The Web edition of the IMF Survey is updated several times a week, and contains a wealth of articles about topical policy and economic issues in the news. Access the latest IMF research, read interviews, and listen to podcasts given by top IMF economists on important issues in the global economy. www.imf.org/external/pubs/ft/survey/so/home.aspx
The Web edition of the IMF Survey is updated several times a week, and contains a wealth of articles about topical policy and economic issues in the news. Access the latest IMF research, read interviews, and listen to podcasts given by top IMF economists on important issues in the global economy. www.imf.org/external/pubs/ft/survey/so/home.aspx
IMF Technical Assistance Focuses on Policy and Institution Building
The expansion of the IMF’s membership and the adoption of market-oriented reforms by a large number of countries worldwide fueled a rapid growth of IMF technical assistance activity during 1990–94. Since then, owing to budgetary and staffing constraints, the quantity of technical assistance and training delivered by the IMF to its members has leveled off to slightly more than 300 years of staff and expert time plus some $10 million for scholarships and trainees annually.
The period of consolidation since 1994 has provided an opportunity to reflect on the proper place of technical assistance in the IMF’s work, in particular on the balance between policy and institution-building technical assistance and their linkages with the IMF’s surveillance work and its support for members’ adjustment programs. Related attention has been given to strengthening the IMF’s monitoring and evaluation of its technical assistance. This, in turn, is leading to a re-examination of some of the ways in which technical assistance programs and projects are designed and implemented.
These were among the issues explored at a recent Executive Board meeting convened to discuss the report of a group of external experts on the technical assistance provided by the IMF’s Monetary and Exchange Affairs Department (one of several IMF departments providing technical assistance). During the meeting, Executive Directors aired a wide range of views on the role and importance of IMF technical assistance and floated suggestions for further improving its planning and implementation. Board members continued to view the IMF’s technical assistance and training as a natural outgrowth of its work on surveillance and members’ adjustment programs. Several believed technical assistance should be linked even more closely to country surveillance and program work, although taking care not to make acceptance of technical assistance a condition for approval of IMF support for a member’s adjustment program.
The IMF’s senior management has endorsed this view, describing technical assistance as “one of the three legs of the IMF stool” (the other two being IMF surveillance and financing); it should thus be as robust as the other two legs to ensure the stool’s overall stability.
Evolving Role of Technical Assistance
The Executive Board discussion revealed changing perceptions about the IMF’s role in technical assistance. As a monetary institution dedicated to pursuing stability in the international monetary system, the IMF has always been keenly interested in fiscal and statistical—as well as purely monetary—issues that have a potential for undermining macroeconomic stability. Since the October 1994 Madrid Declaration (on cooperation to strengthen the global economic expansion) and the late-1994 Mexican financial crisis, interest in these areas has intensified. Also, it is now generally agreed that the IMF’s support for members’ adjustment programs—and much of its surveillance work—is aimed not only at stabilization, but also at creating or maintaining conditions for sustainable growth (for which macroeconomic stability is an important prerequisite).
IMF staff on program and Article IV consultation missions, and resident representatives—IMF staff based in selected member countries—currently spend a significant amount of time advising governments on required structural changes, the capacities needed to manage structural change, and how technical assistance can support these efforts. Although there is still no consensus about how far the IMF should move toward development-related work, the development dimension clearly emerges at the intersection of technical assistance with the IMF’s surveillance and program work.
If current IMF technical assistance activities were still limited, as in the early days, to advisory missions providing policy advice on ways to achieve, or maintain, fiscal and monetary stability, it could be argued that they lack a development dimension. But the IMF now provides a wide range of technical assistance and training designed to develop human skills and institutional capacities in areas of economic and financial management vital to fostering sustainable growth. Indeed, IMF-supported programs have taken on a medium-term perspective and begun to emphasize the institutional and structural weaknesses that need to be addressed if program-induced improvements in the external sector are to lead to increased productivity, investment, savings, and growth. This has prompted the IMF to take a deeper interest in the need for medium-term complementary technical assistance programs that emphasize the development of institutional capacities.
Until recently, it could be argued that even when technical assistance was provided for institution building (for example, to improve tax collection through strengthening tax administration), the goal was not to promote development or even growth but to help achieve macroeconomic stability by closing, or narrowing, fiscal deficits. However, IMF staff have maintained that if fiscal adjustment is to contribute to the long-term success of an IMF-supported adjustment program, it must be growth enhancing (see Finance ȶ Development, June 1996). This implies a careful integration of policy and institution-building technical assistance to underpin the objectives of IMF-supported programs. It also means an even tighter interlocking between the management of IMF programs and technical assistance.
Striking the Right Balance
Recent research on the requisite conditions for sustained economic growth supports the view that the right mix of government policies is key to explaining the differences in economic performance among countries starting at similar levels of development and with similar resource endowments. Paradoxically, this mix appears to require both less and more government: less government involvement in direct economic control and intervention, and more government involvement in indirect economic management that encourages efficient resource use and less waste. The latter requires a set of skills and institutions different from the former. Government involvement in indirect management calls for a greater understanding of—and capacity to use effectively—a broad array of fiscal and monetary instruments; this, in turn, necessitates a greater variety of economic and financial data. More government involvement in indirect economic management also requires an enabling legal and regulatory framework managed impartially by competent professionals with the necessary means of enforcement. The IMF has been active in providing technical advice and training in all of these areas to countries in transition to market-oriented economic systems.
Although the correct mix of economic policies and institutional capacities may appear to be at the heart of the growth conundrum, evidence suggests it is not easy to get the balance right. Producers and consumers in many countries still struggle to react rationally in the face of conflicting government policies and regulations that distort investment and consumption decisions and produce an incentive structure that lowers welfare. Even where governments are ready to take steps to establish the right conditions for a more efficient use of resources, it is not always obvious how they should proceed in the context of an IMF-supported program; nor do many governments have the capacity to design and implement the right structural reforms without strong external technical support. As the IMF is faced with mounting pressures to take these factors into account in the design of three-year adjustment programs, the demand for its technical assistance in tackling structural and institutional impediments to what the Managing Director has termed “high-quality growth” is likely to increase.
The risks of ignoring these issues are great. For instance, if a country liberalizes its financial market before putting in place adequate prudential controls and bank supervision capacity, the banking sector could be destabilized, with disruptive repercussions throughout the economy. Or, for a government needing to undertake fiscal adjustment to avoid excessive reliance on credit restraint to contain inflation, it is not easy to judge the combination of tax and expenditure reforms required to match the short-term goal of restraining demand with the longer-term objective of promoting growth. In both of these cases, the IMF departments providing technical assistance work closely with the relevant area department and the governments concerned to agree on an optimal mix of policy advice and institution-building assistance.
