For more information, see Cape Verde and the IMF
Praia, April 26, 1999Mr. Michel Camdessus
International Monetary Fund
Washington, D.C. 20431
Dear Mr. Camdessus:
1. On behalf of the government of Cape Verde, I have the honor to transmit to you the attached memorandum of economic and financial policies (MEFP). It outlines the progress made in 1998 in executing Cape Verde's economic adjustment program, supported by a Stand-By Arrangement from the International Monetary Fund, and presents the government's economic and financial policies and objectives for 1999. In support of the program, the government requests an extension of the present arrangement which expires on May 30, 1999 to December 31, 1999; it also requests that the size of the arrangement be increased from SDR 2.100,000 to SDR 2,496,000 (26 percent of quota), taking into account the quota increase and in order to have an additional cushion in case of need.
2. As noted in the MEFP, three performance criteria for end-December 1998 could not be met; these concern the approval of the legislation for privatizing the shipyard company Cabmar/Cabnave, the net domestic assets of the central bank, and the continuous performance criterion on the nonaccumulation of external payments arrears; the latter has not been met because of continued delays, through March 1999, in meeting requests of foreign exchange for transfers abroad in respect of current transactions. This is due in part to a postponement in the disbursement of external assistance expected in 1998. The government is requesting a waiver for nonobservance of these criteria, for the reasons set forth in the MEFP. The exchange restriction resulting from the obligation to constitute a deposit with banks at the time a transfer abroad is requested was eliminated at end-1998.
3. The MEFP sets forth the legislative and regulatory measures adopted in the area of exchange regulations to enable Cape Verde to satisfy its obligations under Article VIII of the Fund's Articles of Agreement. With the disbursements of foreign aid in March 1999, it was possible by mid-April 1999 to eliminate the delays in transfers abroad in respect of current transactions. The authorities will make sure that these delays do not recur in the future. The government therefore expect to be in a position shortly to accept the obligations of Article VIII.
4. The government believes that the policies and measures described in the MEFP are sufficient to achieve the program objectives. It will provide the Fund with any information requested regarding program execution and will take any additional measures that may be necessary to achieve the program objectives.
5. The Fund will conduct with the government of Cape Verde the third review of the program, to be completed no later than end-November 1999.
António Gualberto do Rosário
Vice Prime Minister
Attachment: Memorandum of Economic and Financial Policies
April 26, 1999
1. With a view to restoring the conditions for sustainable economic growth in the context of the 1997-2000 National Development Plan, the government of Cape Verde adopted in 1998 an adjustment program covering the period 1998-2000, in support of which the International Monetary Fund approved a 14-month Stand-By Arrangement on February 20, 1998.1 The 1998 program aimed at establishing a sound macroeconomic framework, including prudent budgetary and monetary policies to support the exchange rate peg and a comprehensive domestic debt-reduction operation, funded by external assistance and privatization revenue.
2. With the domestic debt amounting to the equivalent of US$180 million, the debt-reduction operation was designed to take place through the establishment of a Trust Fund, which is to be the beneficiary of resources disbursed by external donors and lenders (US$100 million) and of privatization receipts (US$80 million). In order to avoid the injection of excessive liquidity into the economy, it has been decided that existing government debt obligations will be exchanged for newly issued consolidated financial mobilization securities (TCMFs), denominated in Cape Verde escudos (CV Esc), to be remunerated out of trust fund revenues. In the medium term, the Treasury envisages to redeem these securities as fiscal and monetary conditions permit.
3. Trust Fund resources were initially expected to reach US$95 million in 1998, so as to allow domestic debt-service savings of close to CVEsc 0.4 billion. The balance of Trust Fund contributions (US$85 million) was expected to be received during 1999-2000. In the event, disbursements were delayed, thus requiring for the authorities to postpone the debt conversion operation until 1999 and to tighten the budgetary stance in the second half of 1998.
4. As a result, in consultation with the International Monetary Fund, during the July 1998 midterm review discussions the government of Cape Verde updated certain aspects of its financial program pertaining to the second half of 1998, while confirming its commitment to the basic objectives of the initial program, in particular the absence of any bank financing of the central government. On the expenditure side, the outlays for domestic debt interest payments were revised upward, while savings equivalent to about 0.5 percent of GDP were made in the investment budget and in primary current spending.
