Abstract
Selected Issues
Scaling-up Public Investment in Madagascar: Challenges and Opportunities1
Madagascar faces challenges in financing and executing the scaling-up of public investment as well as getting the expected impact. This paper assesses the growth impact of the public investment scaling-up planned by the Malagasy authorities between 2019 and 2023. It finds that scaling-up public investment is crucial to increase economic growth and achieve sustainable development goals. Improving public investment management could significantly increase the growth impact of the investment scale-up.
A. Introduction
1. Public investment scale-up can raise economic growth. Boosting government spending on infrastructure can increase growth in the short-term by stimulating aggregate demand. It can also raise growth in the longer-term as better infrastructure promotes the economy’s productivity, generating supply effects to expand output. Infrastructure supports the delivery of key public services and connects citizens and firms to economic opportunities.
2. The Malagasy government has an ambitious development plan that is anchored on a significant scale-up of infrastructure investment. The government’s 2019–2023 Plan Emergence Madagascar (PEM) puts emphasis on infrastructure to address long-standing development problems, raise growth, and improve living standards. Preliminary estimates in the PEM suggest financing needs of investment of about USD 12 bn over 2020–2023, expected to be mobilized from domestic resources (about 13 percent of GDP) and private and international investors (about 19 percent of GDP).
3. The scaling up of public investment in Madagascar faces a number of challenges. The estimated needs of investment to realize the PEM are nearly twice as many as the projected investment financing for the next two years. Execution of public investment has been low due to poor performance of externally-financed investment. Public investment spending delivers less infrastructure benefits than it could potentially do, suggesting low public investment efficiency in Madagascar. The capacity to manage public investment is still weak. The planning, preparation, selection and the implementation of multiple investment projects require a large set of technical and managerial resources that are not yet available in Madagascar and take time to be developed.
4. The ambitious plan for scaling up public investment requires a careful assessment of the impact on debt sustainability and growth. It is important to assess the country’s ability to implement the planned scaling up, effectively absorb much higher levels of aid, and efficiently use them to achieve the expected growth impact and development goals. This paper uses the IMF Debt-Investment-Growth (DIG) model to estimate the macroeconomic effects of public investment scale-up in low-income countries. The DIG considers the investment-growth linkages, public external and domestic debt accumulation, the fiscal policy reactions necessary to ensure debt-sustainability, and private sector reactions.
5. The magnitude of the growth impact from the public investment scale-up depends crucially on the efficiency of public investment. Efficiency refers to the rate at which spending on public investment translates into infrastructure. Countries that are more efficient in public investment get more growth impact from boosting infrastructure spending (IMF 2015). Large investment scaling up episodes do not necessarily translate into growth (Warner 2014) and the growth impact is reduced if management is weak leaving room for corruption and rent seeking.
6. Improvements in public investment management can significantly enhance the efficiency of public investment. Countries with stronger public investment management practices have more predictable, credible, efficient, and productive investments (IMF 2015). Strengthening these practices could significantly improve growth impact of public investment.
7. This paper assesses the growth impact of the public investment scaling up planned by the Malagasy authorities between 2019 and 2023. Following the introduction, Section B discusses the scaling up, highlights the importance of public investment scale-up in Madagascar, outlines the key challenges in boosting public investment, and discusses the underlying causes of the challenges. Section C estimates the growth impact of the planned scale-up and recommends how to get more growth impact from the investment boost. Section D concludes.
B. Public Investment Scaling-Up Why does Madagascar Need it?
8. Infrastructure in Madagascar has lagged behind. Access to basic infrastructure such as treated water, schools, and hospitals is lower than the average of low-income countries and sub-Saharan Africa (Figure 1 panel 3). Similarly, the quality of infrastructure in Madagascar is perceived as decreasing in recent years, and relatively lower than the comparators (Figure 1 panel 4). A survey by the World Economic Forum suggests an infrastructure quality score of 2.7 out of 7 for Madagascar compared to 3.0 and 3.2 for low-income countries and sub-Saharan Africa, respectively.