Effective Technical Assistance Is Complex and Costly
Paying closer attention to the removal of structural impediments to growth and to the role of policy and institution-building technical assistance has major cost implications. The resources required for a comprehensive approach to technical assistance are, in many cases, beyond the capacity of the IMF alone, as they entail setting the right policies and approaches; drafting the necessary legislation and regulations; training large numbers of personnel; designing management information systems to collect, process, analyze, and disseminate data; procuring and installing the equipment and supplies needed to complement the human resource inputs; preparing and implementing public information campaigns; and putting in place adequate monitoring and evaluation systems. These broad-ranging tasks pose the question: Should the IMF step up its efforts to enlist the support of other providers of technical assistance, some of which may be better placed to provide inputs on the scale and in the combination required?
In certain individual country cases, the IMF is already collaborating with other agencies—most notably the United Nations Development Program and the World Bank—to take a more comprehensive approach to strengthening economic and financial policy formulation and implementation capacities. But even with the additional resources and field-level support network offered by these arrangements, they still absorb considerable staff time and demand heavy travel. Ensuring adequate internal and external coordination, proper and timely sharing of information, and adequate oversight over project implementation can be nearly as time consuming as delivering and back-stopping the technical assistance itself.
In response to these challenges, the IMF is continuing its efforts to improve the effectiveness of its technical assistance. It is giving management of its technical assistance operations a sharper country focus, yielding a greater synergy between its country programs and its efforts to help countries develop the capability to manage their economies. IMF staff are also paying greater attention to implementation capacities and to development of a broader understanding of institutional and structural constraints in member countries. The IMF is also enhancing staff continuity in the management of country operations and increasing the involvement of its resident representatives in the coordination of technical assistance.
Providing technical assistance on a regional basis offers another way to economize on resources. This approach has been followed successfully for the 15 countries of the Pacific region (see box). The approach permits cross-fertilization of ideas and skills among countries facing similar problems of economic and financial management. It also provides a genuine “expert team approach” to the provision of technical assistance. And it generates a sufficient critical mass to justify using an IMF employee as full-time coordinator to ensure consistency and complementarity between the policy and institution-building aspects of technical assistance. Last, but not least, the regional approach has proved to be a successful vehicle for mobilizing resources. Several bilateral and multilateral agencies have not only made financial contributions, but have become involved in setting the direction and monitoring the implementation of the program, together with the participating beneficiary governments. The IMF is considering extending this approach to other regions.
The PFTAC: A Regional Approach to Technical Assistance
The Pacific Financial Technical Assistance Center (PFTAC) was established in 1993 as a joint undertaking of 15 Pacific island countries with the financial and technical support of the United Nations Development Program (UNDP) and the IMF. It provides advisory services and training to strengthen economic and financial management capacities in the region. The PFTAC was set up in response to the recognition that unrealistic economic planning and policy formulation—divorced from budgetary and institutional realities—had been a common cause of the disappointing economic performance of the Pacific island countries in the 1980s. A reorientation of these economies to lessen their dependence on high levels of foreign aid required comprehensive economic and financial reforms, along with the institutional and policymaking capacities to implement them.
The Center has been providing technical advice and training in public expenditure management, tax and customs reform, banking supervision, and national accounts and balance of payments statistics. It conducts training through expert visits and regional workshops and seminars. The Center’s contribution to capacity building in the region was widely praised at a recent review of the first phase of its operations. The review took place in Suva, Fiji, in March 1996, and was attended by representatives of 12 of the 15 participating countries, as well as by representatives of 8 bilateral and multilateral agencies.
The PFTAC began a three-year second phase of assistance on April 1, 1996, with financing from the UNDP, the Asian Development Bank, Australia, New Zealand, and the IMF (directly and through the IMF’s Japan Administered Account) totaling $5 million. The European Union is expected to provide another $1 million in 1997. The IMF continues to be the executing agency, appointing a team of four experts and several short-term consultants and supplying an IMF macroeconomist as project coordinator. The PFTAC is accountable to the funding agencies and beneficiary governments through a Steering Committee consisting of 6 of the 15 Pacific island countries, chaired by the Governor of Fiji’s central bank. Project activities are monitored by the relevant IMF department and are subject to formal annual review by all parties. An independent evaluation of the PFTAC is planned for 1997.
The IMF will continue to review and adjust its technical assistance operations and procedures to strike the right balance between policy and institution building, and between its technical assistance activities and its surveillance and program work. Its objective is to be as responsive as possible to those of its members embarked on the path toward stable and sustainable economic growth.
IMF, Technical Assistance Secretariat
Financial Discipline: A Critical Element of Kenya’s Adjustment Effort Kenyan Reforms Aimed at Building Investor Confidence and Raising Living Standards
The key to translating Kenya’s recent economic gains into future growth and stability is in policies that enhance the confidence of private investors, according to an internal study by the IMF’s African Department. The chief means for achieving this end is a far-reaching effort to reform the country’s public finances. Such reform is an integral part of Kenya’s medium-term adjustment program, which the IMF recently supported with a new three-year credit under the enhanced structural adjustment facility (ESAF).
Components of Reform
Kenya has achieved a major economic transformation over the last three years. Gross domestic product rose by 4.9 percent in real terms in 1995 from 0.2 percent in 1993. The government’s budget deficit was reduced to 2.5 percent of GDP in 1994–95, from 11.4 percent of GDP in 1992–93. And annual inflation (on a month-over-month basis) declined steadily to 6.9 percent in December 1995 from a peak of 62 percent in January 1994.
Solid progress has also been made in carrying out structural reform. The country’s civil service (excluding teachers) has been reduced by an estimated 34,000, or 13 percent, since mid-1993. The Kenyan government has divested its holdings in over 100 firms, including 43 tea factories where the authorities turned over the bulk of the government’s shares to farmers. And the government has reduced its holdings in another six major enterprises, including Kenya Airways, the Kenya Commercial Bank, and the National Bank of Kenya.
Over the medium term, Kenya faces several challenges:
Fiscal Policy. While the Kenyan authorities have carried forward a major adjustment program, existing expenditure controls remain inadequate. Sizable unbudgeted outlays and continued unauthorized spending could, for example, undermine fiscal viability. Kenya’s fiscal position has been weakened by government expenditure that has consistently exceeded budget targets. To address these difficulties, Kenya’s 1995–96 fiscal program aims at a deficit of 1.9 percent of GDP and an increase in total revenue by 2.3 percent of GDP. A broadening of Kenya’s tax base is also being implemented, including the extension of the value-added tax (VAT) to all products except food items and certain unprocessed products.
Monetary Policy. The conduct of monetary policy will continue to be difficult, according to IMF staff. For example, a reduction in the currently high real interest rates will require a sizable cut in the government’s domestic debt and a lessening of the risk premium demanded by investors. The Central Bank of Kenya plans to reduce substantially its net domestic assets in 1996 to stem monetary expansion and pressures in the foreign exchange market. Foreign exchange intervention is to be limited. To facilitate lower interest rates and limit undue appreciation of the exchange rate, additional fiscal adjustment may also be necessary.
