I. Introduction

1. Our authorities appreciate the constructive Fund engagement during the recent Article IV Consultation mission to the Kingdom of Eswatini. They broadly concur with the staff’s analysis and policy recommendations.

2. The economy of Eswatini continues to face severe macroeconomic challenges characterized by high fiscal deficits, rising debt, accumulation of domestic arrears, and a decline in foreign exchange reserves. At the same time, volatility in Southern African Custom Union (SACU) revenues, recurring droughts, and a recent terms of trade shock have weighed on economic performance. Recognizing these challenges, the new government, which came into power in October 2018 launched the National Development Plan 2019–2022 (NDP), which aims to restore macroeconomic stability by fostering fiscal discipline, ensuring prudent debt management, adherence to good governance practices, and promoting private sector led growth. In addition, the new government launched a Strategic Roadmap, focused on improving the business climate and boosting private investment.

II. Recent Economic Developments and the Outlook

3. Real GDP growth declined from 2.4 percent in 2018 to 1.2 percent in 2019 owing to a decline in private sector activity emanating from an escalation of fiscal challenges that culminated in the accumulation of government arrears. Going forward, the authorities anticipate a modest recovery in medium term growth supported by increased private investment in response to the implementation of policies articulated in the recently developed recovery roadmap and relief for the private sector as government clears some of its arrears.

4. Inflation declined from 4.8 percent in 2018 to 2.6 percent in 2019 due to depressed aggregate demand that accompanied the economic slowdown, and a sustained freeze on water and electricity tariffs. Against the backdrop of subdued inflation and low growth, the Central Bank of Eswatini (CBE) cut the discount rate by 25 basis points in July 2019 to 6.5 percent to support private sector credit and stimulate economic activity.

5. The current account surplus increased from 2.0 percent of GDP in 2018 to 3.8 percent of GDP in 2019 underpinned by improvements in the trade balance as exports recovered somewhat and imports declined slightly. Over the medium term, the current account is expected to slightly weaken due to slow export growth. Meanwhile the fiscal deficit is expected to narrow from 11.2 percent of GDP in 2018 to 6.3 percent of GDP in 2019 supported by several expenditure and tax measures implemented as part of the 2019/20 budget. Going forward, the deficit is expected to further decrease as the authorities implement consolidation measures.

III. Fiscal Policy

6. The authorities recognize the extent of the fiscal challenges and broadly concur that a fiscal adjustment of about 6 percent of GDP would be needed over the next few years to restore fiscal sustainability and place public debt on a downward trajectory. They however, note that a more gradual consolidation path would be more appropriate to smoothen the adverse effects of adjustment on growth and vulnerable households.

7. Since taking office in late 2018, the new government has taken steps to control the rising fiscal deficit, including implementing policies to contain the wage bill and restructure some loss-making public entities. As a result, they estimate the FY 19/20 deficit to be lower than the previous year. Given the magnitude of the adjustment required to restore fiscal sustainability, the authorities intend to use FY20/21 to build consensus towards a comprehensive consolidation plan, while keeping the fiscal deficit low. Starting in FY21/22, the authorities plan to continue a gradual fiscal adjustment spread over four or five years. Importantly, they plan to develop a medium-term fiscal framework to stabilize public debt levels going forward.

8. As part of an effort to place public finances on a sustainable path, the authorities have implemented a combination of expenditure and revenue measures. Going forward, they plan to continue controlling the wage and non-wage expenditures over the medium term through a sustained freeze on new hiring while accounting for capacity constraints. They also plan to leverage a temporary increase in SACU revenue to finance a wage increase in FY2020/21 to cushion civil servants following three years of a wage freeze. Further, they plan to optimize capital expenditures in line with the new NDP to focus on high impact and high return projects, while strengthening the project selection criteria and tendering process, and improving project implementation and management, in line with the recent PIMA recommendations. While they see limited scope to reduce capital outlays in FY2020/21 given the respective legal and financial agreements associated with ongoing projects, the authorities will prioritize spending thereafter as part of their medium-term plan.

9. On the revenue side, measures already introduced by the authorities include increases in excise taxes for alcohol, tobacco and fuel that are expected to be fully effective in FY20/21. The authorities also have plans to improve revenue collection, review tax exemptions, and sell off some government assets to generate additional revenue.

10. The authorities concur with the need to develop an effective and transparent arrears clearance strategy, going forward. To this end, they recently introduced an invoice tracking system to help identify unpaid bills from ministries and government departments and improve the management of government arrears. To clear part of the existing stock of arrears and provide relief to the private sector, they have issued domestic securities and secured external financing.

