Somalia: Second and Final Review Under the Staff–Monitored Program and Request for a New Staff–Monitored Program

Second and Final Review Under the Staff-Monitored Program and Request for a New Staff-Monitored Program-Press Release and Staff Report

Abstract

Second and Final Review Under the Staff-Monitored Program and Request for a New Staff-Monitored Program-Press Release and Staff Report

Background and Context

1. Political developments. On February 8, Mohamed Abdullahi Mohamed was elected as the new president of Somalia in an election that was welcomed by both the Somali people and the international community.1 On April 20, the IMF, the World Bank, and the United Kingdom hosted a roundtable during the 2017 Spring Meetings in Washington, D.C. that outlined a broad macroeconomic reform roadmap that could eventually lead to Heavily Indebted Poor Countries (HIPC) Initiative debt relief. On May 10–11, the United Kingdom hosted a Conference for Somalia in London during which donors reaffirmed their support for Somalia while noting, among other topics, the importance of actions to increase transparency and reduce corruption and accelerate economic reform.

2. State-building and security situation. With donor support, state-building is advancing and the security situation continues to improve, albeit slowly. However, despite more than 80 percent of the country being liberated from Al-Shabaab, a fragile security situation limits the government’s ability to govern effectively and provide much-needed humanitarian support.

3. Humanitarian needs. The ongoing drought is severely affecting the Somali people and increasing the risk of a humanitarian crisis. The harsh impact on crops and livestock2 has left more than 6 million people (about half of the Somali population) in need of assistance and at risk of food insecurity, prompting an urgent need for humanitarian and financial assistance by the government and the international community. This assistance will be crucial for the government to be able to cope with the humanitarian crisis. The authorities are taking steps to facilitating the distribution of aid, developing capacity to respond to the drought and humanitarian needs, and introducing social safety net programs (see ¶29).

4. Economic situation. Somalia’s post-war economic situation continues to be very difficult and poverty is widespread. The authorities are lacking the resources and capacity, as well as the policy instruments, such as social safety net programs, to meet the ongoing drought and humanitarian needs.

5. Fund relations. Since the resumption of relationship with Somalia in 2013, the IMF has provided policy advice and extensive technical assistance (TA). In addition, on May 16, 2016, the Managing Director approved a 12-month Staff-Monitored Program (SMP). The first review under the SMP was completed on February 3, 2017 together with the conclusion of the 2016 Article IV Consultation with Somalia. The SMP ended in April 2017, and the authorities requested a follow-up SMP to help anchor policies and build a track record in reform implementation. Somalia’s overdue financial obligations to the IMF were last reviewed by the Executive Board in February 2017. Somalia is in arrears to the Fund (SDR 238.25 million or 539 percent of quota as of end-May 2017) and is therefore ineligible for financial support from the Fund. The clearance of external arrears will be an important part of normalizing relations with the international community and establishing a roadmap to external debt sustainability.

6. New 12-month SMP. Staff supports the completion of the SMP and approval of a 12-month follow-up SMP (May 2017–April 2018) in view of the broadly satisfactory performance in very challenging conditions (including a prolonged electoral period–August 2016 to February 2017–the ongoing drought, weak revenue mobilization and slow disbursements of donor grants). Also, the authorities’ renewed commitment to policy reform implementation as well as the remedial measures to address the missed targets lend support for the new program. The new SMP focuses on: (1) arrears management and revenue mobilization; (2) currency reform; and (3) financial sector development and effective regulation of money-transfer businesses (MTBs), including on anti-money laundering and combatting the financing of terrorism (AML/CFT), to secure inflows of remittances to support economic activity and poverty reduction. It will also support institution building, governance, and capacity development.

Economic Developments and Outlook

The economic slowdown will continue in 2017, as the drought is severely hitting the agricultural sector and livestock. Risks will continue to be tilted to the downside, not only from the drought, but mainly from weak security and slow progress in policy and reform implementation.

7. Economic activity is weakened by the ongoing drought (Text Table 1). Growth is expected to fall from 3.2 percent in 2016 to 2.4 percent in 2017, with the drought affecting crops and livestock outputs. Due in part to higher food prices, inflation is projected to pick up to 2.9 percent in 2017, from 2.3 percent in 2016. The trade deficit (56.6 percent of GDP on average in 2015–16) is projected to remain sizable and will be largely financed by remittances and grants. Somalia’s external debt stood at 81 percent of GDP ($5,130 million) at the end of 2016 (Tables 7a and 7b).

Text Table 1.

Selected Economic Indicators, 2015–18

(Percent of GDP, unless otherwise indicated)

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Sources: Somali authorities; and IMF staff estimates.

Covers only the Federal Government of Somalia’s operations.