5. Data available in early 1999 indicate that Cape Verde's economic and financial program has, for the most part, been executed in accordance with government commitments. Provisional estimates show that Cape Verde's economic growth rate in 1998 was about 5.2 percent2 (against a programmed 4 percent). Growth was fueled by the expansion of tourism, and the entry into production of new industrial units; in contrast, agricultural production was seriously affected by the severe lack of rain, especially in some of the islands, which, in turn, negatively affected the income level of the most disadvantaged groups. Average annual inflation in 1998 was limited to 4.3 percent (against 8.5 percent in 1997), reflecting the tightening of fiscal policy. During the first three months of 1999, the consumer-price index decreased by one percent, which is the result of a more flexible import system for staple foods and the continuation of prudent fiscal policies.
6. The 1998 budgetary outturn was better than anticipated in the revised program, both in terms of revenue and expenditure. The current budgetary surplus was higher than expected (1.9 percent of GDP against an expected 1.3 percent), and the current primary surplus (excluding foreign-financed investment expenditure) reached 4 percent of GDP, against a programmed 3.6 percent. The revenue target, equivalent to 23.7 percent of revised GDP, was exceeded by 0.3 percentage. Current primary expenditure was less than in the revised program (18.1 percent of GDP, versus 18.7 percent of GDP programmed). While spending on personnel was slightly higher than expected because of the cost of the voluntary departure operation, which involved 280 civil servants, outlays on goods and services were kept below the program target. In contrast, debt interest charges on domestic debt were greater than programmed, by approximately 0.4 percent of GDP. Capital expenditures, which are largely financed from abroad, were significantly lower than programmed (17.1 percent of GDP, against 21.2 percent of GDP in the revised program). However, the domestic contribution to investment was slightly higher than anticipated in the revised program, by 0.3 percent of GDP. Since revenue exceeded the targets, this upward adjustment is consistent with understandings in the program. The government ended the previous system of prefinancing donor-financed investment projects with domestic resources, which had been the primary cause of the accumulation of domestic debt. The overall budget deficit, including grants, was limited to 4.3 percent of GDP, against a programmed deficit of 7.3 percent of revised GDP. As envisaged in the program, there was no recourse to bank financing by the central government.
7. The program envisaged that the targeted reduction of the external current account deficit and the strengthening of the exchange reserves would be achieved through a strong growth of exports, with emigrant transfers remaining stable and external financing increasing. At end-March 1998, when it was announced that the domestic currency exchange rate would be pegged to the Portuguese escudo, effective July 5, 1998, the exchange rate was devalued by close to 6 percent vis-ŕ-vis the basket of currencies. Portugal supported the new exchange policy by granting Cape Verde a line of credit up to a maximum of US$50 million. Despite the exchange rate adjustment, provisional balance of payments data indicate a weakening of exports, mainly owing to a decline in fishing revenue and in reexports of fuel oil, as well as the temporary cessation of activity in certain industrial units, which resumed their activity at end-1998. The services balance worsened, although revenue from tourism continued to increase at a rapid pace; this rise was offset by higher ship-chartering costs and increased outlays for travel, port, and airport services. Workers' remittances increased markedly, reflecting the return of confidence and a vigorous competition among banks to attract these funds. In all, the current balance of payments deficit, excluding official transfers, amounted to 16.6 percent of GDP, as against 17.5 percent in 1997 and the 14.3 percent envisaged in the program. Net external assets of the banking system remained broadly stable (against a programmed decrease of US$4 million, including the aforementioned reduction in commercial arrears), as a decline in Bank of Cape Verde reserves was offset by an increase in net external assets of the commercial banks. The change in the net external assets of the banking system reflects, inter alia, the amount of net trade-related credit received by residents, which remained broadly stable throughout the year, according to provisional estimates.
8. The amount of non-executed requests for transfers abroad on account of current transactions, which had already emerged in 1995, increased in the first half of 1998, reaching US$38 million by June 1998. In order to contain such nonexecuted requests, the authorities required, effective September 1998, the lodging of a correspondent deposit in domestic currency. Nonexecuted requests, which constitute a de facto exchange restriction, were to be eliminated by end-1998 as a structural benchmark. This benchmark was not met, as the amount of payments outstanding was still US$8.5 million at end-1998. This is due, in part, to delays in the disbursement of external assistance expected in 1998. The authorities are requesting a waiver of the obligation not to accumulate external payments arrears, taking into account that they have eliminated nonexecuted payment orders in mid-April 1999, owing to disbursements obtained from the European Union (US$5 million) and a drawing on the line of credit granted by the government of Portugal. Moreover, as of January 1, 1999, they eliminated the exchange restriction represented by the obligation to constitute a domestic bank deposit when requesting transfers abroad.