General Government Investment and Infrastructure
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A002
General Government Investment and Infrastructure
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A002
General Government Investment and Infrastructure
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A002
9. General government investment has been low in Madagascar during the past two decades. General government investment as a percentage of GDP has been lower than the average of sub-Saharan Africa since 2009 (Figure 1 panel 1). It decreased from the peak of 12 percent in 2004 to below 3 percent in 2013, then slowly picked up but remained low, only about 5 percent in 2017. Total investment in Madagascar has been increasingly supported by private investment but declined sharply since 2009, as a result of the country’s major political crisis (Figure 1 panel 2). Private investment was high in the late 2000s reaching almost 22 percent of GDP in 2008 but then declined sharply to only 14 percent in 2013 and has remained low since then. Infrastructure investment through public private partnerships (PPPs) has started recently but has not been enough to compensate for the decrease in general government and private investment spending.2
10. The significant infrastructure shortfall calls for more investment in infrastructure, a key objective of the government. Increased and better-quality investment spending in Madagascar could also lead to higher GDP growth (Figure 1 panel 5).3 Large investment spending is also needed to reach the SDGs. The PEM anchors on a significant scale-up of infrastructure investment including general government and private investment to achieve inclusive growth and sustainable development outcomes.
Challenges in Scaling-up Public Investment
11. Financing the needs of the planned public investment scale-up is challenging. The estimated needs of public investment to realize the PEM are nearly double the projected investment financing for the next two years: public investment needs are about 41 per-cent of GDP in 2020–21 while total investment is projected to be only about 23 percent in these years respectively, leaving a significant financing gap (Figure 2 panel 1). The PPP investment portfolio is currently small to fill this gap, but it is estimated that the construction of two upcoming hydroelectric PPP projects would provide an investment of about 1.3 percent of GDP each year for the next five years.
Public Investment Scale up Challenges
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A002
Source: World Bank, Worldwide Governance Indicators.Public Investment Scale up Challenges
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A002
Source: World Bank, Worldwide Governance Indicators.Public Investment Scale up Challenges
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A002
Source: World Bank, Worldwide Governance Indicators.12. The pace of scaling up set by the government appears to be very ambitious given the country’s absorptive capacity. In the draft PEM, public investment in 2020 and 2021 is expected to be more than double the level of public investment execution during 2016–2019. Cross-country evidence suggests that the pace of scaling-up depends on the institutional framework and management capacity. When the pace of investment scaling up is above the absorptive capacity, countries will not be able to deliver infrastructure results and reap the full benefit of additional public investment.
13. Execution of public investment has been low due to poor performance of externally-financed investment. The significant increase in the budget allocation for public investment has not been followed by an equivalent increase in execution (Figure 2 panel 3a). Total public investment allocated in the budget laws for 2017 and 2018 was about 8 percent of GDP, but executed public investment was only 5.4 and 6 percent of GDP in 2017 and 2018. The low execution reflects poor performance of externally-financed investment (about two thirds of total public investment): externally-financed investment was at 6.1 and 5.7 percent of GDP in the budget laws for 2017 and 2018, but its execution was only 3.5 and 3.7 percent of GDP for 2017 and 2018, respectively and lower than the 4 percent execution in 2016 (Figure 2 panel 3b). Execution of domestically-financed investment is generally in line with budget allocation (Figure 2 panel 3c).
14. The institutional framework and practices of public investment management are weak in Madagascar.4 The planning, preparation, selection, and implementation of multiple investment projects require a large set of technical and managerial resources that are not yet available in Madagascar and take time to be developed. Public investment planning lacks prioritization among projects to ensure financing availability for the most important projects; the selection and ex ante evaluation of projects is still at an embryonic stage; in the allocation phase, the linkage between project financing, results and objectives is unclear; and project management systems, especially for large investment projects, are not yet in place. In addition, the coordination among key stakeholders including between international development partners and the government remains weak.
