Donors Conference for the Union of Comoros, Statement of the IMF Staff Representative, Thomas Krueger, Senior Advisor, African Department, IMF

December 8, 2005

Statement of the IMF Staff Representative
Thomas Krueger, Senior Advisor
African Department, International Monetary Fund
December 8, 2005

1. It is my pleasure to represent the International Monetary Fund at this donors conference for the Union of Comoros. The conference today, the first such event in almost a decade, reflects the significant progress made on the political front. National reconciliation has advanced, helped by domestic leadership as well as by concerted international support, with the African Union, the UNDP, and regional partners playing a critical role. Progress on the political front has also benefited economic performance, and the government's Interim Growth and Poverty Reduction Strategy (I-GPRS) provides a road map for the way ahead. It recognizes that the challenges remain very large after years of economic decline, and the strategy highlights that financial and technical support by the donor community will be indispensable for meaningful progress toward the Millennium Development Goals (MDGs).

2. In assessing macroeconomic performance, it is important to be mindful of the difficult circumstances that prevailed for at least the past decade. A series of political crises took a severe toll, including on living standards as well as on the capacity to plan, implement, and monitor economic policies. Economic developments have also suffered intermittently from terms of trade shocks, with adverse impacts on the narrow export base and the capacity to service a very high external debt. Against this background, GDP per capita is estimated to have declined by some 1 percentage point per annum over the past decade; and performance as measured against several MDG indicators also deteriorated.

3. Important progress has been achieved under a Fund staff-monitored program (SMP) in 2005, even as economic activity was negatively affected by the surge in world oil prices and depressed vanilla prices. Particularly noteworthy reforms included the delineation of fiscal competencies and revenue-sharing arrangements between the union and island governments. These steps have facilitated some progress toward fiscal consolidation in 2005. Nevertheless, economic activity was hampered over the past two years by adverse developments in world commodity prices, notably for oil and vanilla. Against this background, we still expect a moderate rebound in real GDP growth to around 2½ percent in 2005—a growth rate that benefited from improved inter-island cooperation. Considerably faster growth would, however, be needed to achieve the MDGs. Inflation has remained fairly low, and looking ahead, it will be important that recent fuel price increases not spill over into broader cost and price pressures.

4. The external current account deficit (excluding transfers) is expected to widen significantly in 2005 in the wake of adverse shocks to world vanilla and oil prices. Aside from the adverse terms of trade shocks, the current account was also adversely affected by a weakening in competitiveness in recent years, related in part to the appreciation of the euro (to which the Comoros franc is tied). Nevertheless, foreign reserves are expected to remain broadly stable at their high level, benefiting from continued buoyancy in emigrant remittances in 2005.

5. Monetary and credit developments have reflected the fairly sluggish economic conditions as well as the particular problems in the vanilla sector. Private sector credit contracted in 2004-05, and the banking system has strived to limit its exposure to the troubled vanilla sector.

6. Adverse economic shocks, but also a lack of decisive policy actions, contributed to slippages vis-à-vis the authorities' budget targets during the first three quarters of 2005. The targets, which had been incorporated into the SMP, envisaged a considerable strengthening of the fiscal position, with the domestic fiscal balance (excluding interest payments) to move into surplus in 2005. However, a delay in implementing some reform steps led to considerable slippages in the early part of the year. Several quantitative program targets were also missed in June and again in September. Particularly noteworthy were large shortfalls on domestic revenues as well as persistent overruns on the public sector wage bill. Taken together, these slippages have crowded out spending on health, education and in other priority areas, which are not expected to increase during 2005, as intended.

7. The government took measures to strengthen revenue collection and control public spending. The measures included, on the expenditure side, an initial package of wage reduction measures in July. In addition, the government drastically cut outlays on goods and services—an appropriate emergency measure, but not sustainable and some of the related spending needs will have to be addressed in 2006. On the revenue side, the government increased the price of fuel products in September to restore eroded tax margins (an increase that was partially reversed in November). Following social unrest after the initial fuel price increase, customs duties were reduced on essential foodstuffs, with the revenue effects limited by concurrent increases in taxes on luxury items.

8. The government's adjustment steps should contribute to a considerable strengthening of fiscal performance in the last quarter of 2005. While the original full-year targets under the SMP have become unattainable, the measures should result in marked improvements, notably for revenues, in the fourth quarter. Importantly, the expected fiscal outturn for 2005 would represent a significant improvement vis-à-vis 2004, with the domestic primary balance moving into surplus.

9. On structural reforms, there has been some progress but also important delays, especially in areas that could foster private sector development. Notable progress was made in the fiscal area with the assignment of responsibilities between union and island institutions, noted above; and also with the identification of cross-debts of public entities and with steps toward introducing a new nomenclature for the fiscal accounts. On the other hand, the envisaged privatization of two parastatals (Comores-Telecom and Société Comorienne des Hydrocarbures (SCH)) remains outstanding, reflecting in part a lack of external assistance but also a lack of domestic reform momentum. Preparations for customs reforms are also taking longer than originally envisaged.