Structural Measures. Kenya’s medium-term, IMF-supported adjustment program envisions a leaner, more efficient governmental structure. Two primary areas of activity will be affected. First, the authorities intend to streamline the public employment system by initiating further reductions in the country’s civil service. Anticipated staff reductions in 1996 are estimated at 6 percent of the total civil service. To attract competent professionals and narrow existing salary differentials with the private sector, civil service remuneration is also to be reviewed. Second, a major privatization and restructuring initiative to reform Kenya’s parastatal sector is moving forward. The initiative calls for divestiture of government shares in commercially oriented parastatals, as well as the liberalization and restructuring of the few remaining parastatal sectors.
Trade and Donor Assistance. Another cornerstone of a successful reform program is a liberalized and open trade regime in Kenya. This is important not only for competitiveness, but also because it underscores the government’s commitment to domestic economic reform. Kenya’s recent announcement that it is moving swiftly toward closer economic integration with Tanzania and Uganda is a significant step in this regard.
Kenya’s relations with the bilateral donor community have at times been delicate, as donor concerns have encompassed not only economic matters, but also a broad range of governance issues. In view of the importance of donor assistance for Kenya’s economic development, addressing these donor concerns will remain a priority.
Poverty Alleviation. About half of the population lives in poverty. Targeted interventions are necessary to provide income support to those who cannot wait until the growth process gathers full steam. Targeted interventions directed toward high unemployment in rural areas are a major priority. Economic growth has to be sufficient to generate productive employment for Kenya’s rapidly growing labor force. The government plans to target poverty measures and to increase the poor’s access to social services. The authorities are also committed to reallocating funds from university education to primary and secondary education, particularly for underprivileged students.
Kenya Publishes Its Policy Framework Paper
In the interest of openness and transparency, Kenya, on February 16, made public its policy framework paper (PFP) outlining the government’s development strategy and key economic reforms slated for implementation during 1996–98. The PFP is prepared by the authorities of the member country with the joint support of the staffs of the IMF and the World Bank. It is a key requirement for qualifying for concessional assistance under the IMF’s enhanced structural adjustment facility (ESAF). On April 26, the IMF approved a three-year, SDR 149.6 million ESAF credit for Kenya.
Financial Sector Reform Is Vital
The main objective of reform for 1996 and beyond is a stronger financial system in two critical, overlapping areas:
enhancing competition and restructuring financial of portfolios, and
establishing the transparency and accountability of public finances to prevent the misuse of public funds and off-budget outlays.
Competition and Restructuring. Kenya’s financial sector is dominated by a few large banks, around which circulate numerous smaller ones and a variety of nonbank financial institutions. As of June 1995, for example, about 65 percent of deposits were held with two foreign and two domestic banks.
Notwithstanding an adequate regulatory framework, both enforcement of prevailing banking regulations and prudential requirements have been weak. As a result, discretionary exemptions to Banking Act provisions were frequently granted, and a number of the banks receiving exemptions were carrying large portfolios of non-performing loans. Thus, by early 1993, about one third of these entities—accounting for 63 percent of total banking system assets—were identified as distressed.
A number of important steps have since been taken to reform this sector. These include liquidation of several large banks, new regulations pertaining to the operation of nonbank financial institutions, and a program of overall rehabilitation and divestment of mostly state-owned banks. At the end of 1995, the nonbank financial institutions were brought fully under the same cash ratio requirements that apply to regular banks. The government has also embarked on a program to rehabilitate and privatize government-owned banks.
Major efforts are also under way to make the Central Bank of Kenya more independent by strictly limiting its legal ability to extend credit to the government and by establishing security of tenure for its governor. To increase the bank’s independence, the government intends to amend the Central Bank Act.
The government also plans to enhance the soundness of the pension system, and the Kenyan authorities have recently announced their intention to make the National Social Security Fund independent.
Transparency and Accountability. Kenya is taking measures to ensure greater transparency and accountability in its public finances. These include:
the avoidance of further misuse of public funds;
strengthened efforts to enhance the efficiency of the civil service and judiciary. In this regard, the code of conduct for the civil service and its enforcement procedures need to be reinforced to ensure strict and prompt application of appropriate sanctions; and
strict enforcement of existing procedures for granting procurement contracts and, where necessary, modifying such procedures to ensure complete transparency of public finances.
The government has agreed to enter into commitments only if they are explicitly included in the budget as approved by parliament. It has further committed itself to adhere firmly to procedures guiding the award of public contracts; all such contracts exceeding K Sh 10 million will be awarded through public tendering.
Government expenditures will like-wise be monitored monthly by the Kenyan Treasury. And the sanctions of the financial orders and regulations will be strictly applied to accounting officers in ministries and departments that violate spending ceilings without the Treasury’s explicit and prior written approval. To discourage officials from exceeding their quarterly allocations without prior Treasury approval, all such transactions will henceforth be monitored by a computerized accounting system. In addition, the Central Bank of Kenya has been instructed to refer checks issued by spending ministries without sufficient funds to the Treasury.
The Kenyan authorities intend to pursue vigorously the recovery of misused public funds. The Parliamentary Public Accounts Committee and Public Investment Committee are responsible for examining all possible irregularities in budgetary payments and other misuse of public funds.
The Road Ahead
Kenya’s efforts to reform its public finances, within the broader context of its IMF-supported medium-term economic adjustment program, are important not only because they will provide added confidence to investors and the donor community, but because they will raise living standards of the population. While challenges remain to be addressed, Kenya’s progress to date justifies future international support for its ongoing reform efforts.
Camdessus Describes Challenges for Arab World
Following are edited excerpts of a speech by IMF Managing Director Michel Camdessus delivered at the Annual Meeting of the Union of Arab Banks, in New York on May 20. While citing the considerable headway made by such countries as Algeria, Jordan, and Tunisia in stabilizing, reforming, and opening up their economies, Camdessus noted that further reform was necessary to achieve the strong, broad-based growth that would meet employment and other needs.
It is clear that the Arab world needs to improve economic performance and take fuller advantage of the opportunities in today’s global economy. In a number of countries in the region, this will require a fundamental reassessment of the role of the state. It is now nearly universally accepted that the most effective economic strategies are private-sector-led and outward oriented. Governments have an important enabling role to play in ensuring that domestic conditions are such that the private sector has the confidence to save, invest, and produce.
To fulfill this role, governments must pursue disciplined and predictable fiscal and monetary policies. In particular, government deficits must be reduced to a point where they can be financed in a noninflationary way and do not crowd out private investment or require the drawdown of foreign assets. At the same time, governments need to improve the quality of expenditure—by redirecting spending toward education, health, and well-targeted social safety nets.
It is also the government’s role to undertake a critical mass of structural reform to improve resource allocation, facilitate participation in international trade, encourage private capital inflows, and increase productive investment, jobs, and growth. Governments must simplify regulatory systems so that potential investors are attracted by a simple and clear set of rules; establish sound financial systems and flexible markets that promote an efficient allocation of resources; and promote transparency so that economic agents—domestic and foreign—understand what the country’s policies are and how the country is performing. In a globalized world economy with large capital flows between countries, there is a premium on transparency. International capital markets function more smoothly if reliable, regular, and up-to-date information on economic performance is available. We have recently established a voluntary Special Data Dissemination Standard, aimed at countries participating in international capital markets or aspiring to do so. We hope that an increasing number of countries in your region will consider subscribing to it.
