to the government. Communication also needs to be further stepped up and improved, both through the regular publication of information and analyses and exchanges with market participants.

36. Fiscal and debt management reforms could play an important role too. Budget credibility needs to improve and to be accompanied by better cash forecasting on the part of the fiscal authorities. This will also allow the authorities to announce and stick to a bond issuance schedule, which ultimately would strengthen the government securities market. Tap sales should be phased out while transparent rules that govern the bidding process in primary auctions should be adopted. Arbitrary changes (changing or even cancelling offered amounts) should be eliminated. Greater communication with financial market participants would also help in setting the stage for a more effective government securities market.

Authorities’ views

37. The authorities broadly shared these views and underscored that a number of the recommendations were already being implemented. They noted that sustainable credit growth and better SME access to finance would require better and more easily available information to assess credit risks, as well as improved financial literacy, and they laid out their plans in this area. Implementation of partial reserve averaging is about to be implemented, and both the Lombard facility and the collateral framework will be reviewed with a view to improving them. With TA from the Fund, forecasting and policy analysis capacity is being strengthened. Communication with markets participants has improved significantly since mid-2015. The recommendations made to improve the functioning of the government debt market are being considered, together with the possibility of further IMF and World Bank TA to implement them.

38. Micro- and macro-prudential oversight is being strengthened. The BoT recently concluded its pilot consolidated supervision exercise on a large domestic bank with some cross-border operations, and additional pilot exercises are being planned. Work is underway to develop a supervisory framework for community banks. The BoT intends to improve its stress-testing model and capacity. It will review the stringency of future stress tests to ensure that both baseline assumptions and tail risks are adequately explored.

E. Growth-Enhancing Structural Reforms

Background

39. The business environment remains challenging. In the 2016 World Bank’s Doing Business survey, Tanzania ranks 139 out of 189 countries and lags behind its regional peers such as Kenya, Rwanda, and Uganda. Getting credit, paying taxes, and trading across borders are mentioned as the biggest issues. The perception of corruption has increased in recent years, while the perception of government effectiveness has decreased. Corruption has directly affected public finances: for instance, corruption at the Port of Dar es Salaam led to significant tax evasion and lower revenue; corruption in the private placement of a bond in 2013 increased financing costs to the government. In addition to the possibility of potential contingent liabilities, the IPTL case and related court proceedings have also likely increased perception of risk by investors. More broadly, corruption has negatively impacted the business climate, with likely negative implications for investment and growth.15

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Doing Business 2016 Ranking

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Source: World Bank, Doing Business Indicators.
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Tanzania: Doing Business Indicators 2016 Ranking

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Source: World Bank, Doing Business Indicators.

40. Tanzania could become a major producer and exporter of natural gas in the next decade. Recently discovered offshore natural gas, assuming it is exploited, could lead to multi-billion dollar foreign investment in the next 5–10 years and make Tanzania one of the largest exporters of natural gas in the region by the mid-2020s. Potentially significant revenue from natural gas (whose size is highly sensitive to a number of parameters, particularly gas prices; see Selected Issues Paper) could play a critical role for the development of Tanzania, if well managed.

41. The financial sustainability of the public electricity utility, TANESCO, has not been achieved yet, affecting its credibility as an energy purchaser. TANESCO still has a large amount of arrears to gas and electricity suppliers (0.7 percent of GDP in early 2016). A large independent electricity producer (SONGAS) recently decided to shut down partially its operations as a result of TANESCO’s inability to clear its arrears; other investment decisions could also be affected. Despite this context, TANESCO requested a small tariff decrease for the spring of 2016, and a larger one for 2017, anticipating a significant improvement in its financial situation reflecting favorable developments in its production mix.

Staff’s views

42. A rekindling of reform efforts will be needed to foster further structural transformation and sustain high productivity growth and investment (Box 3). Staff supported the new government’s plan to play a facilitating role for private sector-led growth, by creating a better environment for business and job creation, including through better infrastructure (for energy and transportation in particular), access to finance and land, and education and job training. Given that over 70 percent of the population is involved in agriculture, modernizing this sector will help raise income, free labor resources for other sectors of the economy, and could foster the development of certain industries, such as food processing. Staff also argued that Tanzania could significantly benefit from the completion of the EAC common market and urged the authorities to push for the removal of non-tariff barriers in the region.

43. Decisions will need to be made and implemented quickly to ensure the sustainability and development of the energy sector. The investment decision has not yet been made by potential investors in the offshore gas sector, as a number of critical issues related to the legal, tax, and regulatory environment have not been resolved. Staff welcomed the new authorities’ plan to re-engage with the investors to facilitate reaching the investment decision. Further improving the financial sustainability of TANESCO is critical to provide incentives for the existing producers of gas and independent power producers to expand their activities. Staff urged the authorities to finalize and implement the strategy to address TANESCO’s arrears and to reconsider the planned tariff decreases until TANESCO’s financial situation allows it.

