Statement by Alexandre Tombini, Executive Director for Cabo Verde and Pedro Fachada, Alternate Executive Director, March 26, 2018

2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Cabo Verde


2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Cabo Verde

1. On behalf of our Cabo Verdean authorities, we thank the mission team for the constructive engagement during this year’s Article IV consultation. Our authorities reiterate their appreciation for the Fund’s support to Cabo Verde, both in terms of surveillance and capacity building.

2. Cabo Verde’s economy continued to strengthen in 2017 and the medium-term outlook is positive. The recent economic recovery has undoubtedly a cyclical component, but also reflects early dividends from the authorities’ reforms over the last two years, aimed at increasing private sector participation, reducing fiscal risks, and reorganizing public companies. In the authorities’ view, the mission team captured well the strength of the ongoing recovery, but their medium-term projections underestimate the payoff from the reform momentum on growth.

Economic Developments and Outlook

3. Real GDP grew 4.9 percent on a year-on-year basis in the third quarter of 2017 (latest available data), the best performance since the first quarter of 2012. This performance was driven by double-digit expansions in the hotel and restaurant, utilities, and manufacturing sectors, which more than offset declines in agriculture and fisheries due to largely one-off factors. On a cumulative basis, GDP grew 3.9 percent in the first three quarters of 2017, compared to the same period in 2016.

4. In recent years, tourism has been the most dynamic sector in Cabo Verde’s economy. Traffic of international passengers in Cabo Verde’s airports increased by 18.5 percent last year. According to data released by the National Institute of Statistics (INE), the number of nights stayed by visitors increased by 12.3 percent in 2017. Although there is a cyclical component inherent within the tourism industry worldwide, in Cabo Verde’s case there is also a structural element to the tourism boon. In addition to the marketing of Cabo Verde as a safe and “off the beaten track” alternative to Mediterranean destinations, new hotel developments and the expansion in airlinks with the main European markets have increased the attractiveness of the islands.

5. Cabo Verde’s inflation dynamics continued to be influenced by external price developments and the peg to the euro. Inflation returned to positive territory in 2017, and in the 12-months through February 2018 consumer prices increased by 0.8 percent. The benign inflationary environment has positively impacted consumer and business confidence.

6. Given the rebound in economic activity and their structural reform agenda, the authorities consider staff’s medium-term growth outlook to be relatively pessimistic. Partly, this can be attributed to the backward-looking methodologies applied by staff to estimate the growth potential of the economy, which are affected by the weak growth environment that prevailed in Cabo Verde at the time of the euro area crisis between 2012-2015. The relevance of these backward-looking techniques diminishes when structural changes take place, making the use of historic data inadequate to project future GDP growth. High investment and capital accumulation in past years enable the country to grow now at higher rates. The Ministry of Finance estimates GDP to grow between 5.0 and 5.5 percent in 2018, with further strengthening expected in the following years.

Fiscal Policy

7. In 2017, public debt as a share of GDP declined for the first time in a decade. This was a result of the authorities’ strong efforts to put the public debt ratio on a firm downward path and reduce fiscal sustainability risks. The overall fiscal deficit was in line with the authorities’ target, standing at 3 percent of GDP in 2017 and compared favorably to the average fiscal deficit of around 9 percent of GDP in the 2010-2014 period. As recognized by staff (footnote 3), in the absence of a specific operation related to the public housing company IFH, the budget would be close to balance.

8. Fiscal consolidation has been supported by strong revenue mobilization efforts and expenditure restraint. The authorities have managed to increase tax revenues from 19.2 percent of GDP in 2015 to an estimated 21.1 percent of GDP in 2017 by fighting tax evasion, combating informality, collecting tax arrears and strengthening the capacity of the tax agency. To ensure that the budget target was met last year, the Ministry of Finance cut certain approved spending, in accordance with the budget legislation.