It is also the role of government—as well as private sector leaders—to build a domestic consensus in favor of economic reform. When such a consensus exists, governments are more likely to persevere with macroeconomic stabilization and structural reform. And when both the policies and the consensus on reform are in place, savers and investors see that reform is irreversible, that the country is truly integrating into the global economy, and they become less hesitant.
Finally, it is the role of governments to recognize—and to have it endorsed by public opinion—that there is no such thing as prosperity in isolation and to continue devoting part of their national resources to the support of development efforts in poorer countries equally committed to reform. Here let me salute the long-standing contribution of Arab countries in this domain.
Financial institutions also have an important role to play. Banking systems fulfill essential functions in intermediating between savers and investors, financing private sector trade and investment, and helping to ensure that the economy’s financial resources are allocated efficiently. Well-functioning banking systems also increase the effectiveness of macroeconomic policy.
But to play these roles effectively, the banking system must be sound and efficient. Governments and banks should work together to ensure that this is the case. Governments can do so by pursuing sound macroeconomic policies and exercising appropriate bank supervision; banks can contribute by upgrading their technology and improving credit analysis, while ensuring that adequate internal controls are in place.
And, as with other sectors of the economy, banks also benefit from competition. Indeed, easier entry would encourage more efficient banking operations and, hence, more efficient financial intermediation within the economy as a whole. It is important to bear in mind that a modern, efficient banking sector and a dynamic economy are mutually reinforcing. Modern, efficient banks contribute to economic growth and development. By the same token, faster growth and development increase the demand for financial services. Moreover, as policy reforms in Arab countries gain credibility, your institutions are likely to be the main intermediaries for Arab investment capital returning to the region, and an important conduit for other private inflows. From this perspective, your institutions are natural supporters of credible and sustained economic reform in Arab countries.
This agenda of stabilization and reform is a demanding one. Yet given the increased competition for investment capital and export markets in today’s global economy, there is no alternative but to begin the adjustment process as soon as possible and to persevere on a steady course of reform. Countries that embark on this course can count on the support of the IMF and, indeed, of the international community at large. But the greatest support will come—when the conditions are right—from the vast resources of the private sector, both domestic and foreign.
Deepening Structural Reform in Africa: Lessons from East Asia
On May 13–14, officials from African and East Asian countries and staff from the IMF, the World Bank, and several development organizations gathered in Paris for a seminar on “Deepening Structural Reforms and Policies for Growth in Africa.” The seminar, organized by the Japanese Ministry of Finance and the IMF, with assistance from the World Bank, was co-chaired by Hideichiro Hamanaka, Deputy Director General of the International Finance Bureau of Japan’s Ministry of Finance, and Jack Boorman, Director of the IMF’s Policy Development and Review Department. It was the third in a series of seminars, begun in 1994, to explore the lessons the East Asian economies could offer Africa in its quest for more rapid and sustainable growth.
After years of being battered by terms-of-trade shocks, civil strife, and, in some instances, economic mismanagement, many African economies are finally realizing higher growth rates, along with an end to the long decline in per capita income. Macroeconomic stabilization has played a key role in this reversal. Indeed, one important conclusion from the seminar was that the need for macroeconomic stability as a prerequisite for successful reform and adjustment is no longer an issue for debate.
But it had been hoped that Africa would be doing much better by now. Growth rates need to be higher if there is to be a fundamental change in the pace of improvements in the lives of most Africans; this will occur only if the supply sides of the economies respond much faster. Where is the problem? The consensus at the seminar, as noted by co-chairman Jack Boorman, was that many countries have been reasonably successful in implementing “early-stage” structural reforms—reforming exchange rate systems, opening trade and payments systems, removing price controls, and liberalizing production and marketing systems, particularly in the agricultural sector. “But the record on the more difficult reforms—involving revenue mobilization, public enterprises, privatization, and the financial sector—is much more uneven,” he said, which is why the seminar’s agenda was cast around the theme of accelerating structural reform in these areas. Co-chairman Hideichiro Hamanaka noted that although “no single formula will work for every country” and the emphasis must be on formulating country-specific and region-specific policies, cross-regional experiences could provide valuable lessons.
The sequencing and pacing of financial reforms was a prevailing theme at the seminar.
As African governments search for ways to boost tax revenue relative to GDP, Peter Heller, of the IMF’s Fiscal Affairs Department, suggested that they focus on strengthening both tax policy and tax and customs administration. Successful African initiatives point to the need for reducing and controlling exemptions, simplifying tax structures, reducing reliance on trade taxes, introducing a simplified form of the value-added-tax, simplifying the approach to taxing small enterprises, and relying on an integrated rather than a piecemeal approach to tax policy.
On fiscal policy and growth, what are the messages from East Asia? Shahid Yusuf, of the World Bank, noted that East Asian countries embarked on many of the same tax reforms in the early to mid-1980s. But what is most striking about East Asia’s fiscal experience, he said, is that expenditure management, rather than an extraordinary tax effort, was the principal achievement, and it contributed to the increase in national savings that substantially explains East Asia’s growth performance.
The question of sequencing and pacing of reforms—a theme throughout the seminar—surfaced early on in a presentation by David Cole, formerly of the Harvard Institute for International Development. Given the many serious disruptions and financial crises associated with recent attempts to modernize, privatize, and increase the market orientation of financial systems in African countries, he said, policymakers might want to consider a more gradual, market-building approach—one that operated on a timeframe of one or two decades rather than a few years. “Don’t try to push your system ahead too rapidly,” he warned, because a misstep could slow down the entire liberalization process.
But Patrick Downes, of the IMF’s Monetary and Exchange Affairs Department, cautioned that in an era of economic globalization and integrated financial markets—not to mention the sea change in private capital flows and the new opportunities they present—one must ask whether the relative costs and benefits for Africa of opening up its markets only slowly were the same as those faced in Asia when these countries made their decisions regarding liberalization. He argued that the cost of acting slowly—forgoing the benefits that faster access to outside capital and technology can provide—was too dear, and that delaying financial reforms often worsens existing problems in the monetary and banking system.
This sentiment was shared by the African participants, who felt strongly that they could not afford to proceed at the pace that some Asian economies had adopted, given the changed economic environment. As Mali’s Minister of Finance and Commerce, Soumaila Cisse, put it, “we have to accelerate or they’ll just sweep us out of the way.” Moreover, several speakers pointed to cases where quick moves to market-oriented systems helped to depersonalize and depoliticize decision making. Ghana’s former Finance Minister, Kwesi Botchwey, noted that Ghana initially tried taking a gradual approach to exchange rate and interest rate reform “until we ourselves decided it was impossible to proceed that way.” He said that whenever the exchange rate needed to be adjusted even the slightest bit, according to the agreed formula, “it took long meetings in the middle of the night, with daggers drawn.” Eventually, he said, policymakers realized that the only way to end the paralysis was to adopt a market-based system overnight, and interestingly, “those who were the most vociferous in opposing even the smallest changes very quickly got used to what the market said and did.”