9. In order to liberalize external transactions, the government has decided to take all necessary measures to ensure full domestic currency convertibility for current transactions and for a certain number of capital transactions. To this end, the exchange legislation has been amended, with the adoption of Decree Laws 25/98 and 26/98 on June 29, 1998 and with the central bank's adoption of implementing regulations 2/1998 and 4/1998 in July and December 1998; the latter concern the increase in travel allowances and the list of capital transactions subject to prior authorization and/or prior verification by the central bank. The authorities have made a substantial effort to reduce--during the second half of 1998--the delays in transfer of foreign exchange for current transactions. With the elimination of non-executed the transfer requests in April 1999, the only remaining restriction is the limit on travel allowances. The government plans to eliminate this restriction before end-June 1999. Cape Verde will thus be in a position to accept the obligations of Article VIII of the Fund's Articles of Agreement.
10. Monetary policy was tightened in the second half of 1998 to contain the excessive expansion of credit to the private sector observed in the first half of the year (12.6 percent on an annual basis). During the year, credit to the economy increased by 11.9 percent (against the 10.5 percent envisaged) as a result, in particular, of a strong demand for construction loans. Money supply grew by 1.8 percent in 1998 (against the 6 percent programmed). Taking into account the stability of net external assets of the banking system and net credit to the government, the overall increase in the capital and reserves of commercial banks was an important factor in the moderation of money supply growth. Net domestic assets of the Bank of Cape Verde increased, contrary to the program, because of a decline in government project-related deposits, which are linked to the pace of project execution, and a year-end increase in the amount of operations to be regularized, which were cleared in early January 1999. Consequently, the performance criterion with respect to this aggregate was not met, for which the authorities are requesting a waiver.
11. A decree law eliminating all quantitative import restrictions and replacing them with tariff protection was adopted at end-1998. The revised customs tariff came into force on January 1, 1999, providing tariff protection on the order of 50 percent for certain domestically produced sensitive goods. The government has undertaken not to introduce any new quantitative restrictions. The government is aware that this high level of protection should be maintained only temporarily; it has requested assistance from the Fund's Fiscal Affairs Department to review the entire external tariff structure and make recommendations toward its simplification.
12. Structural improvements have been made in government finance management including, in particular, the adoption of a new organic budget law approved in December 1998, which defines the principles of budgetary unity, the presentation of current expenditure and investment, as well as the procedures for monitoring budget execution. The implementation of these reforms, together with the overhaul of public accounting and strengthening of the management of the public investment program, benefits from technical assistance by the World Bank and the IMF; additional improvements in budgetary management are scheduled for 1999. All structural benchmarks through end-December 1998 were met, including the publication of revised national accounts, with the exception of the elimination of nonexecuted requests for transfers abroad on account of current transactions, which should have taken place by December 31, 1998 at the latest. The structural performance criterion on the government's adoption of the legislation for privatizing the shipyard company, Cabmar/Cabnave, and the electricity company, Electra, by end-December 1998 was only partly met, as the legislation for the former enterprise was delayed until 1999 because of the need to adhere to procedures agreed with the World Bank; it is now expected that the legislation--also including the ports--will be adopted by end-November 1999, given the complexity of this privatization and the requirement to define the terms of agreement for port concessions.
13. Regarding public enterprise reform, the Accelerated Privatization Program (APP), prepared in consultation with the World Bank, provides for the full or partial privatization of 17 public enterprises between 1998 and 2000, including two banks, the insurance company, the airline, the food import and distribution company, the beverage-manufacturing companies and the energy company. Although the privatization program has been progressing satisfactorily in 1998, on the whole, it has experienced some delays, which have been agreed with the World Bank in order to ensure compliance with the relevant procedures. Thus, certain sales originally scheduled for 1998 have been shifted to the first half of 1999. During the first four months of 1999, invitations to tender were launched for the two commercial banks (BCA and CECV), the insurance company (GARANTIA), and the venture-capital firm (PROMOTORA). The preselection process of potential investors for the power station (ELECTRA) has also been concluded.
14. In 1998, the National Institute of Statistics (INE) strengthened its role of coordinating the preparation of economic statistics, particularly with respect to relations with the central bank and the Ministry of Finance. Significant improvement was made in the ability to prepare the national accounts, in final and provisional forms; the INS is planning to publish the provisional 1997 and 1998 national accounts during 1999. Improvements have also been made in the preparation of the balance of payments, although the increasingly complex economy requires a more comprehensive effort, especially in compiling data from the services sector.
15. The financial objectives for 1999 remain those established in the 1998-99 program, supported by the Stand-By Arrangement with the Fund. In particular, the government will not make any recourse to domestic bank credit, and monetary and budgetary policy will remain prudent, so as to be consistent with the peg of the Cape Verde escudo and the strengthening of the official reserves.