9. For 2018, the authorities are committed to sustain fiscal discipline, targeting a budget deficit of around 3.1 percent of GDP. They continue to see space for additional domestic revenue mobilization by combating tax evasion and recovering tax arrears. They take note of staff’s recommendation to raise the VAT rate from 15 to 17 percent, similar to the level of other highly-indebted small island economies, but they are not planning any tax increase at this juncture. As was the case in 2017, the authorities have already announced cuts of certain spending categories to alleviate budget pressures.

10. Efforts to address vulnerabilities in important state-owned enterprises (SOEs) are ongoing. Significant progress has already been achieved regarding the national airline, TACV. The company withdrew last year from the domestic market and management was transferred to Icelandair Group, which is restructuring TACV’s international operations and preparing for its privatization. The strategy of the new management envisages using Cabo Verde’s central location in the South Atlantic as a hub for intercontinental air traffic. Regarding IFH, part of the stock of low-income houses was transferred to municipal governments, which are better prepared to manage local housing needs, while the sale of middle-income houses to the public was accelerated. Finally, the electricity and water utility company Electra advanced the internal process to increase operational efficiency, reduce commercial losses and prepare for privatization.

11. Despite the decline recorded in 2017, the authorities are aware that the public debt to GDP ratio remains very high. However, as recognized by staff, debt service is manageable and there is no medium-term sustainability concern, given the long maturity profile and highly concessional terms of external debt. Over the medium-term, the authorities intend to continue their gradual fiscal consolidation process and attain a balanced budget by 2021, significantly improving public debt sustainability. Further, they welcome staff’s recommendation to anchor fiscal policy with the objective of reducing the present value of external public debt to below 55 percent of GDP by 2023 from 67 percent in 2017, as a way to diminish the risk of external debt distress.

Monetary Policy and Financial Stability

12. The Banco de Cabo Verde (BCV) has continued to successfully support the exchange rate peg with the euro. The authorities take note of staff’s assessment that the real exchange rate is broadly in line with economic fundamentals, and that international reserves are adequate. Despite the widening in the current account deficit in 2017, international reserves stood at a comfortable level at 5.6 months of prospective imports of goods and services.

13. In the absence of inflation or international reserves pressures, monetary policy in 2017 remained accommodative. The BCV reduced the policy rate by 200 basis points to 1.5 percent in June 2017, while adopting measures to improve communication and the transmission mechanism of monetary policy.

14. The banking sector remains relatively well capitalized and liquid, despite high legacy non-performing loans (NPLs) and low profitability. The BCV continues to work with banks to resolve the stock of legacy NPLs and stimulate credit. More recently, Cabo Verde has been affected by the withdrawal of correspondent banking relationships due to the small size of the domestic market. Like in many other small economies, low scale relative to increasing costs of due diligence processes have reduced their attractiveness to correspondent banks, especially for operations in US dollars. Cabo Verde has a comprehensive anti-money laundering/combating the financing of terrorism (AML/CFT) framework and the BCV is cooperating with foreign supervisors and intergovernmental bodies to address the issue.

Structural Reforms

15. The Cabo Verdean authorities are aware that the implementation of structural reforms is fundamental to increase potential growth, generate jobs, and improve the welfare of the population. Moving forward, they agree that private sector participation is critical to ensure long term economic growth and sustainability. Reforms to the business environment, better education and vocational training, improved access to financing, and privatization of inefficient SOEs are expected to crowd-in private investment and bring innovation and diversification, which will boost productivity and competitiveness.

16. The 2017-2021 Strategic Plan for Sustainable Development (PEDS) lays out the authorities’ medium-term growth vision and redefines Cabo Verde’s position in the regional and global economy. Alongside tourism as the main driver of growth, the PEDS envisages Cabo Verde as a viable and robust hub for air and maritime transportation, and regional business center. The authorities also plan to develop the digital economy. They are determined to push ahead with the diversification drive to ensure a socio-economic environment that is attractive to both domestic and foreign investment.