Public Enterprise Reform
On the privatization front, John Nellis, of the World Bank, noted that there had been a decline worldwide in the number, as well as in the economic and financial weight, of state-owned enterprises over the past decade. In Africa, however, parastatals still accounted for a large share of GDP, nonagricultural employment, and investment, which remained a problem, he said, because these entities consume about 20 percent of available human and physical capital in the region, while contributing only about 10 percent to value added. What are the key obstacles? Nellis pointed to lingering government fears that urban unemployment would rise, that the only buyers would be seen as undesirable (for example, foreigners, a particular ethnic group, or well-connected domestic elites), that sources of patronage and perks would be lost, or that deindustrialization would result.
Most African participants felt that obstacles to privatization were largely political and social, not just technical.
Most African participants, however, underscored the progress made in recent years, stressing that the remaining obstacles were largely political and social, not just technical. Several speakers pointed to the challenge of convincing unions, parliaments, and political parties to embrace privatization when the costs are immediate, while the benefits are long term and diffuse. “The government needs to do a bit of door-to-door salesmanship,” said Joseph Tsika, Chief of Staff of the Finance Ministry in the Congo. This was echoed by Mary Consolate Muduuli, Commissioner of Economic Planning with the Ugandan Ministry of Finance and Economic Planning, who noted, “we’re only waking up now to putting advertisements in the media to explain the advantages of privatization.”
But the African participants also felt that the multilateral institutions and donors could help by not setting structural targets and conditions that are unrealistic and even perverse—a case in point being the fire sales that can result when a set number of firms in a targeted sector must be privatized by a certain date. And they took issue with what they viewed as a provocative statement by Yasuo Yokoyama, Senior Regional Coordinator in Southern Africa for Mitsui and Co. Europe Ltd., that it would take a very long time to get the economic fundamentals right and allow the private sector to mature in Africa before major privatizations could be undertaken.
The Cultural Dimension
As donors and governments debate the best path forward, Ravi Kanbur, of the World Bank, suggested that apart from timing and conditionality, a key issue will be cultural receptivity to change. Tetsuji Tanaka, Senior Bank Supervisor with the Bank of Japan and a Special Economic Advisor to the President of the Kyrgyz Republic, commented that “it is said that ethics and philosophy with asceticism are required to operate a capitalist market economy.” As evidence, he said, many observers point to the Protestant ethic of nineteenth-century Europe, Confucianism in East Asia, and a folk epic in the Kyrgyz Republic (“Manas Epoth”) that extols diligence, saving, abiding by contracts, and service to the community. However, Kanbur noted that only 40-50 years ago, many observers cited Confucianism for the slow economic progress in East Asia, underscoring the need for further exploration of the connection between culture and economic growth.
One unmistakable message of the seminar was that the politics of structural reform are tough. Participants agreed that more effort should go into communicating the costs and benefits of policy options so that policymakers could enlist the support of their own civil societies—especially the private sector—for reform. Indeed, the need to secure both short-term results to sustain the reform process politically and long-term results to deliver on promised reductions in poverty prompted Mark Baird, of the World Bank, to urge countries to persevere with adjustment. “All of the evidence, including from Africa,” he said, “is that when you implement and can sustain sound macroeconomic policies, you do get a large and quick supply response.” But in Africa, he noted, progress in policy reform has been uneven, with slippages, raising questions about the credibility of the programs.
As the dialogue accelerates, pressures for democratization and good governance will only grow. In his concluding remarks, Boorman cited the widespread acceptance of the view that good governance—defined to include greater transparency and accountability in the conduct of governments—is socially desirable, that it can have a positive effect on growth, and that it is increasingly and inevitably a concern of donors. At the same time, new ways must be found to craft programs and sector projects in a way that assures donors that their monies are being well spent while permitting governments to retain “ownership” of their reforms. Boorman also noted, however, that many participants felt that good governance and democracy were not the same thing and that “there needs to be more exploration country by country—and perhaps with more subtlety—in the search for democratic processes appropriate to the conditions of Africa.”
IMF External Relations Department
Bank Conference Highlights Development’s Dynamic Nature
Inaugurating the eighth World Bank Annual Conference on Development Economics, World Bank President James D. Wolfensohn stated that successful development should be based on strong macroeconomic policy fundamentals. In this broad context, four major issues were discussed at the April 25–26 meeting: the prevention of banking failures; poverty reduction; legal systems and economic development; and labor and environmental standards in international trade.
In the keynote address, Joseph E. Stiglitz, of the U.S. Council of Economic Advisers, focused on the appropriate role of government in economic development. He made two major points:
The failure of socialist planning had inadvertently lent support to the mistaken view that government’s role in economic activity should be radically reduced, if not completely eliminated.
The earlier U.S. and more recent East Asian experiences suggest, however, that government can play a beneficial economic role in such key policy areas as education, financial regulation, environmental protection, and social welfare.
Stiglitz advocated a more balanced perspective in assessing the role of government in the modern economy. Instead of rehashing old arguments about the superiority of private over public enterprise, he said, analysts and policymakers should instead identify areas where the activities of governments and private markets can most effectively complement each other. Stiglitz noted that the role of government itself is dynamic. Thus, changes in the economic environment fundamentally alter what the government can and should do. At the same time, Stiglitz said that one of the chief virtues of government remains its ability to “help societies embrace change.”
Selected IMF Rates
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Data: IMF Treasurer’s Department
Understanding Banking Failures
Frederick S. Mishkin of the Federal Reserve Bank of New York called on developing countries to devise stronger bank regulatory and supervisory structures before initiating financial market liberalization. Failure to take this step, he warned, could encourage unconstrained risk taking and ultimate financial collapse. Gerard Caprio Jr. and Daniela Klingebiel, both of the World Bank, called for more rigorous analytical frameworks in assessing the potential impact of banking failures in both industrial and developing countries. Using a database covering about eighty episodes of insolvency, they analyzed the causes of these crises and how governments responded to them. To manage insolvency better, Caprio and Klingebiel urged policymakers in developing countries to devise market-based regulatory frameworks that encourage bankers to engage in prudent risk taking. One suggestion they put forward would require banks to issue concentrated amounts of subordinated debt, thereby creating a group of investors with sufficient motivation to oversee their operations.
Timothy Besley of the London School of Economics called for a two-pronged assault on developing-country poverty, consisting of better targeted interventions to facilitate the flow of scarce resources to the most deserving groups and greater latitude for nongovernmental organizations (NGOs) in coordinating such interventions.
Ernest Aryeetey of the University of Ghana maintained that improved credit delivery systems could be an effective means for combating poverty in Africa. The goal, he said, was to ensure that appropriate structures were in place to assist the poor once financial market liberalization ensued.
