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 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

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.

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.

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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.

Fiscal Reform

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.

Financial Reform

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.

Summing Up

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.”

Laura Wallace

IMF External Relations 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.

Poverty Alleviation

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.

Moldova: EFF

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

¹Estimates.

²Program.

Data: Moldovan authorities and IMF staff estimates

Republic of Moldova: Selected Economic Indicators

		1994	19951	19962	19972	19982
		(percent change)
GDP at constant prices		−31.2	−3.0	4.0	5.0	5.0
Consumer prices (end of period)		116.0	23.8	15.0	10.0	6.0
Real wages (1994 = 100)		100.0	101.0	102.0	110.0	118.0
		(percent of GDP)
External current account balance		−6.9	−6.7	−6.8	−3.4	−2.2
Government budget balance
	(cash basis)	−9.0	−5.5	−3.4	−3.0	−2.8

¹Estimates.

²Program.

Data: Moldovan authorities and IMF staff estimates

View Table

Republic of Moldova: Selected Economic Indicators

		1994	19951	19962	19972	19982
		(percent change)
GDP at constant prices		−31.2	−3.0	4.0	5.0	5.0
Consumer prices (end of period)		116.0	23.8	15.0	10.0	6.0
Real wages (1994 = 100)		100.0	101.0	102.0	110.0	118.0
		(percent of GDP)
External current account balance		−6.9	−6.7	−6.8	−3.4	−2.2
Government budget balance
	(cash basis)	−9.0	−5.5	−3.4	−3.0	−2.8

¹Estimates.

²Program.

Data: Moldovan authorities and IMF staff estimates

Latvia: Stand-By

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 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).

Press Release No. 96/27, May 24

Republic of Latvia: Selected Economic Indicators

¹Program.

Data: Latvian authorities and IMF start estimates

Republic of Latvia: Selected Economic Indicators

	1992	1933	1994	1995	19961
	(percent change)
Real GDP	−35.0	−16.0	2.0	—	2.0
Consumer prices	958.0	35.0	26.0	23.0	18.0
	(percent of GDP)
External current account balance	1.8	7.0	−2.4	−3.6	−3.0
Government financial balance	—	1.0	−1.7	−2.7	−1.3

¹Program.

Data: Latvian authorities and IMF start estimates

View Table

Republic of Latvia: Selected Economic Indicators

	1992	1933	1994	1995	19961
	(percent change)
Real GDP	−35.0	−16.0	2.0	—	2.0
Consumer prices	958.0	35.0	26.0	23.0	18.0
	(percent of GDP)
External current account balance	1.8	7.0	−2.4	−3.6	−3.0
Government financial balance	—	1.0	−1.7	−2.7	−1.3

¹Program.

Data: Latvian authorities and IMF start estimates

Guinea-Bissau: Second Annual ESAF

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

¹Estimates.

²Program.

Data: Guinea-Bissau authorities and IMF staff estimates and projections

Guinea-Bissau: Selected Economic Indicators

		1994	19951	19962	19972	19982
		(percent change)
Real GDP growth		5.0	4.2	4.3	4.4	4.3
Consumer price index (average)		15.2	45.4	26.5	11.5	7.5
		(percent of GDP)
Overall fiscal balance (excluding grants)		−22.7	−20.4	−21.5	−16.2	−14.3
External current account
	(excluding grants and interest payments)	−13.2	−18.9	−18.0	−16.3	−15.4

¹Estimates.

²Program.

Data: Guinea-Bissau authorities and IMF staff estimates and projections

View Table

Guinea-Bissau: Selected Economic Indicators

		1994	19951	19962	19972	19982
		(percent change)
Real GDP growth		5.0	4.2	4.3	4.4	4.3
Consumer price index (average)		15.2	45.4	26.5	11.5	7.5
		(percent of GDP)
Overall fiscal balance (excluding grants)		−22.7	−20.4	−21.5	−16.2	−14.3
External current account
	(excluding grants and interest payments)	−13.2	−18.9	−18.0	−16.3	−15.4

¹Estimates.

²Program.

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.

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

¹Projections.

Data: Moldovan authorities and IMF staff estimates

Moldova: Key Domestic Indicators

	1992	1993	1994	1995	19961
	(percent change)
Real GDP	−29.1	−1.2	−31.2	−3.0	4.0
Inflation (end of period)	2,198.4	837.0	116.0	23.8	15.0
Broad money (end of period)	356.0	320.3	115.7	65.1	36.5

¹Projections.

Data: Moldovan authorities and IMF staff estimates

View Table

Moldova: Key Domestic Indicators

	1992	1993	1994	1995	19961
	(percent change)
Real GDP	−29.1	−1.2	−31.2	−3.0	4.0
Inflation (end of period)	2,198.4	837.0	116.0	23.8	15.0
Broad money (end of period)	356.0	320.3	115.7	65.1	36.5

¹Projections.

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.

Medium-Term Prospects

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