Abstract
On behalf of my Malagasy authorities, we would like to express our appreciation to Executive Directors, Management and Staff of the International Monetary Fund for their continued support to Madagascar. Fund assistance is especially critical in the current challenging global environment and in the face of more frequent climate shocks that are exacerbating the country's fragility, with notably increasing food insecurity and growing poverty. It is indeed noteworthy that the Board meeting on Madagascar takes place after the intense Cyclone Freddy that hit the eastern part of the country last Tuesday and claimed several lives, displaced thousands more, and caused extensive physical damage; compounding the effects of the earlier tropical storm Cheneso that killed more than 30 people in January 2023. The authorities are actively deploying assistance to the victims of these extreme weather events with the support of partner international organizations. They appreciate the staff report which provides a good account of the discussions on policies over medium-term and the Selected Issues paper that addresses key priority issues on the authorities' development agenda.
On behalf of my Malagasy authorities, we would like to express our appreciation to Executive Directors, Management and Staff of the International Monetary Fund for their continued support to Madagascar. Fund assistance is especially critical in the current challenging global environment and in the face of more frequent climate shocks that are exacerbating the country's fragility, with notably increasing food insecurity and growing poverty. It is indeed noteworthy that the Board meeting on Madagascar takes place after the intense Cyclone Freddy that hit the eastern part of the country last Tuesday and claimed several lives, displaced thousands more, and caused extensive physical damage; compounding the effects of the earlier tropical storm Cheneso that killed more than 30 people in January 2023. The authorities are actively deploying assistance to the victims of these extreme weather events with the support of partner international organizations. They appreciate the staff report which provides a good account of the discussions on policies over medium-term and the Selected Issues paper that addresses key priority issues on the authorities' development agenda.
Economic activity was marked in 2022 by the intensification of inflationary pressures due in part to the war in Ukraine, and the occurrence of extreme climate events, including five cyclones, which complicated the implementation of the Fund-supported program under the Extended Credit Facility. Nevertheless, program performance during the period under review has been broadly positive and decisive actions have been taken to address the underlying causes of missed targets and delayed reforms, reflecting the authorities' continued determination to keep the program on track. Going forward, the authorities remain committed to the program, which supports the implementation of their development strategy Plan Emergence Madagascar (PEM) aimed at promoting good governance, strengthening human capital, accelerating growth, and building resilience to climate shocks.
Considering the corrective actions taken and their continued commitment to the program, the authorities are requesting waivers for the non-observance of missed quantitative performance criteria (QPCs) on the domestic primary deficit and net foreign assets and the completion of the third review of the Fund-supported program.
I. Recent Developments and Outlook
Economic activity moderated in 2022 amid high inflation. After rebounding by almost 13 percentage points to 5.7 percent in 2021, growth moderated in 2022 to 4.2 percent, owing partly to climatic shocks. Inflation reached 11 percent in 2022 reflecting the impact of higher food and energy prices caused by weather shocks, the war in Ukraine, and the authorities' decision to adjust upwards regulated fuel prices to contain related subsidies. The current account deficit widened further, reflecting a significant terms-of-trade deterioration. Indeed, import costs soared, outweighing the positive impact of a notable increase in commodity exports. Nonetheless, the external balance is assessed to be broadly in line with the level implied by fundamentals and desired policies. The level of international reserves remains adequate although declining from 5.8 months of imports in 2021 to 4.3 months of imports at end-2022 despite FX interventions in line with related program commitment. Overall, the banking sector is liquid, profitable and well capitalized, with non-performing loans standing at 7.7 percent at end-2022 slightly above the pre-pandemic level (7.3 percent at end 2019).
The fiscal position deteriorated in 2022 due to the non-payment of fuel taxes in the absence of an agreement to settle past government arrears to oil companies. Faced with revenue shortfall, the authorities contained expenditures and accumulated arrears. Public debt increased by 4.8 percentage points to 57.1 percent of GDP and remains at moderate risk of distress in the latest debt sustainability assessment (DSA). The 2023 budget approved in December 2022 is in line with program objectives. To improve budget execution in 2023, the authorities eliminated the cumbersome requirement of spending commitment authorization by both the President and the Prime Minister. One other important enhancement to the budget process is the creation of a budgetary unit to strengthen the budgetary autonomy of the Cour des Comptes. Also, the Cour des Comptes has been given full access to the information systems of the Ministry of Economy and Finance to strengthen ex-post financial oversight of government institutions. The Strategic Plan for the Modernization of Public Financial Management was updated in October 2022 and will be implemented with the support of technical partners.