Legal Issues in Development
Robert D. Cooter of the University of California at Berkeley argued that effective laws require citizens to supplement official enforcement with their own private efforts. When state laws respond to social norms, most people perceive the law as just and worthy of respect. A legitimate legal system, he explained, must be society-specific. Thus, Cooter cautioned that efforts to import the legal structures of other countries were doomed to failure. Avner Greif of Stanford University observed that effective contract enforcement in developing countries requires greater appreciation of surrounding—”context-specific”—factors reflecting distinct economic, social, cultural, and political elements. There is no uniquely optimal combination of contract enforcement institutions: one set of institutions may be more efficient in one economic situation but not in another, he said.
Alan Krueger of Princeton University suggested that developing countries that lack the capacity or will to enforce internationally accepted labor standards should be encouraged to enforce their own. While supportive of international environmental standards, he cautioned that many developing countries would likely refuse to enforce unrealistically high standards. According to Kym Anderson of the University of Adelaide, national environmental policymaking needs to take the interests of other countries into account. She said that raising incomes in developing countries—through more liberalized trade—would probably have a greater impact than trade sanctions in reducing pressures on the environment in developing countries.
Krueger questioned whether international campaigns to discourage the mistreatment of workers and children in developing countries constitute the most efficient means for achieving such a goal. One possible alternative, he suggested, might involve direct subsidies from rich countries to employers in poorer ones to improve the conditions of workers and children.
Recent IMF Publications
Working Papers ($7.00)
96/29: Volatility and Predictability in National Stock Markets: How Do Emerging and Mature Markets Differ?
96/30; Is MENA a Region? The Scope for Regional Integration
96/31: Stabilization and Growth in Transition Economies: The Early Experience
96/32: Working Paper Summaries
96/33: Fiscal Balance During Inflation, Disinflation, and Immigration: Policy Lessons
96/34: Have Institutional Investors Destabilized Emerging Markets?
96/35: A Destination VAT for CIS Trade
96/36: Italian Unemployment 1975–95: An Analysis of Macroeconomic Shocks and Policies Using Evidence from a Structural Vector Autoregression
96/37: The Reform of Wholesale Payment Systems and its Impact on Financial Markets
96/38: Rational Liquidity Crises in the Sovereign Debt Market: In Search of a Theory
96/39: Currency Convertibility and the Fund: Review and Prognosis
World Economic and Financial Surveys ($34.00; academic rate: $23.00)
World Economic Outlook, May 1996
Occasional Papers ($15.00; academic rate: $12.00)
No. 136: Jordan: Strategy for Adjustment and Growth
No. 137: The Lao People’s Democratic Republic: Systemic Transformation and Adjustment
Financial Programming and Policy: The Case of Sri Lanka ($ 19.00)
Policy Challenges in the Gulf Cooperation Council Countries (free)
1995 Annual Report of IMF Committee on Balance of Payments Statistics (free)
Publications of the International Monetary Fund, April 1996 (free)
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From the Executive Board
The IMF approved a three-year credit under the extended Fund facility (EFF) for the Republic of Moldova, equivalent to SDR 135 million (about $195 million), in support of the government’s economic program for the period 1996–98.
Following more than two years of economic reform, supported by two IMF stand-by credits in 1993 and 1995, financial stabilization has largely been achieved in Moldova. Inflation during 1995 was the lowest among the countries of the Commonwealth of Independent States, falling to about 24 percent during 1995 from 116 percent during 1994. Interest rates have declined to moderate levels, and the exchange rate has been stable. Exports are rising, particularly to countries outside the former Soviet Union, and economic activity is recovering. Progress has also been achieved in certain areas of structural reform, notably price and trade liberalization, and privatization. Since 1992, the exchange system of Moldova has been dramatically liberalized and, on June 30, 1995, the Moldovan authorities accepted the obligations of Article VIII, Sections 2, 3, and 4 of the IMF’s Articles of Agreement (see Press Release 95/39, IMF Survey, July 17, 1995). However, only limited success has been achieved so far in enforcing budget constraints on enterprises and in developing a private agricultural sector.
Medium-Term Framework and the 1996–98 Program
Moldova’s medium-term policy objectives are to maintain financial stability and establish the institutions and mechanisms of a market economy by the end of the program period, in order to lay the foundation for sustainable growth and a viable balance of payments. Consistent with this strategy, the main macroeconomic objectives for 1996–98 are to achieve an average real GDP growth rate of 4–5 percent over the three years, lower inflation to 6 percent by 1998, and reduce the external current account deficit to about 2 percent of GDP.
Within this medium-term framework, the objectives of the program for 1996 are to achieve real GDP growth of 4 percent, reduce inflation to 15 percent during the year, and contain the external current account deficit to about 7 percent of GDP. To achieve these objectives, fiscal policy aims to reduce the overall budget deficit to 3.4 percent of GDP from 5.5 percent in 1995 by reforming the tax structure and administration in order to strengthen revenues, and by better prioritization and rationalization of expenditures. Monetary policy has been tightened following the monetary expansion that took place in the second half of 1995 and will increasingly rely on indirect monetary instruments. Measures will also be adopted to strengthen the banking system. Exchange rate policy will remain flexible and will be conducted in conformity with the program’s inflation objective.
Republic of Moldova: Selected Economic Indicators
Data: Moldovan authorities and IMF staff estimates
Data: Moldovan authorities and IMF staff estimates
Structural Reform Policies
Structural measures under the program will focus on completion of the privatization process, energy and land sector reform, and establishing a sound legal system. The next stage of privatization will include foreign investors and cash auctions. Financial discipline will be promoted by continued bankruptcy proceedings against loss-making state enterprises and the limiting of loan guarantees and budgetary transfers to such enterprises. The government has also introduced a package of strong measures to address the problems of the energy sector and reduce the risk of any further buildup of external arrears. Several measures are also planned to establish a market-based agricultural sector, including the introduction of trading in agricultural land.
Addressing Social Costs
The government will restructure the social safety net through a consolidation of programs into a well-targeted system of old age pensions, unemployment benefits, and income transfers for the poor.
The Challenge Ahead
Moldova has now largely achieved financial stabilization and has made progress in its transformation to a market economy. The challenge now is to build upon these gains while maintaining financial stability, thus setting the stage for faster growth and higher living standards. Substantial work remains to be done, especially in accelerating the pace of structural reforms. A continued failure to impose financial discipline on the state enterprises and break the chain of arrears could undermine the progress already achieved toward financial stabilization.
The Republic of Moldova became a member of the IMF on August 12, 1992; its quota is SDR 90 million (about $130 million), and its outstanding use of IMF credit currently totals SDR 153 million (about $223 million).
Press Release No. 96/25, May 20
Photo Credit: Nigel Bradshaw, page 198.
The IMF approved a 15-month stand-by credit for the Republic of Latvia equivalent to SDR 30 million (about $43 million) to support the government’s economic program.