11. To address weaknesses in public financial management, the authorities are planning to accelerate operationalization of the Public Financial Management Act, implement an Integrated Financial Management Information Systems and introduce a Treasury Single Account. They also plan to undertake a comprehensive review of public enterprises to reduce relevant subventions and increase dividends through potential mergers, where appropriate. The authorities also concur with the need to develop a cost-effective and transparent procurement system, including revamping the tender board and would require Fund technical assistance in this area.

IV. Monetary and Financial Policies

12. The authorities reiterate that the exchange rate peg has served the economy well, providing an effective policy anchor and helping to contain inflation. Recognizing deterioration in the level of reserves, the CBE launched a program to purchase FX from banks at market price to support the exchange rate peg. In addition, they intend to secure a large FX swap to further bolster the reserves’ position. In parallel, the CBE will continue to employ effective monetary policy instruments to mop up resultant excess liquidity. Further, the authorities plan to maintain the policy rate broadly in line with the South African Reserve Bank’s rate, taking into account differential risks and other key economic factors.

13. Despite the challenging macroeconomic environment, the financial sector has remained broadly stable, well capitalized, and profitable, with ample liquidity buffers. Nonetheless, vulnerabilities in the banking sector have continued to grow with a weakening in bank’s asset quality, rising exposure to the sovereign.

14. To improve financial sector oversight, the authorities are progressively implementing Basel II standards, strengthening risk-based supervision and requiring exposed banks to develop plans to address high NPLs. While an early intervention regime is in place, the authorities have identified gaps and plan to introduce mandatory corrective actions to strengthen the regime. They recognize the importance of introducing a macro-prudential policy framework to address financial stability risks and will continue to monitor risks emanating from high household debt.

15. The authorities are presently reviewing the Financial Services Regulatory Authority (FSRA) Act and laws regulating specific sectors to strengthen the non-bank financial institutions’ oversight framework. At the same time, the FSRA has continued to expand its coverage of non-banks under its purview and continues to build its regulatory and supervisory capacity with Fund TA. Further, the authorities plan to conduct a national risk assessment in 2020, which will inform a review of AML/CFT requirements and risk-based activities of the CBE, FSRA, and the Financial Intelligence Unit. They also intend to expedite enactment of the Financial Institutions Act and the CBE law, to strengthen the oversight of the financial sector and the bank resolution framework.

V. Structural Reforms

16. The authorities recognize that implementing structural reforms is critical to facilitate private sector growth, bolster long-term inclusive growth, and reduce poverty. To this end, the Strategic Roadmap identified priority high impact actions to facilitate private investment. In this connection, the authorities recently established special economic zones with investment incentives and launched a National Financial Inclusion Strategy to enhance access to finance, stimulate SME growth, and support small-holder farmers. In addition, they are facilitating the set-up of selected large foreign investment projects.

17. As part of an effort to improve the business environment, the authorities plan to establish a one-stop shop for business registrations, simplify licensing requirements, and enhance the use of e-government and digital processes. They also plan to reduce the costs and time associated with commercial court cases and resolution of commercial disputes as well as improve the governance and strengthen the anti-corruption framework.

18. To help increase competition in the ICT sector and reduce communication costs, the authorities intend to accelerate liberalization of the ICT sector by unbundling the Eswatini Posts and Telecommunications Corporation (EPTC) into three separate and independent entities as well as encouraging competition in the fixed and mobile telephone market. They also plan to restructure the electricity sector by supplementing electricity supply with renewable energy sources while adjusting electricity cross-subsidies to ensure cost-effective pricing, in line with the objectives of the NDP.

19. The authorities continue to allocate substantial budgetary resources towards social spending, including education, health, and cash transfers. They have also decentralized social services to increase access at more affordable costs. Going forward, the authorities plan to strengthen social safety nets, increase the old age grant, and introduce programs to target poor children to further protect the vulnerable segments of the population.

20. Finally, the authorities are working on improving access to quality, relevant, and inclusive education, reducing the skills gap in the economy, enhancing research and development and innovation, and removing wage rigidities with a view to enhancing social and human capital deployment.

VI. Conclusion

21. The authorities are committed to implementing a comprehensive fiscal consolidation plan and structural reforms needed to restore fiscal stability, stop accumulation of government arrears, stabilize the public debt, and support inclusive growth. They appreciate Fund’s advice and technical support and look forward to continued collaboration in implementing their reform agenda.