16. The prospects for GDP growth in 1999 are favorable; growth is expected to reach about 6 percent in real terms, with an average inflation rate of some 3 percent. The rise in GDP should be sustained by continued foreign direct investment, increased industrial production, expansion of tourism and services, and a sizable volume of public investment, financed mainly by concessional foreign loans and grants. On a national accounts basis, gross fixed capital formation is projected to increase from 40 percent of GDP in 1998 to about 42.6 percent in 1999 as a result of increased public and private investment. Private sector domestic savings is expected to increase, and to be accompanied by stable public saving; thus, total domestic savings is projected to rise from 8.3 percent of GDP in 1998 to 11.1 percent of GDP in 1999; national saving, boosted by workers' remittances, is projected to rise from 23.5 percent of GDP in 1998 to 26 percent in 1999.
17. Regarding the balance of payments, an upturn is expected in 1999 in exports of goods and services, as a result of the large private investment in the manufacturing sector and the continued growth of tourism and other services. Imports of consumer goods are projected to remain at a moderate level, while those linked to foreign private investment (tourism and the manufacturing sectors) are expected to increase more rapidly. In value terms, total imports are expected to increase by 12 percent in 1999. With a rapid growth of tourism receipts, reflecting sizable investment under way, the current account deficit, excluding official transfers, is projected to decline from 16.6 percent of GDP in 1998 to 16.3 percent in 1999 and to 15.7 percent in 2000. Taking into account expected disbursements of loans and grants related to the investment program, debt amortization, and private investment, the official reserves of the central bank are expected to increase by approximately US$6 million in 1999 and by about US$8 million in 2000, reaching the equivalent of three months of imports. Debt service payments arrears to Brazil, amounting to US$7.3 million, are being cleared through a concessional rescheduling agreement, which is to be signed shortly, and which includes cancellation of two-thirds of the debt. As for debt-service arrears to Spain (equivalent to US$6.5 million), the government has requested a conversion of this amount into a contribution to the Trust Fund.
18. The 1999 government budget envisages that revenue will increase significantly, to reach the equivalent of 24.4 percent of GDP (as against 24.0 percent in 1998). This reflects, in particular, the expected strong performance of corporate income tax on account of (I) the end of the exemption period for several enterprises in the manufacturing and tourism sectors, (ii) improved monitoring of taxpayers subject to the simplified reporting system, (iii) faster recovery of tax arrears. Customs revenue is projected to increase by 13 percent, reflecting the introduction of higher tariff rates for certain products. Primary current expenditures are projected to increase from 18.1 percent of GDP in 1998 to 19.4 percent in 1999, while interest expenditure should decline markedly (from 3.9 percent of GDP in 1998 to 2.1 percent in 1999) as a result of the operation under way to convert the domestic debt into securities remunerated out of revenues from the Trust Fund. In all, the current budgetary surplus is expected to increase from 1.9 percent of GDP in 1998 to 2.9 percent in 1999. The wage bill (presented in the budget on a new basis including wage costs for the autonomous funds, the Office of the Presidency, and the National Assembly, previously recorded as transfers) is budgeted to increase by 15 percent; this reflects recruitments in the education and health sectors, the increase in the employers' retirement contributions, and an increase of 3.8 percent in the basic wage, effective January 1, 1999. The latter was agreed with the labor unions to take account of anticipated inflation (3 percent) and to compensate for the difference (0.8 percent) between 1998 inflation and that year's wages.
19. Public investment expenditure for 1999, which constitutes the annual tranche of the 1998-2000 program, will be covered up to CVEsc 900 million by domestic budgetary resources (1.7 percent of GDP, against 2 percent in 1998). In the budget, the external contribution to investment financing was estimated at CVEsc 9 billion; taking into account a likely execution rate of approximately 90 percent, this amount would be reduced to CVEsc 8.1 billion, equivalent to 15.4 percent of GDP, with total public investment reaching 17.1 percent of GDP. The external investment financing would comprise grants in an amount of CVEsc 5.2 billion, and highly concessional external loans n an amount of CVEsc 3.9 bil lion. The investment program accords priority to strengthening the education system, particularly at the secondary level, to improving the health sector, and to developing maritime transportation and infrastructure. An emergency labor-intensive public works program aimed at creating jobs in the areas most affected by the 1998 drought was initiated in January 1999. The maximum envelope of this program is set at CVEsc 1.5 billion (2.9 percent of GDP), of which at least CVEsc 200 million is to be financed by external donors. With normal levels of precipitation, the program will be reduced by a significant amount. There is also some uncertainty concerning the execution rate of the different municipalities, which could further reduce the program's expenditures. Taking into account these factors, the related expenditures financed with internal resources are expected to amount to about CVEsc 1.1 billion. The rate of program execution will be evaluated during the next review. The internal resources for program execution will come from CVEsc-denominated privatization revenues, which will be channeled to the Special Stabilization and Development Fund (FEED); in turn, the treasury will borrow from the FEED the resources needed for executing the public work program.