The fiscal operations are recorded on cash basis.

Wages and salaries. Figure for 2017 includes salary payments for 12 months.

Program definition; and millions of U.S. dollars.

Table 1.

Somalia: Prior Actions and Structural Benchmarks under the Staff-Monitored Program, May 2016–April 2017

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The action is still in progress. Significant progress has been made, and the authorities and the World Bank agreed to revise the eligibility criteria of contracts over $50,000.

Table 2.

Somalia: Economic Developments, 2013–18

(IMF Quota = SDR 44.20 million; Population: 14 million, 2015 estimate)

(Population growth rate: 2.5 percent, estimate; Per Capita GDP: N61$425, 2015 estimate)

(Poverty Rate: n.a.; Main Export: Livestock)

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Sources: Somali authorities; and Fund staff estimates and projections.

Budget data for the federal government. Fiscal operations are recorded on a cash basis. GDP data cover the entire territory of Somalia.

Includes only donors’ support provided to the Federal government through treasury accounts at the Central Bank of Somalia.

Includes Treasury (single account) deposits, donor grants, and assets recovery.

Table 3a.

Somalia: Federal Government Operations, 2015–18 1/

(Millions of U.S. dollars)

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Sources: Somali authorities; and Fund staff estimates and projections.

The fiscal operations are recorded on a cash basis.

Includes spending covered by recovered assets.

Includes only donors’ support provided to the Federal government through treasury accounts at the Central Bank of Somalia.

Figure for 2017 includes salary payments for 12 months.

Estimated arrears. The figure for 2016 includes only wages, salaries and allowances.

The figure for 2016 includes $17.3 million (November and December wages) that were taken out of the revised budget.

Table 3b.

Somalia: Federal Government Operations, 2014–18 1/

(Percent of GDP)

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Sources: Somali authorities; and Fund staff estimates and projections.

The fiscal operations are recorded on a cash basis.

Includes spending covered by recovered assets.

Includes only donors’ support provided to the Federal government through treasury accounts at the Central Bank of Somalia.

Figure for 2017 includes salary payments for 12 months.

Estimated arrears. The figure for 2016 includes only wages, salaries and allowances.

The figure for 2016 includes $17.3 million (November and December wages) that were taken out of the revised budget.

Table 4.

Somalia: Summary Accounts of the Central Bank, 2014: Q4 – 2017: Q1 1/

(Thousands of U.S. dollars)

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Sources: Central Bank of Somalia; and Fund staff estimates.

Based on the Central Bank of Somalia (CBS) financial statements. The CBS’ account data are still preliminary and incomplete.

Gold valued at market price.

Includes external assets recovery, official grants, and earmarked funds.

Includes treasury and Development Bank deposits, and grants.

Excluding Somalia’s overdue financial obligations to the IMF.

Table 5.

Somalia: Consolidated Commercial Banks Balance Sheet, 2015: Q1 – 2017: Q1 1/

(Thousands of U.S. dollars)

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Sources: Central Bank of Somalia; and Fund staff estimates.

Deposits and Placements with banks and other financial institutions.

In securities, associates and Joint ventures, and property.

Deposits and Placements of banks and other financial institutions.

The financial sector is nascent. Quarterly data have started been produced since March 2015.

Table 6a.

Somalia: Balance of Payments, 2013–18

(Millions of U.S. dollars)

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Sources: Authorities, Direction of Trade Statistics, UN Comtrade, and Fund staff estimates and projections.

2013 data from Barclays Bank, PLC.

Includes direct budget support.

Excluding Somalia’s net position with the IMF. Negative sign means increase in reserves.

Table 6b.

Somalia: Balance of Payments, 2013–18

(Percent of GDP, unless otherwise indicated)

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Sources: Authorities, Direction of Trade Statistics, UN Comtrade, and Fund staff estimates and projections.

2013 data from Barclays Bank, PLC.

Includes direct budget support.

Excluding Somalia’s net position with the IMF. Negative sign means increase in reserves.

Table 7a.

Somalia: External Public Debt, 2013–16

(Millions of U.S. dollars)

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Sources: Somalia Debt Management Unit; World Bank; and AfDB.

Claims in currency of loan are converted to US$ at period-end exchange rates.

For Paris Club creditors, extrapolations of known penalty interest rates were applied. The average penalty interest rate is about 3.4 percent. For Non-Paris Club creditors, late interest rate is only known for Kuwait. No penalty interest has been included for 2014.

Data of Non-Paris Club creditors is preliminary as a large portion is estimated from the World Bank debt database (WBXD).

Table 7b.

Somalia: External Public Debt, 2013–16

(Percent of GDP)

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Sources: Somalia Debt Management Unit; World Bank; and AfDB.