Strategy (I-GPRS)

10. The completion of the I-GPRS was a significant accomplishment and should facilitate concrete steps to strengthen growth and reduce poverty. The document benefited from extensive consultations on the three islands at the community level, and the extensive participatory process is likely to benefit future policy measures. The strategy defines clear objectives, highlights priorities, and is underpinned by a broadly appropriate macroeconomic framework. The I-GPRS is complemented by an action plan for 2006-09, which focuses on seven strategic pillars. It could serve as a catalyst for civil society's participation in social development and, starting with this roundtable, for Comoros's foreign partners to assist with financial and technical support.

11. Looking ahead, it will be important to establish immediate priorities among the many objectives, taking into account potential social benefits and capacity constraints. Concerning capacity constraints, there is an urgent need to improve public expenditure management; among others, this should include steps that would allow the tracking of priority-sector spending. The decentralized setting provides also particular challenges in the statistical and accounting arrears and for expenditure control, and foreign support and domestic engagement could jointly help addressing these challenges.

IV. Near-Term Strategy And Economic Outlook

12. The I-GPRS provides a framework that is also expected to guide short-term policy priorities. Accordingly, the 2006 budget priorities discussed with the authorities in recent days envisage further progress toward macroeconomic stabilization, while making room for some clearance of arrears and for an increase in social and capital expenditures.

13. Concerning macroeconomic prospects for 2006, we broadly share the government's assessment—provided that policy implementation proceeds as currently envisaged. On the basis of ongoing political progress, rising donor support, and fairly good prospects for the tourism sector, real GDP growth could strengthen to above 3 percent and the large external current account deficit is expected to decline gradually. Moreover, slower world oil price increases are expected to help maintaining the fairly low inflation rate.

14. The 2006 budget priorities, which the authorities presented to a visiting Fund mission last week, strike a broadly appropriate balance between fiscal stabilization and meeting the government's development objectives. Consistent with the government's macroeconomic objectives, the budget envisages a domestic primary surplus of around 1 percent of GDP, a further improvement from the underlying small surplus expected for 2005. At the same time, allocations for priority sectors would rise, with, for example, much-needed capital spending set to almost double to above 7 percent of GDP—if foreign financing in line with the I-GPRS became available. In addition, the budget allocates resources for the partial clearance of wage arrears. It will be important that these arrears be settled only after they have been verified and that the arrears clearance strategy is consistent with the implementation of other priority programs of the government without jeopardizing fiscal stability. Consistent with earlier technical assistance advice by the Fund, the budget also envisages significant trade-supporting tax reforms, notably a reduction in customs duties in conjunction with an increase in some domestic taxes.

15. The main risks to achieving the fiscal objectives relate, aside from financing issues (see below), to the domestic revenue and wage bill targets. The civil service is excessively large, with the wage bill absorbing some 60 percent of domestic revenue, and sizable salary arrears have persisted for several years and are not clearly accounted for. Despite the difficult measures taken by the government in July, the costs associated with the civil service would, absent major retrenchments, continue to prevent the much-needed increase in social expenditures. The latter could also be jeopardized if envisaged revenue measures proved difficult to implement or were not to yield their ambitious budgeted results.

16. Full financing of the 2006 budget has not yet been identified. Discussions with the authorities point to a financing gap equivalent to about US$7.6 million (1.9 percent of GDP). The gap takes into account that domestic financing possibilities are very limited, not least in view of the need to safeguard the exchange rate arrangement.

V. IMF Involvement in the Period Ahead

17. In view of the mixed performance to date under the SMP, additional time is likely to be needed before entering into an arrangement under the Fund's Poverty Reduction and Growth Facility (PRGF). We intend to review the end-December 2005 outcome and recent policy reforms early next year, and would then consider the options for the way forward. We are hopeful that the review will confirm a marked improvement in fiscal performance in the fourth quarter of 2005, which would be a first step toward establishing the needed track record for entering into a PRGF arrangement. In any case, the Fund staff will remain closely engaged with the authorities in the context of both ongoing policy advice and technical assistance.

18. We note that the authorities remain strongly committed to the policy reforms that could open the door for future debt relief. It will be important that progress be sufficiently deep and rapid so that the Union of Comoros can enter into a PRGF arrangement before end-2006, when the sunset clause sets in for the enhanced Heavily Indebted Poor Countries (HIPC) Initiative. Thereafter, the Union of Comoros could also benefit from substantial debt relief under the Multilateral Debt Relief Initiative (MDRI).

VI. External Financing Requirements

19. As indicated above, donor support of at least US$7.6 million would be needed to fill the financing gap expected for 2006; and an urgent need for donor financing of some US$4.6 million remains for 2005, if a further net accumulation of wage arrears is to be avoided. For 2006, the financing gap is in addition to some US$27.7 million already incorporated into the budget—a sizable increase vis-à-vis 2005, as the authorities are pursuing a forceful start toward achieving their I-GRSP objectives and progressing toward the MDGs. In light of a clearly unsustainable debt burden, successful implementation will require extending additional donor support on concessional terms, preferably in the form of grants. While eventual debt relief could provide some of these resources, larger and more predictable donor support would be critical for meeting the rightfully ambitious development aspirations of the Union of Comoros.


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