The central bank (BFM) further tightened monetary policy to contain inflationary pressures and pursued reforms to strengthen its operations. It further increased its policy rate by 120 points in November 2022, making it the fifth increase since October 2021. Deposit and marginal lending rates were also increased markedly since May 2021. As regards BFM reforms, the migration to the interest rate targeting framework is advancing with the reform of the monetary policy operating framework entering its final stages. Forecast modeling capacity is being strengthened while transparency and communication are being improved to better anchor expectations of economic actors and markets and increase the BFM credibility. Reform of the foreign exchange market is also progressing with the adoption in August 2022 of a new decree modifying the management of foreign currency accounts, the establishment of the surrender requirement and the improvement of reporting by banks.
The medium-term outlook is overall positive. Economic growth is projected to remain stable at 4.2 percent in 2023 despite the planned scaling up of public investment spending, reflecting the weaker global growth prospects. Inflation is expected to decline below 10 percent in 2023 with lower global inflation but inflationary pressures could persist owing to second-round effects from increases in public wages and fuel prices in 2022. The current account will widen further while reserve coverage should remain stable. This outlook is subject to significant uncertainties related to the war in Ukraine, global growth, weather conditions, and the pace of reform implementation. The authorities recognize that the materialization of related downside risks might have an adverse impact on FDI and reserve adequacy. They are closely monitoring developments going forward and remain committed to carry out stronger policy adjustment as may be needed to preserve macroeconomic stability. Upside risks to growth include a stronger performance in tourism, textile, and mining sectors.
II. Program Performance
Program performance in the period under review was mixed. Three out of five quantitative performance criteria at end-June 2022 have been met. The QPC on domestic primary balance was missed, reflecting a shortfall in domestic tax revenue and delays in the payments of oil taxes by fuel distributors in 2022. A related dispute with the government was settled in December 2022 in an agreement to clear cross-debts between the two parties. This agreement guarantees the resumption of payments of fuel taxes in 2023. The QPC on net foreign assets was missed despite regular foreign exchange purchases by the central bank to smooth high market volatility. Performance improved at end-September 2022 with all five related indicative targets met. The authorities are requesting waivers for the non-observance of the missed two QPCs to account for recent macroeconomic developments and new program understandings.
The three indicative floor targets on domestic tax revenues, customs revenues and social spending were missed at end-June 2022 and end-September 2022. Although social spending at end-June 2022 increased compared to June 2021, it was lower than programmed due to budget execution difficulties in the social ministries. Revenue performance was affected by the non-payment of oil taxes.
The implementation of the structural reforms is advancing. Five of the nine structural benchmarks (SBs) have been implemented. Despite the effective publication of the quarterly budget execution reports with significantly improved coverage and content, staff has assessed the related continuous SB as missed due to missing relevant information, notably on expenditure breakdown and external financing. This information will be incorporated in future reports with the support of Fund TA. Despite a 43-percent increase in fuel prices in July 2022, the continuous SB on gross liabilities to oil distributors was missed due to the delay in reaching an agreement between the government and oil companies on the amount and settlement of cross-debts—which was reached in December 2022. The adoption of the national power company (JIRAMA)'s recovery plan was delayed due to changes in the company's management team.
III. Policies for the medium-term
The authorities remain committed to the program objectives that are aligned with the priorities of the PEM. The program contributes to the effectiveness of economic policies to strengthen macroeconomic stability, improve governance, and increase resilience to shocks, which are essential to create a favorable climate for private investment and inclusive growth.