Figures for 2016 are based on information through end-December 2016.

Claims in currency of loan are converted to US$ at period-end exchange rates.

For Paris Club creditors, extrapolations of known penalty interest rates were applied. The average penalty interest rate is about 3.4 percent. For Non-Paris Club creditors, late interest rate is only known for Kuwait. No penalty interest has been included for 2014.

Data of Non-Paris Club creditors is preliminary as a large portion is estimated from the World Bank debt database (WBXD).

8. The fiscal position came under further pressure in 2016 (Tables 3a and 3b). Budgetary grants and revenue fell short of program projections (by $19.1 million). This, for the most part, reflected weak revenue mobilization and low grant disbursements. Arrears continued to build up in the face of a cash shortfall.3 In 2017, the fiscal situation is projected to improve as yields from new revenue measures are expected to materialize toward the end of the year, and no new domestic arrears are anticipated.

9. The Central Bank of Somalia’s (CBS) balance sheet remained broadly stable (Table 4). CBS assets remained between $71 million and$73 million. The SOS4/USD exchange rate depreciated by 2.6 percent year-on-year in April 2017, but appreciated by 11.3 percent from February to March 2017 following the peaceful presidential election.5

10. Commercial banking activities are being strengthened (Table 5). The CBS made significant progress in developing bank licensing frameworks, particularly on methods for periodic financial reporting by commercial banks, and on a system for bank financial analysis, as well as on the Capital adequacy–quality of Assets–quality of Management–Earnings–Liquidity (CAMEL) bank supervisory scoring system. Capitalization of banks remains strong and their assets increased by 20.5 percent in 2016 (and 7.6 percent between December 2016 and March 2017).

A01ufig1

Somali Shilling Per U.S. Dollar

(Monthly average, January 2015–April 2017)

Citation: IMF Staff Country Reports 2017, 204; 10.5089/9781484309100.002.A001

Performance Under the SMP

Somalia’s performance under the SMP was broadly satisfactory considering the various events that tested the authorities’ capacity to implement their reforms.

11. For December 2016 targets (Text Tables 2 and Table 1), four out of five indicative targets (ITs) and all but one structural benchmarks (SBs) were met.

  • Missed IT on domestic arrears (continuous IT). The ceiling on the accumulation of new domestic arrears was missed by $25.6 million (excluding $17.3 million, equivalent to two months of salaries, which was not included in the 2016 budget).6 Despite remedial measures agreed to at the time of the first review, delayed payments, and domestic arrears continued to accumulate through the end of 2016. The root causes of these new arrears are weak tax collection, lower-than-projected grants, and still-poor public financial management (PFM). The failure to establish the Domestic Arrears Management Committee (DAMC) also weakened the authorities’ ability to monitor new arrears.

  • Missed SB on non-salary Recurrent Cost and Reform Financing (RCRF) reimbursement. The benchmark of “achieving 100 percent of non-salary RCRF reimbursement” was missed. While some treasury and procurement processes require additional improvement, the authorities and staff noted that progress has been made in many reforms underlying the reimbursement, such as in payment processes. To allow for more reimbursements under the program, the authorities and World Bank staff also agreed to revise the eligibility criteria of contracts over $50,000, and to accelerate efforts to modernize payment processes, and develop commitment controls for all Ministries, Departments, and Agencies (MDAs).

12. For March 2017 targets (test date), all ITs and all SBs were met, albeit with some delays. Revenue mobilization during the first quarter of 2017 was strong. Domestic revenue reached $28.8 million compared to $26.2 million in the same quarter in 2016.7 As a result, in the first quarter of 2017, the authorities were able to pay $7.5 million in domestic arrears (equivalent to October 2016 delayed payments). Given that the authorities included the November and December 2016 delayed payments in the stock of arrears as of end 2016 (¶11 and ¶14, bullet #1), there was no accumulation of new domestic arrears in the first quarter of 2017.The SBs on “Complete an action plan to improve the policy and processes for cash management function” and “Complete a plan to modernize the revenue and customs administration” have been completed with some delays (Table 1).8

13. Developments since March 2017 are encouraging. Total revenue has continued to improve through end-April 2017 and the authorities are current on their payments. The two proposed SBs set for June 2017 under the new SMP are expected to be implemented on schedule (MEFP9 ¶10, SB #1 and 2, and MEFP Table 2). The supplementary budget has been drafted and approved by the Cabinet on June 8. It is expected to be submitted to the parliament for approval by end-June.

