Program Performance

3. The implementation of the ECF-supported program in the period under review has been strong. All the end-December 2018 performance criteria (PCs) were met, some of them with margins. Two out of six indicative targets (IT) were not observed at end-December 2018. The IT on tax revenue was missed by the equivalent of 0.2 percent of GDP due notably to a strike in the tax administration. Priority social spending slightly fell short of its indicative target due to lower domestically-financed investment. All end-March 2019 ITs were met except the one on social spending. Preliminary data at end-May 2019 indicate that all PCs for end-June 2019, the last test date of the ECF arrangement, should be observed. The IT on social spending is expected to be missed due to the under-execution of public investment. The structural reform agenda monitored in the program is advancing albeit at slower pace than expected. Of the eight structural benchmarks (SBs) for the second half of 2018 and the first half of 2019, five SBs were fully achieved, and significant progress has been made on the other SBs including those on the banking law and the law on financial stability.

4. The authorities remain committed to the objectives of the program which will expire by end-2019. In light of the performance at end-December 2018 and their continued commitment to the program, the authorities request the completion of the fifth review under the ECF arrangement.

Recent Developments, Outlook and Risks

5. Macroeconomic performance in 2018 was sound. Economic growth increased to 5.2 percent in 2018 from 4.3 percent in 2017, supported notably by a recovery in agriculture production. Inflation continued to decline from 9.1 percent in 2017 to 6.1 percent in 2018 and remained under control in the first half of 2019. Fiscal balance has turned positive despite lower-than-programmed revenue and public debt is sustainable. The risk of external public debt distress is low and the risk of overall public debt distress is moderate according to the recent debt sustainability assessment. The current account balance shifted from a deficit of 0.5 percent of GDP in 2017 to a surplus of 1 percent of GDP in 2018 on the back of higher vanilla and mining export receipts. Monetary and exchange rate policies have been successful in managing liquidity and accumulating international reserves, which stand above 4 months of imports.

6. Economic prospects remain positive. Growth is projected at 5.2 percent in 2019 supported by an acceleration of public spending in the second half of the year, before inching up to at least 5.3 percent in 2020 driven notably by the envisaged scaling-up and improved quality of public investment. The authorities share staff’s assessment of the downside risks, notably a slower-than-projected acceleration of public investment. Moreover, as a low-income fragile country, Madagascar faces persistent and significant challenges. In particular, the country remains highly vulnerable to external and internal shocks, including climate change and terms of trade shocks particularly from oil, metal and vanilla prices. Going forward, the authorities are committed to accelerate progress in strengthening macroeconomic stability, promoting inclusive and sustainable growth, and reducing poverty in the context of the Plan Emergence Madagascar. Continued financial and technical support from the IMF remains essential, including to help catalyze financial support from donors.

Creating More Fiscal Space to Continue Increasing the Quality of Spending

7. Fiscal performance continued to improve in the first half of 2019. Total revenue overperformed thanks to ongoing reforms in the revenue administrations, while expenditures, including social spending, remained limited during the administrative transition and the preparation of a revised budget law. In this context, the authorities took advantage of the good fiscal position to repay all statutory advances from the central bank, Banky Foiben’i Madagasikara (BFM), and to accumulate deposits at the BFM.

8. Going forward, fiscal policy will focus on further enhancing domestic revenue mobilization and reducing nonessential spending to create fiscal space for higher public investment and priority social spending. The revised budget law for 2019 adopted in May 2019 reflects those priorities and is consistent with the program objectives. The domestic primary balance is expected to amount to a deficit of less than 0.4 percent of GDP in 2019 and will be fully financed thanks to budget support committed by the World Bank and the African Development Bank.

9. Revenue collection is expected to increase, supported by ongoing improvements in tax administration, including better collection of the value-added tax (VAT) payments on public investment projects and enhanced collection of tax arrears. The authorities are determined to ensure that the new tax incentives for investment offered in the new laws on Special Economic Zones and industrial development are effective and cost-efficient to safeguard the authorities’ core objective of boosting revenue collection. Moreover, the tax policy unit has already undertaken an impact analysis of tax expenditures for 2016 and 2017 and is completing the one for 2018. The unit is also finalizing an analysis of the tax potential in Madagascar.

10. On the expenditure side, the 2019 wage bill has been slightly lowered, reflecting the authorities’ commitment to implement the wage adjustment in the second half of 2019, while spending on goods and services will also be reduced to accommodate higher public investment and priority spending, notably in social sectors. The scaling up in public investment will be consistent with the country’s absorptive capacity. The authorities will continue to use primarily concessional borrowing to finance higher public investment to maintain debt sustainability.