The fiscal program is the centerpiece of the program for 2023. As envisaged at the inception, fiscal policy pursues fiscal consolidation while creating space for social and sustainable development spending, which will enable to halve the domestic primary deficit to 0.4 percent of GDP in 2023, excluding one-time revenues related to the agreement with the oil companies. A particular focus will be on strengthening mobilization of domestic tax and customs revenues and improving efficiency in the execution of public expenditures.
The 2023 budget targets an increase in the tax ratio by 1.1 percentage-point to 12 percent of GDP, supported by the economic recovery and implementation of several legislative and administrative revenue measures. The latter include the reinstatement of the VAT rate on fuel at 20 percent, the introduction of exit duties on exports of non-renewable resources and the expansion of the electronic payment system. Taxation of the mining sector is being optimized in the mining code currently under revision in consultation with the World Bank, the IMF, and mining companies. The mining code is expected to be submitted to the Parliament by end-June 2023. New revenue-enhancing measures could be introduced in case revenue collection falls short of target.
On the expenditure side, efforts will focus on controlling expenditures and improving their execution. The modernization of payroll management and reforms of the pension system will continue and are expected to contain growth of related budget appropriations over the medium-term. The 2023 budget envisages a 51-percent increase in priority public investment to support the economy, well within the ceiling permitted under the DSA. Particular attention will be devoted to prioritization of projects, taking account of absorptive capacity and climate change considerations as per the recommendations from the recently completed Climate Macroeconomic Assessment Program (CMAP). Further, the budget contemplates an acceleration of the execution of social expenditures and an enhancement of the social protection system with the support of development partners including the World Bank, the IMF, the World Food Program and UNICEF. In particular, an appropriation of $5 million has been made for the Intervention Fund for Development to support (i) agricultural production and development activities, (ii) schooling and nutrition; and (iii) response for early recovery from natural disasters. Also, the authorities are establishing a single social registry to serve as a reference for all social protection activities undertaken in the country.
Efforts to strengthen public financial management and economic governance will be sustained. The authorities will consolidate the gains in budget transparency and public procurement, while taking the necessary actions to correct the deficiencies noted. Regarding specifically public procurement, the related legal framework will be amended to allow for the collection of information on the beneficial owners of bidding companies or other legal entities in the first half of 2023. Later in 2023, a new draft law on cash management which is essential to the implementation of the Treasury Single Account (TSA) will be presented to the National Assembly. The implementation of the national anti-corruption strategy and national strategy to combat anti-money laundering will continue with the adoption of the necessary implementation decrees and the provision of sufficient resources for the effective operationalization of all concerned institutions, notably the Agency for the Recovery of Illicit Assets. Publication of related activities and statistics will be further improved.
Reforms and monitoring of public enterprises will continue to strengthen the financial autonomy of these entities and reduce related fiscal risks. The restructuring of JIRAMA will remain a top priority. A new strategy to restore the company's financial viability is under preparation with the support of the World Bank. Likewise, the restructuring of Air Madagascar will continue following the development of a new business plan and the provision of a sovereign guarantee to support leasing of aircrafts. As regards fiscal risks from public-private partnerships (PPP), the national PPP strategy which has been finalized is expected to be adopted by June 2023, and the PPP management framework is projected to be operational by June 2023 with the activation of the National Committee. Fiscal risks related to the newly created Malagasy Sovereign Wealth Fund will be contained by ensuring that its governance and operations are in line with international best practices.
Given the country's high vulnerability to climate change, the authorities are committed to improve climate resilience by enhancing climate policies and risk and disaster management. They will pursue the development of the Strategic Framework for Climate Change, with notably the development of the country's priority programs that could be financed by the Green Climate Fund (GCF). National Risk and Disaster Management Office (BNGRC) will be allocated with the human, material and budgetary resources needed to carry out its emergency response mission, such as in the case of the recent climatic events. Fund support under the RST would play a critical role in strengthening the country's resilience against such events.
IV. Conclusion
The authorities are strongly committed to the program and are taking the necessary steps to advance its implementation amid a difficult external and domestic environment. Considering current performance and their continued commitment to the program, the authorities are requesting the completion of the Article IV consultations and of the third review of the ECF-supported program and associated decisions. Directors' favorable consideration of these requests will be appreciated.