14. Staff’s views

  • On domestic arrears accumulation (MEFP ¶9, bullet #2). Considering the difficult environment, the commitment of the new government to address the root causes of arrears, and the importance of maintaining reform momentum, staff agreed with the authorities’ strategy that: (1) given the government’s limited resources and the need to introduce proper fiscal management in 2017, all new domestic arrears and delayed payments from 2016 be included in the stock of arrears; (2) the DAMC be established and empowered to swiftly begin monitoring arrears and finalize domestic arrears stocktaking for 2015 and 2016 (MEFP ¶10, SB #1, and MEFP Table 2); and (3) no new domestic arrears be accumulated. Also, any revenue windfall will be allocated to paying down domestic arrears. To keep this and subsequent SMPs on track, staff stressed the importance of adhering to this strategy.

  • On the non-salary RCRF. Given the importance of payment reforms in improving fiscal transparency and accountability, staff and the authorities agreed on the need to continue making progress under the RCRF (MEFP ¶10, SB #4, and MEFP Table 2).

  • On the completion of the SMP. Staff supports the completion of the SMP in view of the broadly satisfactory performance, and progress the authorities have made in many important areas. Since May 2016, Somalia has coped with a raft of difficult circumstances, including: a prolonged electoral period (August 2016 to February 2017), the ongoing drought, weak revenue collection, and slow disbursement of donor grants.

Text Table 2.

Somalia: Indicative Targets under the Staff-Monitored Program, 2016–17 1/

(Millions of U.S. dollars)

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Sources: Somali authorities; and Fund staff estimates and projections.

Cumulative from the beginning of the year.

Test date for the first review of the SMP.

Test date for the second review of the SMP.

Continuous indicative target.

The arrears figure for December 2016 includes the 2-month salaries ($17.3 million) not included in the 2016 budget.

Calculated using program exchange rates. See Technical Memorandum of Understanding (Attachment II) for definitions of the program targets.

Removed after September 2016 test date.

New SMP and Policy Discussion

Staff supports the authorities’ request for a new 12-month SMP (May 2017–April 2018). Policy discussions focused on the program objectives, modalities, monitoring, and risks as well as macroeconomic policies and necessary reforms for 2017–19 to: (1) improve PFM and revenue mobilization; (2) keep the momentum of currency reform; (3) revive the financial sector; and (4) lay the foundations for inclusive economic growth.

A. Follow-Up 12-Month SMP

15. Staff supports the request for a new SMP. Based on progress under the previous SMP, the remedial measures to end domestic arrears accumulation and to complete the non-salary RCRF, as well as the authorities’ commitment to maintain reforms and policy implementation momentum, staff supports the authorities’ request for a new 12-month SMP (May 2017–April 2018).

Objectives and Features of the New SMP

16. Program objectives and anchors. The new 12-month SMP is guided by the findings of the 2016 Article IV Consultation and lessons learned from the previous SMP. It will help Somalia maintain reform momentum and macroeconomic stability, and continue to build a track record of implementing policies. Despite encouraging progress under the first SMP, significant challenges remain to advance the needed policies and reforms to lay the foundations for future growth and poverty reduction. The new SMP is guided by the lessons learned from the current SMP (Box 1). The new SMP will continue to be geared toward supporting macroeconomic stability, rebuilding institutions, and capacity for improved macroeconomic management and governance. It will be anchored on: (1) a floor for the fiscal balance (zero cash balance); (2) non-accumulation of new domestic arrears and increasing arrears payments in the event of a revenue windfall; (3) a revenue floor; and (4) a floor on the central bank’s net foreign assets.

17. Key features of the program. The program is designed on three pillars: fiscal policy and reforms, monetary and financial sector reforms, and governance and capacity development. In the fiscal sector, the program aims to broaden the tax base, as well as improve PFM and arrears and cash management. In the monetary and financial sector, implementing the agreed currency reform measures and establishing a financial sector development roadmap will be critical. In the governance and capacity development areas, continued progress with building institutions, economic data, and capacity are integral parts of the program (MEFP, Attachment I).

Program Monitoring and Risks

18. The SMP will be monitored based on quarterly ITs and SBs (MEFP Tables 1 and 2). It will have two reviews which are expected to be completed by end-December 2017 and end-June 2018, respectively. The program’s ITs are defined in the Technical Memorandum of Understanding (TMU, Attachment II).

Somalia: May 2016–April 2017 SMP and Follow-up SMP: Lessons Learned

Objectives, Outcomes, and Lessons

The SMP design was in line with the recommendations of the July 2015 Article IV Consultation, the IMF’s first with Somalia since 1989. The previous SMP sought to achieve macroeconomic stability and anchor policy through improved fiscal and financial institutions, as well as build capacity. Program design was rudimentary and focused on short-term objectives, while accounting for weak institutional and human capacity and scarce data. The program also correctly identified key risks, some of which materialized.