Since regaining its independence five years ago, Latvia has made remarkable progress in attaining macroeconomic stability and in advancing its transition to a market economy. Inflation has been brought down swiftly from very high levels; economic recovery began in 1994; and gross official reserves have increased. Nearly all prices, including interest rates, are determined by the market; the exchange and trade system is very liberal; 35 of the 38 operating banks at the end of 1995 were privately owned; and privatization of small and medium-sized enterprises is advanced. The economy faced major strains in 1995, however, because of the combined effects of a banking crisis and slippages in fiscal policy that led to a pronounced decline in international reserves and stagnation in economic output. Developments in the early part of 1996 have been encouraging, however, following a substantial tightening of both banking supervision and fiscal policy.
The 1996 Program
Latvia’s program for 1996 targets an increase in real GDP of 2 percent, an inflation rate of 18 percent, an external current account deficit of 3 percent of GDP, and gross official reserves equivalent to three months of imports. To achieve these objectives, the program aims at tightening fiscal policy and ensuring that sufficient resources are available for private sector investment. To strengthen revenues, numerous measures will be undertaken to improve tax administration and address the problem of tax arrears. Monetary policy is designed to support the inflation and balance of payments objectives and will rely increasingly on indirect, market-based instruments of monetary control. At the same time, the acceleration of privatization and other structural reforms will provide the necessary underpinnings to encourage resumed growth and increased private sector activity.
By the first quarter of 1996, the government had authorized the privatization of most enterprises, including the large ones such as the shipping company and the energy utilities. Foreign investors are now allowed the same access to investment opportunities as domestic investors, including privatization vouchers. In addition, the government has drafted insolvency and bankruptcy legislation that covers legal definitions, the liquidation procedure, delineation of responsibilities, and the rights of all involved parties. The government will also continue to accelerate financial sector reform and encourage competition and efficient intermediation in the banking system.
The numerous measures to improve tax administration and address the problem of tax arrears are expected to place government finances on a more solid footing and allow increased expenditure on social services and infrastructure maintenance. Over the medium term, a more equitable and perhaps even a reduced tax burden is envisaged as a result of the reforms.
The Challenge Ahead
To hasten the transition process and the resumption of economic growth, Latvia has adopted a far-reaching structural reform program. Accelerated privatization measures, together with the recent steps undertaken to promote foreign direct investment, acceleration of land registry, and legal reform, will lend support to the development of financial markets and institutions to underpin future growth.
The Republic of Latvia became a member of the IMF on May 19, 1992; its quota is SDR 91.5 million (about $132 million), and its outstanding use of IMF credit currently totals SDR 105 million (about $151 million).
The IMF approved an augmented second annual loan for Guinea-Bissau under the enhanced structural adjustment facility (ESAF) equivalent to SDR 4.2 million (about $6 million), in support of the government’s 1996 macroeconomic and structural adjustment program. The loan, which includes part of an undisbursed amount under the first annual ESAF loan, will be made in two equal installments, the first of which will be available shortly. The three-year ESAF credit for the equivalent of SDR 9.5 million (about $13.6 million) was approved in January 1995.
Guinea-Bissau’s adjustment effort spans the last decade. Following a period of relapse and renewed large financial imbalances, a major tightening of the fiscal and monetary policy stance took place in 1993 and laid the basis for adopting a program that could be supported by the ESAF. The 1994–95 ESAF-supported program achieved real GDP growth of 4–5 percent, but inflation rose to 45.4 percent, and fiscal performance under the program ran into serious difficulties. The authorities initiated corrective measures in March 1995, and performance was satisfactory under a program for the second half of 1995 that was monitored by IMF staff. Tax revenues increased, monetary policy was considerably tightened, and international reserves were used more effectively. Nonetheless, inflation remained high.
The 1996 Program
Guinea-Bissau’s macroeconomic objectives for the period 1996-98 are to achieve a real GDP growth rate of at least 4 percent a year, lower the average rate of inflation to 7.5 percent by 1998, and reduce the external current account deficit from 18.9 percent of GDP in 1995 to about 15.4 percent of GDP in 1998.
Guinea-Bissau: Selected Economic Indicators
Data: Guinea-Bissau authorities and IMF staff estimates and projections
Data: Guinea-Bissau authorities and IMF staff estimates and projections
Consistent with the medium-term strategy, the 1996 economic program aims at achieving real GDP growth of about 4 percent, reducing the average annual rate of inflation to 26.5 percent, and limiting the external current account deficit to 18 percent of GDP. The government intends to remain current on its external debt obligations during 1996.
To these ends, fiscal policy is aimed at containing the overall budget deficit at 21.5 percent of GDP. A sharp reduction in widespread import duty exemptions, combined with efforts to collect direct tax arrears, is expected to enhance revenue mobilization. To strengthen expenditure control during 1996, the government will assess the decentralized expenditure authorization system introduced in 1995 and reintroduce treasury control over all expenditures should it find a rise in domestic arrears accumulation by spending ministries. The monetary program has been designed to reduce inflation sharply.
Structural reforms are intended to increase the role of the private sector in the economy and to support broad-based growth. These reforms center on an acceleration of the privatization program initiated in 1994, a civil service reform, and a strengthening of the legal framework through revisions of the investment code, adoption of a land code, and an extension of the network of judicial courts. Sectoral programs in agriculture, fisheries, and infrastructure have been prepared in consultation with donors and will be adopted shortly.
The government attaches high priority to providing education and primary health care, particularly to the rural areas where the majority of the population lives, and to developing measures aimed at reducing poverty. An emergency program has been adopted for 1996 to address the declining quality of basic education and enrollment rates by strengthening the financial capacity and management of the Ministry of Education. In the health sector, a five-year program has been introduced to increase the number of primary care centers, particularly in the rural areas, and to ensure the availability of essential drugs.
The Challenge Ahead
Guinea-Bissau has an extremely heavy debt burden, which continues to hinder the country’s prospects for growth. Its debt stock at end-1995 was in excess of 360 percent of GDP, with a net present value of 19 times its exports, and an estimated debt service equivalent to 94 percent of projected fiscal revenue for 1996, after debt relief. Guinea-Bissau cannot achieve debt sustainability in the foreseeable future unless it receives exceptional treatment of its debt-service obligations beyond the Naples terms already granted by the Paris Club creditors on official bilateral debt.
Guinea-Bissau joined the IMF on March 24, 1977. Its quota is SDR 10.5 million (about $15 million), and its outstanding use of IMF credit currently totals SDR 3.6 million (about $5 million).
Press Release No. 96/28, May 31
Russia Accepts Article VIII
The Russian authorities have notified the IMF that, with effect from June 1, 1996, the Russian Federation has accepted the obligations of Article VIII, Sections 2, 3, and 4, of the IMF Articles of Agreement. IMF members accepting the obligations of Article VIII undertake to refrain from imposing restrictions on the making of payments and transfers for current international transactions or from engaging in discriminatory currency arrangements or multiple currency practices without IMF approval. A total of 116 countries have now assumed Article VIII status.