44. Staff welcomed the new authorities’ strong drive against corruption. Staff underlined that anti-corruption and anti-money laundering laws and their corresponding penalties should be fully applied to any established corruption cases. Strengthening transparency will also help reduce the incidence of corruption.

Productivity, Growth, and Structural Reforms 1/

Tanzania experienced macroeconomic stabilization and significant structural change over the last three decades, including two major waves of reforms, first in the mid-1980s and more importantly in the mid-1990s. Staff analysis shows that both reform waves were followed by total factor productivity (TFP) and growth spurts. Over the recent period, growth remained strong with high investments to address infrastructure gaps, but TFP growth decreased.

Table 1.

Tanzania: Basic Growth Accounts

(Annual average growth rates)

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Source: IMF staff calculations.

Contributions to GDP growth.

The lower TFP performance coincided with a less strong reform drive in recent years. Certain indicators suggest that recent progress has been limited in a number of priorities areas, with even a deterioration of certain aspects of public governance (e.g., control of corruption) and overall government effectiveness. The business environment is challenging, even by regional standards.

Vigorous reforms are needed to sustain high growth and foster further structural transformation of the economy. While higher investment is welcome, particularly in a country with a low capital stock, a growth model relying mostly on capital accumulation is less durable than one also underpinned by TFP improvements. In emerging Asian countries which achieved sustained high growth, TFP growth contributed more to GDP growth than in Tanzania in recent years. There seems to be considerable room for productivity improvements through sustained structural and institutional reforms, which would support continued diversification of the economy.

Table 2.

Growth Accounts: Cross Country Comparison

(Annual average growth rates)

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Sources: IMF staff calculations; and Lee and Hong (2010).
1/ See Chapter I of the Selected Issues Paper.

Authorities’ views

45. The authorities stressed that the growth strategy laid out in FYDP II was broadly consistent with staff’s recommendations, with its focus on further structural transformation and a facilitating role for the government in this process. With regard to the EAC integration process, they noted that the first implementation phase of the common market is currently being assessed by the regional authorities, with a view to drawing lessons for the next steps. The authorities reiterated their intention to maintain close engagement with potential investors in the offshore gas sector.

F. Reducing External Vulnerability

Background

46. The external current account deficit is expected to remain high. Tanzania has recorded large current account deficits over the past decade, financed mainly by official flows and FDI. High development and infrastructure needs are expected to continue to lead to large investment-related imports and current account deficits.

47. Empirical analysis suggests that the exchange rate is broadly in line with fundamentals and desirable policies and that international reserves are adequate. The EBA-lite external sustainability and real exchange rate approaches indicate that the shilling, which was last assessed in 2014 to be somewhat overvalued, is now close to equilibrium (Annex III). The EBA-lite current account approach, however, suggests that Tanzania’s current account deficit is larger than the level consistent with fundamentals and desired policies, implying some overvaluation. This model, however, does not seem to capture well Tanzania’s situation (including substantial imports financed by FDI), as indicated by a very large residual. Moreover, the shilling has not been under significant pressure since mid-2015. According to traditional metrics and a cost-benefit analysis, Tanzania’s reserves at about 3.6 months of imports at end-June 2016 are adequate (Annex III).

Staff’s and authorities’ views

48. Staff and the authorities agreed that the real effective exchange rate had moved close to equilibrium and about the need to keep the exchange rate flexible. However, efforts will be needed to expand the narrow export base to reduce external vulnerability. Given other countries’ experiences, allowing exchange rate flexibility is critical to keeping tradable goods and services competitive. Foreign exchange market interventions should be used to smooth excessive volatility in the exchange rate, but not to resist sustained depreciation pressures when they exist. The economy is expected to be increasingly exposed to risks arising from rising recourse to international capital markets, the ongoing capital account liberalization, and commodity price fluctuations, particularly oil prices. To address these risks, further accumulation of reserves is desirable in the next few years; it would also help bring the reserves level closer to EAMU’s convergence criterion of at least 4.5 months of imports.

Program and Others Issues

49. Program implementation to date. Performance under the PSI has been mixed. Most end-2015 and end-March 2016 quantitative targets were met, and the 2015/16 budget was adjusted in line with the authorities’ commitment made at the time of the third review.16 Staff regretted, however, the absence of a supplementary budget to formalize it. Progress on structural benchmarks was limited (see authorities’ memorandum). The delay in implementing structural reforms reflects, to a significant extent, the transition to a new government, which has involved reconsideration of a number of measures.