The authorities’ commitment to policy and reform under the program and continued donor support helped ease the challenges of implementing the program. The program was effective in helping implement critical reforms in budget, PFM, tax policy, and developing the process for issuing a new currency. TA programs from the IMF and donors aimed at developing capacity were also instrumental in the program being successfully completed.

At the same time, the previous SMP exposed weaknesses in reform implementation that will need to be addressed under the new SMP. Experience under the previous SMP revealed that domestic arrears accumulation and monitoring continue to be difficult issues. Furthermore, the authorities’ efforts to generate additional revenue by improving efficiency and broadening the tax base required more political support and TA. Also, grants continue to be volatile and delayed, complicating budget execution. While the previous SMP supported the currency reform and focused on strengthening the central bank, it did not address issues related to the weak financial intermediation which is nearly absent in Somalia. Finally, Somalia will need to overcome key impediments to growth (weak institutions and governance; weak human capital; poor infrastructure; and an underdeveloped financial sector).

Follow-Up SMP

The follow-up SMP’s reform priorities and monitoring seek to address the above issues. The election of a new government with a four-year mandate is important for generating political will for difficult reforms.

  • On the fiscal side, the new SMP will support the authorities’ reform agenda by including SBs on PFM and the revenue floor which will require broadening the tax base. Arrears monitoring will be improved through the introduction of an automated system of recording fiscal operations on a commitment basis. The structural agenda covers a well-defined set of macro-critical areas with the highest pay-off in terms of Somalia’s growth and development priorities.

  • On the financial sector and growth, the new SMP, while continuing to support the currency reform, pays greater attention to reviving the financial sector development and the effective regulation of the MTBs to secure remittance inflows (from the Somali diaspora) to support economic activity and help reduce poverty.

19. Program risks. Risks to the program and to the outlook are high. These stems mainly from fragile security; weak policy commitment and slow progress in policy and reform implementation, which could weaken the fiscal position; the accumulation of new domestic arrears; severe drought conditions in some key regions of Somalia, followed by humanitarian crisis and a significant refugee problem; and possible shortfalls in donor support to the FGS (Risk Assessment Matrix, Annex I). Another critical risk to the program could be the authorities’ capacity to implement the agreed set of SBs.

  • Staff views. Staff stressed that the authorities’ continued commitment to the program, and sustained and coordinated international support—including with regards to security, peace, and capacity building—would help mitigate risks. In this context, adherence to the agreed strategy to avoid new domestic arrears and remain current on government bills will be critical. Staff also noted that achieving the tax revenue targets will be critical for the success of the program and will depend on necessary political will and on coordination between the Ministry of Finance (MoF) and the Ministry of Posts and Telecommunication. On the government’s capacity to implement the set of SBs, staff noted that they have been backed by IMF TA and discussed with the authorities. The authorities and staff also agreed that their phasing is appropriate.

B. Improving Fiscal Discipline and Revenue Collections

20. The authorities are preparing a supplementary budget. The current 2017 budget approved by the parliament in early April10 is ambitious, as it includes the repayment of three months’ worth of civil servant salaries from 2016 (about $24 million). It envisages $267.6 million in expenditure, compared to an outturn of $171.1 million in 2016. In view of the security situation, weak revenue collection capacity (due in part to a weak legal enforcement framework),11 delays in the implementation of new tax revenue measures (Box 2), and poor performance in grant disbursements, the authorities and staff agreed on the need to prepare a more realistic budget. Hence, a supplementary budget which is more closely aligned with the SMP (MEFP ¶9) will be submitted to parliament by the end of June.

21. The authorities agreed that the supplementary budget should feature more realistic revenue and grants, and prudent expenditure (MEFP ¶9). The revised budget will be underpinned by the following policies and measures:

  • Overall policy. The fiscal framework (Tables 3a and 3b) in the SMP will guide the supplementary budget, taking into account the strategy to avoid new domestic arrears accumulation (¶13, bullet #1). In the event of a revenue windfall, the authorities will increase the amount allocated for paying down domestic arrears. Under the current framework, the authorities and staff have agreed on initial payments of $16.1 million and $12.6 million in 2017 and 2018, respectively.

  • Revenue policy (MEFP ¶9, bullet #1). Projected budgetary grants are based on confirmed and committed pledges. Domestic revenue is projected to increase to $137.6 million (2.1 percent of GDP) from $112.7 million (1.8 percent of GDP) in 2016. This increase is being underpinned by a set of tax policy and reform measures aimed at replacing the current negotiated taxes with the existing tax law. Revenues from these measures, are projected to be about $23 million (Box 2).