Two of the main purposes of the IMF, as stated in its Articles of Agreement, are to facilitate the expansion and balanced growth of international trade and to contribute thereby to the promotion and maintenance of high levels of employment and real income; and to assist in the establishment of a multilateral system of payments in respect of current transactions between IMF members. In seeking to achieve these objectives, the IMF exercises firm surveillance over the exchange rate policies of its members and oversees the elimination of exchange restrictions that hamper the growth of world trade.
By accepting the obligations of Article VIII, the Russian Federation gives confidence to the international community that it will continue to pursue sound economic policies that will obviate the need to use restrictions on the making of payments and transfers for current international transactions and thereby contribute to a multilateral payments system free of restrictions. Russia’s acceptance of the obligations of Article VIII on the fourth anniversary of its joining the IMF is a welcome step toward full convertibility of the ruble and marks an important milestone in the country’s rapid integration into the global economy.
Russia joined the IMF on June 1, 1992; its quota is SDR 4.3 billion (about $6.2 billion).
After the collapse of the former Soviet Union, and Moldova’s independence in 1991, output dropped sharply and inflation soared. The country has now achieved financial and macroeconomic stabilization, and its policy makers have turned to structural reforms to lay the foundations for higher and sustainable economic growth.
After the breakup of the former Soviet Union, Moldova experienced a severe deterioration in its terms of trade, loss of traditional markets, and disruptions in its payments and trade relations. GDP declined by more than 40 percentage points between 1991 and 1994. And annual inflation peaked at almost 2,200 percent in 1992—following price liberalization and monetization of a fiscal deficit equivalent to 26 percent of GDP.
Beginning in 1993, the authorities embarked on a comprehensive program of financial stabilization. By 1995, the fiscal deficit had been cut to 5½ percent of GDP and the National Bank had adopted a tight monetary policy. Annual inflation fell to 24 percent, and the velocity of broad money continued to decline—reflecting increasing confidence in financial stabilization and in the Moldovan currency. Exports and imports rose rapidly, and the current account deficit narrowed to the equivalent of 6½ percent of GDP. Data for the early months of 1996 show inflation remaining low and output rising.
Moldova has thus far achieved only limited success in enforcing hard budget constraints and restructuring the industrial and agricultural sectors. This has contributed to a buildup of domestic and external arrears that could retard investment and complicate the conduct of macroeconomic policy.
Deeper Structural Reforms
To maintain macroeconomic stability and lay the basis for sustained growth in the medium term, deeper structural reforms are necessary. The authorities have begun a three-year program—supported by the IMF’s extended Fund facility—that should quicken the pace of Moldova’s transformation and solidify the gains already achieved.
Corporate Governance. Moldova has made important progress in privatizing state assets. Over 70 percent of the housing stock has been transferred to private ownership, and more than 2,200 state enterprises (approximately 70 percent of the industrial enterprises) have been sold using privatization vouchers. The government has also taken preliminary steps toward creating private farms. With the emergence of new private enterprises, a substantial share of the economy is now privately owned.
The title transfer, however, has not yet been accompanied by a fundamental change in corporate governance, and little genuine restructuring of enterprises has taken place. Furthermore, the legal system has not adequately supported the operations of a market economy. The absence of clearly assigned property rights and effective mechanisms for enforcing contractual obligations—including the credible threat of bankruptcy—has encouraged a lack of financial discipline on the part of enterprises. It has also led to a substantial accumulation of inventories and corresponding arrears.
The government’s reforms emphasize post-privatization restructuring. Bankruptcy legislation will be streamlined and enforced to ensure that insolvent enterprises are reorganized or closed. Also, larger state enterprises will now be sold through cash auctions to strategic investors, and, for a number of key enterprises, to foreign investors as well. Moldova plans to strengthen corporate governance and improve the transfer of management know-how by opening up the economy to foreign investors. It also hopes to secure better access to foreign markets and more rapid improvements in productivity through the transfer of modern technology associated with foreign direct investment.
Energy Sector Reform. Strong measures are necessary to confront the problems of the energy sector. Industrial energy tariffs were adjusted upward in 1992, but social concerns did not allow for residential energy tariffs sufficient to recover operating costs. In addition, consumer payments have not been rigorously enforced. Eventually, external arrears built up, in particular to the Russian gas supplier Gazprom.
Moldova has now designed a comprehensive set of policies to put the energy sector on a sound footing. Residential electricity and heating tariffs have already been raised by 50 percent, which generally allows recovery of operating costs. Tougher measures are being implemented to enforce financial discipline. During 1997, cross-subsidization from industrial to residential consumers will be reduced, and tariffs will be set to allow for full cost recovery, including for capital. A system of targeted income subsidies will soften the impact of rising energy prices on the most vulnerable groups.
Agriculture. With excellent soil, a moderate climate, advanced agricultural research facilities, low labor costs, and specialization in high-value crops, Moldova’s agricultural sector is likely to be a major source of growth over the medium term. Agricultural production and processing currently account for 60 percent of GDP. Although farm ownership has been transferred to management and workers, and workers on collective farms have received land certificates to establish ownership rights, restructuring of this sector has been slow. Restrictions on dividing existing plots have effectively prevented laborers from leaving farms; more important, agricultural land has not yet been made tradable. Common ownership of, and marketing arrangements between, collective farms and processing industries have allowed food processors to postpone restructuring.
Moldova: Key Domestic Indicators
Data: Moldovan authorities and IMF staff estimates
Data: Moldovan authorities and IMF staff estimates
Policies promoting the efficient use of land are critically important for restructuring the sector. In 1997 land will become tradable. Clearly specified ownership and property rights will also give the sector better access to credit markets. A likely export expansion will foster new marketing channels and institutional arrangements.
Banking System Stability. The banking system will need to play an increasingly important role in resource allocation. So far, the banking system has been responsible for little financial intermediation, with transactions carried out mostly in cash. Savings are either held outside the banking system or are non-financial; and—with bank lending being short term and trade related—investment has largely been financed through retained earnings of enterprises.
The banking system is continuing to undergo substantial reform, including a gradual increase in minimum capital requirements and decisive action to put banks with negligible net worth into receivership before their capital is depleted. Monitoring of the sector and enforcement of prudential requirements are also being improved. The banking sector is likely to remain fragile for some time, however.
The government’s reforms aim to reduce inflation to 6 percent and to boost annual output growth to 5 percent by 1998. Energy reforms should help reduce Moldova’s dependence on energy imports and contribute to a decrease in the current account deficit to 2 percent of GDP by 1998 from 6½ percent in 1995.
Continuing export expansion is expected to drive Moldova’s output growth. High growth in exports, however, can only be sustained with considerable increases in investment. The government will further tighten fiscal policy to avoid crowding out private investment. Increasing confidence in structural reform should also spur more interest by foreign investors and contribute to increasing private capital inflows.
If firmly adhered to, the government’s program could lay the foundations for higher living standards. A successful implementation of such wide-ranging reforms will require a broad political consensus. Ultimately, risks are attached to hesitant or filtering reforms: a failure to deepen reforms could adversely affect Moldova’s financial stability.
Alfred Kammer IMF, European II Department
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