50. Forward-looking part of the review. The fiscal program had to be amended significantly from the previous review to accommodate the new authorities’ priorities, as reflected in their draft 2016/17 budget (see table below). While staff would have preferred that the 2016/17 budget be based on lower revenue projections, it can support the two-step approach to its implementation, with some large projects not to be started before confirmation of readiness and availability of revenue at the time of the mid-year budget review. This approach will facilitate reaching the fiscal deficit target of about 4.5 percent of GDP while reducing the risk of arrears accumulation.17 The 5th PSI review will provide an opportunity to reconsider the broader fiscal outlook (revenue, financing, and pace of expenditure implementation) and refine the medium-term scenario, based on a more detailed assessment of large infrastructure projects. It is proposed to: reschedule to end-December 2016 the two missed structural benchmarks on the clearance of arrears to pension funds, to allow for a new verification of claims by the Internal Auditor General; and modify the assessment criteria on net international reserves and the overall fiscal deficit for end-June 2016, to reflect the large expected shortfall in ENCB. New benchmarks are also proposed in the authorities’ memorandum.

Summary Fiscal Operations

(Percent of GDP)

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Sources: Tanzanian authorities and IMF staff estimates.

51. Safeguards assessment. An update safeguards assessment of the BoT was finalized in November 2012. The assessment found a strengthened governance and safeguards framework at the BoT. While the BoT has since implemented most of the recommendations, progress in establishing a modern internal audit function has been slow.

Staff Appraisal

52. The macroeconomic outlook is favorable, but risks are tilted to the downside. Growth is projected to remain strong at about 7 percent in 2016 and the medium term, supported by the implementation of FYDP II. Inflation would remain close to the authorities’ medium-term target of 5 percent, provided that the BoT maintains a tight monetary policy stance. However, there are significant risks. External current account deficits will remain high, as higher investment boosts imports. Further external risks include the tightening of global financial conditions and a significant slowdown in China and other large emerging markets. Domestic risks include the possibility of fiscal slippages due to spending pressures stemming from FYDP II’s implementation, continued challenges to raise the required revenue and financing for the budget, and in the medium term slow reforms that could affect potential growth.

53. Sustaining high growth and implementing FYDP II while preserving fiscal and external sustainability will require a range of deep reforms. The updated debt sustainability analysis suggests that somewhat higher fiscal deficits could be sustained for a few years while keeping a low risk of debt distress. However, creating fiscal space for higher infrastructure investment, which staff fully supports, will necessitate first and foremost sustained efforts to raise additional domestic revenue and streamline current expenditure. Staff is encouraged by the authorities’ plan to strengthen tax administration drawing on a recent diagnostic mission and to consider tax policy reforms in a broad range of areas (including VAT, corporate income tax, excises, and property taxation). Reforms to increase spending efficiency, particularly in the area of public investment, will also be needed. More broadly, the targeted high growth and structural transformation of the Tanzanian economy will require a rekindling of the reform agenda, which lost some momentum in recent years.

54. The implementation of the 2016/17 budget will be a first test of the authorities’ capacity to reconcile these various objectives. To avoid the difficult experience of recent years, characterized by expenditure adjustments in the course of the year and domestic arrears accumulation, careful prioritization and implementation of expenditures will be required to ensure that spending does not exceed realistic revenue and financing projections. In this regard, staff welcomes the authorities’ intention to postpone the launch of two large investment projects until the next mid-year budget review confirms readiness and the availability of revenue. Fiscal risks and debt management also needs to be strengthened. Having realistic budgets and contingency measures should be the first line of defense against fiscal risks. Utilizing PPPs for large infrastructure projects would reduce government borrowing but the related fiscal risks need to be carefully evaluated and reported. Ongoing efforts to better monitor and manage parastatals are welcome.

55. Further financial development is highly desirable. Significant progress has been made in recent years, particularly with regard to household access to the financial sector, an area where the spectacular development of mobile money has played an important role. However, the level of financial development remains below what could be expected given Tanzania’s income level and characteristics. Recent empirical work suggests that further financial development would likely yield higher growth and greater stability. It would also improve the effectiveness of macroeconomic policy. Beyond credit growth, financial development will require improving further access, particularly for businesses, and reducing high borrowing costs, which reflect a range of issues typically found in LICs (e.g., imperfect information and slow resolution of disputes by the judicial system). The development of the key interbank and government debt markets is desirable and could be helped by the modernization of the monetary policy framework, fiscal and debt management reforms, and better coordination between fiscal and monetary policies.