  • Expenditure policy (MEFP ¶9, bullet #2). The authorities agreed that, starting in 2017, fiscal projections will assume full payment of all civil servant and security forces salaries; that the government will improve budget execution and fiscal discipline; and that it will remain current on its payment obligations. The fiscal program also envisages assessing the effectiveness of MDA spending and the civil service with an aim of eliminating duplicated activities and ghost workers. The authorities also plan to introduce a social safety net program, particularly for vulnerable areas facing large humanitarian needs.

  • Debt management (MEFP ¶29). The authorities agreed to step up efforts to swiftly complete the debt database and improve capacity at the Debt Management Unit (DMU). They are reaching out to creditors and are expected to complete about 95 percent of the external debt database by the end of August 2017.

22. The authorities are establishing an ambitious package of structural reforms, consistent with the SMP, to improve budget execution, fiscal management, and revenue collection (MEFP ¶10–14, and MEFP Table 2).

  • On avoiding accumulation of new domestic arrears and arrears management, the authorities are determined to swiftly initiate a plan to establish the cash management function unit (MEFP, SB #1), and form and empower the DAMC (MEFP ¶10, SB #2).

  • On treasury management and budget execution, the authorities’ commitment to update and adopt the PFM Bill (MEFP ¶10, SB #3) remains a critical reform priority. To support this reform, the authorities will move quickly to: (1) implement commitment controls and operationalize the purchasing module functionality of the Somalia Financial Management Information System (SFMIS); (2) improve annual budget preparation procedures; (3) improve the fiscal transparency and accountability under the RCRF (MEFP ¶10, SB #4 and #5); and (4) make progress toward a functional Treasury Single Account (TSA). On the latter, staff supports the authorities’ efforts to prepare a transitional plan in which all bank accounts will be mapped to the SFMIS. They will also continue the review of MDAs accounts with the view of closing non-critical ones and substantially reducing the use of cash advances to MDAs.

  • On revenue mobilization, important structural efforts are underway to lift revenue. In the context of reforming the tax and customs administrations, the government is determined to: (1) conclude the renegotiation of all existing revenue-collection contracts (MEFP ¶13, SB #6); (2) establish a large- and medium-sized taxpayer office (LMTO) (MEFP ¶13, SB #7); (3) undertake actions to eliminate tax loopholes and revenue leakages at Customs (MEFP ¶14, SB #8); and (4) develop an audit program to revamp business processes for automated processing to combat fraud and tax evasion and facilitate the movement of goods (MEFP ¶14, SB #9).

Somalia: New Measures to Increase Tax Revenues

Projected yields from the new revenue measures were revised down. At the time of the first review, these efforts were projected to yield about $43 million in additional revenue in 2017, of which more than half was to come from the telecommunications sector (see Text Table). However, some projected yields have now been revised down due to delays in the implementation of revenue measures and revisions in revenue projections. The yield from sales taxes on petroleum, khat, and hotels as well as from income tax are expected to be lower due to delayed implementation (ranging from two to six months). Income from telecommunications fees was excluded and the base for the telecoms sales tax was reduced based on a peer analysis. Plans to introduce sales taxes on utilities were removed particularly in view of the burden already represented by the drought. The vehicle registration tax was delayed but could be implemented in the future. The net effect, including the new measures, will lead to a reduction of identified revenues from these measures of about $20 million.

Text Table. Projected Yields from New Tax Revenue Measures

(Millions of U.S. Dollars)

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Sources: Somali authorities; and Fund staff estimates and projections.

As in the 2016 Article IV Consultation staff report.

Revised 2017 projections lower largely due to delayed implementation and exclusion of the telecom fees, about $14 million under the program

The program projection included telecom licensing fees. These are not included in the revised projection.

Authorities started appointing new personnel, streamling processes, and improving inspections to reduce leakages and improve efficiency at the Mogadishu airport and port.

Additional offsetting measures have already been implemented. Since early 2017, the authorities have introduced new tax administrative measures at the port and airport in Mogadishu. These measures include the improvement in the electronic payments and the reduction of cash transactions to reduce corruption. In addition, they have renewed the contracts of several staff and are enforcing the existing tariff rates to reduce leakages. These efforts have resulted in about a 20 percent increase in Customs revenue through the first four months of 2017 compared to the same period in 2016.

Tax revenue collection could also surprise on the upside. Some possible sources of additional revenue were not included in staff projections, such as income tax on telecommunications sector employees. While revenue from telecommunications fees was removed, passage of the Communications Act (MEFP ¶17, SB #10, and MEFP Table 2) would make these revenues more likely to materialize. Finally, the authorities are benefiting from TA to improve the tax and customs administrations.

C. Keeping the Currency Reform Momentum

23. Reforming the national currency remains a key priority. The CBS is preparing to reissue new SOS banknotes to combat massive counterfeiting in the country, restore confidence in the national currency, and provide the CBS with the ability to conduct monetary policy. The authorities prepared a reform roadmap in late 2016; however, the process is taking longer than initially envisaged mainly due to weak capacity and a lengthy electoral period which lasted from August 2016 to February 2017.