11. Implementation of fiscal-related reforms is progressing well. The fuel pricing reform aiming to limit liabilities to oil distributors is advancing, with an agreement reached between the authorities and the distributors on a new fuel reference price structure in June 2019. Following this agreement, pump prices were lowered by about 4.5 percent on average and are now closer to reference prices, thereby reducing liabilities to oil distributors to a level consistent with the related program objective. The adoption of a fuel pricing mechanism is expected in September 2019. A communication campaign to explain to the population the changes in the price structure and the fuel pump price is ongoing. The agreement on fuel pricing is also benefitting the public utility enterprise JIRAMA which is striving to improve its financial situation by lowering its operational costs, including through a renegotiation of contracts with suppliers and actions to fight fraud, with the assistance of the World Bank. This will help the company to avoid increasing tariffs. In the same vein, JIRAMA has prepared contingency plans in case the cost-saving measures do not yield the expected gains.

12. The authorities will sustain the momentum of fiscal reforms. The investment management capacity will be further reinforced in line with the recommendations from various technical assistance (TA) missions. In particular, they will streamline the procedures to speed-up project management, while strengthening controls and inter-ministerial coordination on the selection of investment projects. The authorities remain committed to enhance public financial management in the context of the 2018–2026 Strategic Plan of Modernization of Public Financial Management. They will notably continue to minimize fiscal risks and expand the coverage of the budget, by better supervising and integrating autonomous entities, state-owned enterprises (SOEs), and public-private partnerships (PPPs).

Maintaining Stable Inflation and Building External Resilience

13. The authorities remain committed to keeping inflation in single digits, with a focus on managing fluctuations in bank liquidity. The BFM is strengthening its monetary policy framework with the view notably to improve the management of excess liquidity and continue to gradually move to interest rate targeting. In this regard, the BFM introduced in May 2019 an overnight rate, in addition to its key policy rate for one-year maturity transactions. In pursuit of its mission of safeguarding external stability, the BFM will continue building international reserves, in the context of a flexible exchange rate regime, to progressively increase import coverage to 6 months or more, consistent with the convergence criteria of the Southern African Development Community (SADC).

Building a Sound Financial Sector Supporting Growth

14. The authorities will continue to pursue a sound and inclusive financial sector. The banking sector remained solid in 2018 with notably the reduction in non-performing loans (NPLs) to their lowest level in almost a decade. The financial sector landscape in Madagascar is changing, with notably the expansion of electronic money services and microfinance activities that foster financial inclusion, which poses new challenges to financial stability. To address those challenges, the authorities have prepared and revised several important legislations, including the draft banking law, the draft law on financial stability and the draft law on foreign exchange market, which will be submitted to Parliament. To further develop the foreign exchange (FX) market, a plan to gradually phase out the requirement to surrender export proceeds, has been prepared and will be approved following the adoption of the law on the foreign exchange market, if conditions do not destabilize the FX market. Going forward, the priorities to reinforce financial stability will include implementing risk-based supervision (RBS), and containing systemic risks with notably the expected approval this year of the banking law, the law on financial stability, and updated various prudential directives, in line with international standards and the Financial System Stability Assessment (FSSA) recommendations. The modernization of the central bank operations will continue. BFM remains committed to fully adopt International Financial Reporting Standards (IFRS) for its 2020 accounts, with the IMF technical assistance. It will continue its efforts to strengthen internal and external audit mechanisms as per the safeguard assessment recommendations.

Enhancing Economic Governance and Improving the Business Environment

15. The governance and transparency frameworks are being reinforced. The law on anti-money laundering and combating the financing of terrorism (AML/CFT), which better aligns the AML/CFT framework with international standards, was enacted in February 2019. The related implementation decrees will be issued by end-September 2019. The asset recovery law, which enables seizure and confiscation of proceeds of crime, has been adopted in June 2019 and promulgated in July, thereby completing the legal anti-corruption framework. The authorities are strengthening the institutions responsible for effective enforcement of this new legal framework, with the ongoing establishment and operationalization of a second anti-corruption court in Mahajanga. Transparency is increasing, as the reporting on various governance activities, including some court decisions and data on investigations on corruption, is expanding. The authorities are confident that these reforms will contribute to improving the business environment and stimulating private investment.

Conclusion

16. Madagascar is continuing to make good progress in strengthening macroeconomic stability, promoting inclusive and sustainable growth, and reducing poverty. Implementation of the authorities’ program under the ECF has been strong during the period under review. Going forward, the authorities are determined to sustain the momentum of reforms, consistent with the objectives of the program in the context of the Plan Emergence Madagascar. In this light, our Malagasy authorities will appreciate Executive Directors’ favorable consideration of their request for the completion of the fifth review under the ECF.