56. Improving the business environment, which remains challenging, is also a priority. Tanzania lags behind its regional peers in international surveys, with access to credit, paying taxes, and trading across borders mentioned as the biggest issues. The perception of corruption has increased in recent years, while that of government effectiveness has decreased. FYDP II’s focus on creating a better environment for business and job creation, including through better infrastructure, access to finance and land, and education and job training, is therefore welcome, like the authorities’ strong drive against corruption. Decisions will need to be made and implemented quickly to ensure the sustainability and development of the energy sector. Finally, Tanzania could significantly benefit from the completion of the EAC common market and the removal of non-tariff barriers in the region.

57. Although program performance to date has been mixed, staff supports the new authorities’ policy orientations and commitments, the proposed modification of two assessment criteria, and recommends completion of the fourth PSI review.

58. It is proposed that the next Article IV consultation be held on the standard 24-month cycle for program countries.

Figure 1.
Figure 1.

Tanzania: Real and External Sector Developments

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Sources: Tanzanian authorities and IMF staff calculations.
Figure 2.
Figure 2.

Tanzania: Fiscal Developments

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Sources: Tanzanian authorities and IMF staff calculations.
Figure 3.
Figure 3.

Tanzania: Inflation and Monetary and Exchange Rate Developments

Citation: IMF Staff Country Reports 2016, 253; 10.5089/9781498390774.002.A001

Source: Bank of Tanzania, Bloomberg
Table 1.

Tanzania: Millennium Development Goals

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Sources: Tanzanian authorities and World Bank.

Tanzania Household Budget Survey 2011/2012 (survey every 10 years)

Tanzania Demographic and Health Survey 2010 (2015 survey results to be published soon)

Basic Education Statistics in Tanzania 2013 and UNESCO summary

Tanzania HIV/AIDS and Malaria Indicator Survey 2011/2012

Inter-parliamentary Union. http://www.ipu.org/parline-e/reports/2337_E.htm

Table 2.

Tanzania: Selected Economic and Financial Indicators, 2013/14–2019/20

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Sources: Tanzanian authorities and IMF staff estimates and projections.

From the third review under the Policy Support Instrument.

E.g. Calendar year corresponding to 2014/15 is 2015.

These are the spending adjustments needed to achieve the budget deficit targets.

Actual and preliminary data include adjustment to cash basis.

Net of Treasury bills issued for liquidity management.

Excludes interest payments due on external debt under negotiation for relief, and domestic unpaid claims (reported in Table 3b).

Including change in stocks.

Table 3a.

Tanzania: Central Government Operations, 2013/14–2019/201

(Billions of Tanzanian Shillings)

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Sources: Ministry of Finance; Bank of Tanzania; and IMF staff projections.

Fiscal year: July–June.

Includes sale of shares in two manufacturing companies amounting to 0.2 percent of GDP in 2015/16. Local Government Authorities’ own revenues and the equal amount of transfers, are included starting from FY2009/10.

Excludes interest payments on external debt obligations that are under negotiation for relief with a number o

Basket funds are sector-specific accounts established by the government to channel donor support to fund-specific activities.

The net expenditure float for year Y relates to expenditures recorded in year Y whose financing was recorded in year Y+1, minus the additional financing that occurred in year Y for expenditures that were recorded in year Y-1.

These are the spending adjustments needed to achieve the budget deficit targets.

The change in 2014/15 compared to the previous year reflects reclassification of 1.5 percent of GDP from goods and services to development spending, and 0.1 percent of GDP from goods and services to wages and salaries.

Excludes interest payments due on external debt under negotiation for relief, Treasury bills issued for monetary policy purposes, and domestic unpaid claims.

Includes domestic expenditure arrears defined as unpaid claims that are overdue by more than 30 days for goods and services, and more than 90 days for contract works as set out in the government circular No 9 of 8th December 2014.

Table 3b.

Tanzania: Central Government Operations, 2013/14–2019/201

(Percent of GDP)

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Sources: Ministry of Finance; Bank of Tanzania; and IMF staff projections.

Fiscal year: July–June.

Includes sale of shares in two manufacturing companies amounting to 0.2 percent of GDP in 2015/16. Local Government Authorities’ own revenues and the equal amount of transfers, are included starting from FY2009/10.

Excludes interest payments on external debt obligations that are under negotiation for relief with a number of creditors.

Basket funds are sector-specific accounts established by the government to channel donor support to fund-specific activities.

The net expenditure float for year Y relates to expenditures recorded in year Y whose financing was recorded in year Y+1, minus the additional financing that occurred in year Y for expenditures that were recorded in year Y-1.

These are the spending adjustments needed to achieve the budget deficit targets.

The change in 2014/15 compared to the previous year reflects reclassification of 1.5 percent of GDP from goods and services to development spending, and 0.1 percent of GDP from goods and services to wages and salaries.

Includes domestic expenditure arrears defined as unpaid claims that are overdue by more than 30 days for goods and services, and more than 90 days for contract works as set out in the government circular No 9 of 8th December 2014.