15. As a result, public investment spending in Madagascar delivers less infrastructure benefits than it could potentially do. For the same amount of public investment spending, Madagascar generates less infrastructure results than peers due to low public investment efficiency: public investment spending in Madagascar delivers only about 30 percent of the potential infrastructure benefits compared to the average of about 60 percent for sub-Saharan Africa (Figure 2 panel 2).
16. Other factors could also affect the public investment scale-up implementation. On the supply side, the construction sector faces challenges including the increasing costs of imported raw materials and equipment, low access to finance and operational difficulties. Recurring political volatility in Madagascar has led to changes in infrastructure priorities and delays in project implementation. For example, the government change has resulted in the delays and low execution in many projects in 2019. Corruption in Madagascar is perceived as high compared to peers (Figure 2 panel 4) which potentially affects the integrity of the public investment process and its efficiency.
C. Growth Impact of the Public Investment Scale-up
The DIG Model—Baseline
17. The ambitious plan for scaling up public investment requires a careful assessment of its impact on growth and debt sustainability. We apply the IMF’s DIG model to estimate the growth and other macroeconomic impact of the planned public investment scale-up in Madagascar (Box 1).
18. The baseline scenario assumes a predetermined path of public infrastructure investment, grants, and concessional financing equivalent to levels under the DSA. Additional financing will be needed to cover the financing gap, which is covered predominantly by public external commercial debt. Two alternative financing options, faster tax mobilization and financing predominantly via public domestic debt are not discussed here. Other parameters are specified to follow either LIDC averages or are Madagascar specific (see Buffie et al. 2012 and IMF 2017b for comparison).
19. The efficiency of public infrastructure investment is set to 31 percent, the estimated current efficiency of public investment in Madagascar. The initial return on infrastructure investment5 stands at 30 percent, gradually declining over the forecast horizon. The real interest rates on public domestic and external commercial debt are set at 9 and 5 percent, respectively. The risk-free foreign real interest stands at 1 percent.
The Debt – Investment – Growth (DIG) Model
The DIG model estimates the macroeconomic effects of public investment scale-up in low-income countries taking into account (i) the investment-growth linkages; (ii) public external and domestic debt accumulation; (iii) the fiscal policy reactions necessary to ensure debt-sustainability; and (iv) private sector reactions (Figure 1). The public investment, growth, and debt sustainability nexus is modelled by means of a quantitative macroeconomic equilibrium framework with LIDC-specific components.1 The model emphasizes the fiscal reaction of governments to rising public debt stemming from borrowing for public investment financing, with options to recreate a realistic path of tax revenue mobilization. It also allows for an analysis of different financing options and impediments to public investment scaling up, such as absorptive capacity constraints, and it assumes that only a portion of each dollar spent in public investment is transformed into capital, owing to investment inefficiency.
Debt-Investment-Growth (DIG) Model
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A002
Source: Buffie et al. (2012)Debt-Investment-Growth (DIG) Model
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A002
Source: Buffie et al. (2012)Debt-Investment-Growth (DIG) Model
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A002
Source: Buffie et al. (2012)20. The baseline scenario results shown in Figure 4 are summarized as follows:
Real GDP per capita growth accelerates from a steady state of 2.7 to 3.5 percent between 2019 and 2023 and stabilizes at 3.4 percent in the long-run. With a population growth of about 2.5 percent per year, the model predicts a real GDP growth rate of 5.9 percent in 2023, and 5.6 percent in the long-run, which is similar to the macroeconomic framework’s projections. In the model, these numbers are driven by public investment as well as private activities.
Private consumption and investment decrease in the short-run. Higher VAT taxes lead to a decrease in private consumption. Higher income tax and more borrowing leading to higher interest rate crowd-out private investment. The creation of infrastructure helps promote private investment.9
Domestic public, commercial, and total debt closely follow the numbers projected in the macroeconomic framework. The tax ratio would gradually increase from 20 percent in 2019 to 25 percent in 2023. The fiscal deficit increases to 3.9 percent of GDP in the medium term and stays between 3.4 and 4.9 percent in the long run as the public investment scale up continues. Current expenditures are projected to gradually decrease over time.