24. Since the approval of a revised currency reform roadmap in late February 2017, progress has been encouraging (MEFP, ¶15–16). The revised roadmap features the key legal and operational frameworks required for the launch of the new currency. Several important reforms have been implemented since February. In line with the roadmap, the CBS: (1) has finalized the anti-counterfeit strategy note; (2) has designed special accounting and reporting system modules; and (3) has developed a task force of high-level CBS staff to manage the currency reform program.

25. The authorities are committed to keeping the currency reform agenda on track. In this context, they plan to undertake a package of new measures under the currency reform roadmap, including establishing a national anti-counterfeit center (MEFP ¶16, SB #10). They have also initiated discussions with the Ministry of Finance on key reform modalities, including the denominations and design features of the new banknotes and the estimated costs of the reform (MEFP ¶16, SB #11).

D. Reviving the Financial Sector

26. The authorities recognize the urgent need to revamp the financial sector. At the same time, they are aware that currency reform and financial sector reform will reinforce each other. The most pressing obstacles to increased financial intermediation include: (1) absence of centralized payment and inter-bank payment systems; (2) weak re-licensing, supervision, regulation, and compliance of MTBs, which has significant implications for securing inflows of remittances to Somalia; (3) shortcomings in the AML/CFT framework and its weak implementation, which can negatively affect correspondent banking relationships; and (4) a still-weak central bank capacity and widespread SOS counterfeiting.

27. The authorities envisage several important reforms to revive the financial sector (MEFP ¶17 and MEFP Table 2). In this context, they will: (1) submit to parliament the longstanding Communication Act to license mobile network operators (MEFP ¶17, SB #12) which will allow them to regulate mobile money operations; (2) outline a roadmap for financial sector development (MEFP ¶17, SB #13); (3) develop software for MTBs to reduce gaps in compliance; (4) develop a plan to strengthen the procedure for the renewal of MTB licenses and enhance compliance with existing regulations, including on AML/CFT (MEFP ¶17, SB #14). ; and (5) develop and implement key regulations for banking and MTBs, as well as continue building supervisory capability at the CBS and strengthening compliance with AML/CFT standards. The implementation of a targeted financial sanctions regime to comply with terrorist financing-related United Nations Security Council Resolutions should help alleviate some of the pressure on correspondent banking relationships and MTBs.

E. Laying the Foundations for Inclusive Economic Growth

28. Developing Somalia’s economic resilience is one of the priorities of the new government. At the London Conference on May 10–11, 2017, donors expressed their broad support for the authorities’ economic recovery and resilience-building plans set out in the National Development plan (NDP). To achieve their development objectives, the authorities will implement a coherent set of reforms guided by the SMP, and the outcomes of the London Conference and the Roundtable which was held in April in Washington D.C. This will include critical reforms to improve the business environment as well as the financial sector.

29. Staff supports the authorities’ economic recovery and social inclusion strategy (MEFP ¶18–19). The strategy is rightly set up around three pillars that focus on leveraging the country’s comparative advantages and addressing its structural weaknesses; namely: (1) improving infrastructure with basic water and energy access; (2) generating employment through agribusiness, including livestock, fisheries, and agriculture; and (3) increasing skills and access to finance, and developing capacity. Staff also supports the authorities’ efforts to improve the business environment and welcomes the passage of the foreign direct investment (FDI) law and the adoption of the procurement bill. The inclusion of Somalia into the Global Doing Business Survey for the first time in 2017 is also a welcome step for the development of the private sector. Staff encourages the authorities to start preparing a revised NDP to focus more on a number critical areas, including: (1) developing social safety net programs; (2) strengthening the NDP linkage to the annual budget; and (3) outlining a strategy for stronger private sector participation in the economy.

30. While the authorities’ development strategy is commendable, staff stressed that focus on governance, economic statistics, and capacity development is equally important.

  • On governance (MEFP, ¶20–22), staff welcomed the recent renewal of the Financial Governance Committee (FGC) which will review large procurement and concession contracts, and play a key role in reviewing progress in PFM and currency reform. Staff also encouraged the authorities to make progress on fiscal federalism, natural resource management and transparency, and procurement.

  • On statistics (MEFP, ¶23), the authorities will submit to parliament the new statistical law (MEFP ¶23, SB #15, and MEFP Table 2); and take several actions to improve economic statistics, including improving the business registry list and external sector data.

  • On TA (MEFP, ¶24–26), the authorities are cognizant of the merit of the TA delivered by donors in helping improve institutions and capacities in the fiscal and financial areas. The authorities and staff agreed that, the successful completion of many of the SBs identified under the new SMP would require additional TA support. Staff indicated that the Fund will continue to provide a high level of TA.

Staff Appraisal

31. The Somali authorities are to be commended for implementing important reforms in challenging conditions. Since late 2016, Somalia has been hit by a severe drought. It is becoming apparent that this impact could be more significant than initially anticipated, leading to a downward revision of growth in 2017. In addition, the parliamentary and presidential elections—originally planned for August – September 2016—were completed in February 2017. Furthermore, execution of the 2016 budget was difficult, largely due to weak revenue mobilization, slower-than-expected grant disbursement, and poor PFM practices. Nevertheless, despite low administrative capacity, the FGS was able to implement several tangible reforms under the SMP.

32. Risks to the program and the outlook are high. Economic outlook and the SMP are vulnerable to the fragile security situation; slow progress in policy and reform implementation; poor fiscal management; weak institutional capacity; persistent drought conditions and the humanitarian crisis; and shortfalls in donor support to the FGS. While the number of proposed measures agreed on is appropriate, a lack of policy commitment could signal overwhelming structural reform agenda under the SMP. Staff believes that the authorities’ continued commitment to the program, and sustained and coordinated international support would help mitigate these risks. In addition, political support for the reform measures under the SMP will be essential for the success of the program.

33. Mobilizing domestic revenue and improving expenditure management are key fiscal goals of the new program. Guided by the lessons learned from the current SMP, the new SMP emphasizes domestic revenue mobilization and expenditure management, including budget execution and cash and treasury management. Lifting domestic revenue from its current very low level, through strong reforms, will offset the volatility of grants and support the country’s development goals. Staff welcomed the authorities’ continued effort to improve the TSA system.

34. Reform momentum of the national currency should be maintained. Progress under the currency reform roadmap has been encouraging since it was endorsed by the CBS Board of Directors in late February 2017. The roadmap carefully featured the key legal and operational frameworks required for the launch of the new currency. In this context, critical steps toward combating counterfeiting, and on the accounting and reporting modules, have been completed.

35. Financial sector development is urgently needed. The authorities recognized the urgent need to revamp the financial sector. At the same time, they are cognizant that currency reform and financial sector reform will mutually re-enforce each other. Staff recommended that the authorities step up efforts to: (1) outline a roadmap for financial sector development; (2) regulate the use of mobile money; (3) develop software to be used by all MTBs to reduce gaps in compliance; (4) develop a plan to strengthen the procedures for the renewal of MTB licenses and enhance compliance with existing regulations, including on AML/CFT; and (5) develop and implement key regulations for banking and MTBs.

36. The need for capacity development remains significant. There is a significant need to develop capacity of government institutions and the CBS. In addition, successful completion of several structural benchmarks under the new SMP will require additional TA from the Fund. Provision of TA from the Fund is expected to remain high in the period ahead.

37. Performance under the SMP was broadly satisfactory and, therefore, staff supports the completion of the second and final review. For December 2016 targets, four out of five indicative targets and all but one of the SBs were met, albeit with some delays. For March 2017 targets, all indicative targets and all SBs were met. Considering the broadly satisfactory progress under the SMP, remedial measures to address the missed targets, particularly on the accumulation of new domestic arrears, and the authorities’ strong commitment toward policy and reform implementation in what remains a difficult environment, staff supports the completion of the second and final review of the SMP.

38. Based on the broadly satisfactory performance under the previous SMP, staff supports the authorities’ request for a new 12-month SMP. Despite the progress thus far, significant challenges remain to build a track record in policy and reform implementation. Somalia is facing daunting challenges to: (1) start mobilizing domestic revenue on an ad-valorem basis and lift revenue collection; (2) boost PFM to improve cash, treasury, and arrears management, as well as budget execution; (3) complete currency reform; and (4) develop the financial sector. The new SMP will help maintain reform momentum and macroeconomic stability. It will also boost confidence and continue to catalyze donor support and will focus on: (1) arrears management and revenue mobilization; (2) currency reform; and (3) financial sector development and effective regulation of MTBs, including on AML/CFT, to secure important inflows of remittances to support economic activity and poverty reduction.

39. Staff supports the authorities’ economic recovery and social inclusion strategy. It will address Somalia’s infrastructure needs, particularly in the water and energy sectors, and generate employment, increase skills and access to finance, and capacity development. To this end, staff supports the outcomes of the London conference on Somalia. This will include helping Somalia cope with the humanitarian crisis resulting from the drought, one of many priorities identified by the conference in London. The IMF will continue to assist the authorities with the needed technical assistance and policy advice to achieve the objectives set under the SMP.

Figure 1.