The current account deficit increases to 4.8 percent of GDP in the medium-term and gradually decreases to above 4 percent in the long-run. Imports increase to provide materials for the public investment scale up for the whole period. The real exchange rate appreciates in the short and medium term due the increase in external loans and grants as well as the imports for construction of infrastructure at the beginning of the public investment scale up. The real exchange rate reverts to pre-investment scale up levels in the long run.
Macroeconomic Impact of Public Investment Scale-Up: DIG Model Estimates
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A002
Source: IMF staff estimates.Macroeconomic Impact of Public Investment Scale-Up: DIG Model Estimates
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A002
Source: IMF staff estimates.Macroeconomic Impact of Public Investment Scale-Up: DIG Model Estimates
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A002
Source: IMF staff estimates.Alternative Scenario—Boosting Public Investment Efficiency
21. An alternative scenario assumes that public investment efficiency in Madagascar improves to the sub-Saharan Africa average efficiency level. Holding all else constant, public investment efficiency increases from 31 to 63 percent. This is in line with the follow-up of the 2016 PIMA, and the government’s efforts to adopt the Public Investment Management Reform Strategy and an action plan in 2017 to strengthen the institutional framework (see MEFP).10 It is expected that these improvements will be implemented in the next years and increase public investment efficiency.
22. Improvement in public investment efficiency could lead to a significant increase in real GDP per capita growth. Real GDP per capita growth increases by up to 0.7 percent in 2023 and 0.5 percent each year thereafter compared to the baseline, for a total increase real GDP per capita growth of 5 percent over 2019–2028.
23. Higher public investment efficiency could also promote private consumption and investment in the long-run. More efficiency in public investment leads to more pronounced crowding out of private investment in the short-run but promotes private investment in the long-run with more and better infrastructure. Since the capital account is assumed to be closed, the crowding-out of private investment makes reduces the contraction of private consumption in the short-run. More infrastructure created would enlarge the share of formal economic activities, leading to higher wages and thus higher consumption in the long-run.
24. Given the potential of additional increases in growth, Madagascar should focus on improving public investment efficiency. This can be achieved by strengthening public investment management can help improve public investment efficiency. Countries with stronger infrastructure governance have more predictable, credible, efficient, and productive investments (IMF 2015). Madagascar could improve infrastructure governance by focusing reform efforts on the following practices of public investment management.
Identify the highest priority projects among priority projects. Funding availability would need to focus first and foremost on fully financing these projects to ensure their completion. The total cost of these projects would need to be presented in the budget documents together with existing information on the start year and estimated completion year.
Present financing progress against the total project cost and duration to ensure sufficient resource allocation. For each major project, the budget documents should show the reference to specific engagement and priority in the PEM as well as specific targets in the SDGs. This would allow to better monitor progress in PEM and SDGs.
Allow enough time and resources to prepare projects to ensure they are ready for implementation. This would help achieve the expected results and reduce inefficiency in the implementation of these projects including delays and cost overruns.
Proactively monitor the implementation of the major projects. This would identify projects experiencing delays and action can be taken to expedite them. Experience from other countries suggests that establishing high-level committees to identify and remove implementation obstacles and to ensure projects are completed on schedule and within budget, is a good way to ensure the delivery of the expected outputs.11
Ensure enough funding to complete ongoing projects. If projects already started do not receive enough funding to cover expenditures planned in the budget year will result in delays and likely increase total project costs. Such costs can be avoided if budget practices give priority to funding ongoing projects before starting new projects.12
D. Conclusion
25. Scaling-up public investment in Madagascar has the potential to boost economic growth. How much growth impact can be obtained from the public investment scale up depends crucially on how the government manages it. There is significant scope to strengthen public investment management to maximize the growth impact from the scale up.
26. Boosting public investment in infrastructure is crucial to increase economic growth and achieve sustainable development goals in Madagascar. Infrastructure in Madagascar has lagged behind while general government investment has been low during the past two decades but the government has put infrastructure as a key to achieve inclusive growth and sustainable development. Large investment spending is also needed to reach the SDGs. The 2019–2023 PEM is expected to anchor on a significant scale-up of infrastructure investment including general government and private investment to achieve inclusive growth and sustainable development.
27. Improving public investment management could significantly increase the growth impact of the investment scale up. Scaling up of public investment in Madagascar could increase annual real GDP growth from a steady state of about 5 percent in 2019 to about 6 per-cent in 2023 and 5.6 percent in the longer term. Improving public investment management would significantly increase public investment efficiency which could lead to an additional increase of about 0.5 percent real GDP growth each year and additional 4.5 percent over ten years.
28. Madagascar should strengthen public investment management practices to realize the additional growth benefits. Madagascar could focus reform efforts on the highest priority projects and manage them well. Funding availability would need to focus on fully financing these projects to ensure their completion. Sufficient time and resources would be required to prepare these projects to ensure their quality and implementation readiness. Proactive implementation monitoring of the major projects would identify projects experiencing delays and action can be taken to expedite them.
References
Gaspar, Vitor, David Amaglobeli, Mercedes Garcia-Escribano; Delphine Prady, and Mauricio Soto. 2019. “Fiscal Policy and Development: Human, Social, and Physical Investments for the Sustainable Development Goals.” Staff Discussion Notes No. 19/03, International Monetary Fund, Washington, DC.
IMF. 2014. “Is It Time for an Infrastructure Push? The Macroeconomic Effects on Public Investment.” Chapter 3 in the World Economic Outlook. Washington.
IMF. 2015. “Making Public Investment More Efficient.” IMF Policy Paper.
IMF. 2017a. “Macroeconomic Developments and Prospects in Low Income Developing Countries– 2016.” IMF Policy Paper, Washington.
IMF. 2017b. “Macroeconomic Implications of Scaling Up Public Investment in Madagascar.” IMF Selected Issues, Washington.
IMF. 2018. “Public Investment Management Assessment: Review and Update.” IMF staff report.
Terrill, Marion. 2016. “Cost Overruns in Transport Sector.” Grattan Institute, Australia.
Warner, Andrew. 2014. “Public Investment as an Engine of Growth.” Working Paper 14/148, Washington, International Monetary Fund.
Prepared by Ha Vu, with inputs from Anja Baum and Luis-Felipe Zanna.
There has been one PPP contract signed and two PPP projects in negotiation in Madagascar since 2015. The concession of Ivato and Nosybe airport has almost completed construction and will start operating in 2020. Priority Hydroelectric Project Sahofika and Priority Hydroelectric Project Volobe are expected to start construction in 2020.
IMF 2015 suggests that increased investment spending in countries with better infrastructure governance leads to higher output.
IMF, Technical Assistance reports, 2016 PIMA and 2019 Public Investment Management in Madagascar.
Rate of return to effective public capital is the marginal product of public capital. “Efficiency” refers to the rate at which spending on public investment translates into public capital. See Appendix in Buffie et al. (2012).
Strong complementarity is expected between private and public investment in Madagascar, as the main constraints on private sector involvement relate to poor infrastructure including unreliable electricity supply, and lack of access to roads and water.
The institutional framework has been enforced in the area of budgeting and monitoring of projects. These include the adoption of an action plan to implement commitment authorization and appropriations, the creation of the Investment and Financing Coordination and Monitoring Unit (Organe de Coordination et de Suivi des investissements et de leur financements, OCSIF) and the development of a project database. In addition, the government is preparing a manual on selection of projects with the IMF technical assistance.
Examples include the Operational Bureau of Monitoring (Bureau opérationnel de suivi, BOS) in Senegal, Committee for Acceleration of Priority Infrastructure Delivery (KPPIP) in Indonesia, and the Performance Management Delivery Unit (PEMANDU) in Malaysia during 2009–2017.
In the Philippines, a two-tier budgeting approach is adopted. Annual budget estimates for ongoing projects (Tier 1) are first prepared by the line agencies, discussed with the Department of Budget and Management, and then approved by the Development Budget Coordination Committee. The allocation of new spending is later discussed during new projects (Tier 2) hearings.