20. The resources of the Trust Fund are expected to reach the equivalent of US$39 million by end-March 1999, and US$73 million by end-June, as a result of disbursements expected from the World Bank, the European Union, and some bilateral donors significant. Privatization receipts earmarked for the Trust Fund are expected the second half of the year, as a result of the sale of two banks, a venture-capital company, the electricity company, and the main insurance company. The revenue from these privatizations could reach to be about US$50 million. With the sales foreseen in 2000--the ports, the shipyards, the power station, the national airline, and the stage marketing company--the total privatization receipts in 1999-2000 will reach approximately US$80 million, or 16 percent of GDP. On this basis, the government has decided to start swapping the existing domestic debt for TCMFs, with a first tranche in May-June and a second in the third quarter of 1999. In May-June an amount of securities equivalent to CVEsc 3.9 billion will be converted, plus an amount of CVEsc 5 billion held by the central bank. In the third quarter of the year, an additional amount equivalent to CVEsc 5 billion will be swapped. Short-term securities, amounting to CVEsc 4 billion will not be swapped before 2000; for these securities an active secondary market exists. As a result of these conversions, interest charges on domestic debt will be contained to CVEsc 700 million in 1999, or 1.6 percent of GDP less than in 1998; these charges will be covered mainly by revenue from the Trust Fund. The remainder is being covered by an additional bridge loan drawing from Portugal. The authorities will examine the technical modalities for establishing a secondary market in TCMFs, which will be traded initially among the banks; subsequently, the market will be expanded to include nonbank investors.
21. The government will continue to strengthen budgetary procedures by introducing a centralized monitoring mechanism of budget execution. A new government accounting system is under preparation; to this end, a new computer network will be put in place in 1999 for real-time monitoring of all revenue and expenditure operations, including at a decentralized level. This reform benefits from technical assistance from the Fund, the World Bank, and Portugal.
22. Improving the efficiency of the customs and tax administration and modernizing the tax system remain key government objectives. In addition to simplifying the customs tariff, as mentioned previously, a priority is the preparation of the value-added tax, which is expected to enter into force at the beginning of 2001. To this end, the government has requested technical assistance from the Fund's Fiscal Affairs Department. The budget, customs, and tax directorate computer systems have been made year 2000 compatible.
23. The government intends to reduce gradually the maximum customs tariff, in the context of a modernization and cost-reduction program discussed and agreed with domestic manufacturers supplying the local markets, particularly those in the detergents, beer, medicine, and furniture sectors. These enterprises had been established with the purpose of import substitution during the period before the country's process of trade liberalization, and have traditionally enjoyed significant protection. The tariff reduction will be discussed with the experts from the IMF's Fiscal Affairs Department (FAD) in 1999 in the context of tariff simplification and the introduction of the VAT in 2001. On the basis of FAD's recommendations, specific decisions will be made on the reduction of tariff rates to be phased over a number of years.
24. Monetary policy in 1999 will continue to be guided by the objective of maintaining domestic demand in line with available resources in an environment of stable prices, and strengthening the net external assets of the banking system and the central bank's official reserves. As part of its strategy to make recourse to indirect monetary policy instruments, the central bank has eliminated bank-by-bank credit ceilings, effective January 1, 1999, replacing them with enhanced monitoring of banking developments. The central bank is planning to control bank liquidity--in addition to using the reserve requirement--by issuing short-term securities that will be tradable among financial institutions. The central bank has strengthened the supervision of and the prudential controls on banks through more frequent on-site inspections; the largest bank's nonperforming loans declined sharply in 1998 as a result of intensified loan recovery efforts implemented after a central bank inspection.
25. Major improvements are under way in the payments system, as part of a World Bank-supported project; each bank's data communication network was upgraded, so as to permit transfers between branches and headquarters in real time and provide reliable centralized accounting. A second phase, to be completed in 1999, will allow for electronic transfers among banks, and for the establishment of an electronic clearing system between banks and the central bank; it will also support the introduction of debit and credit cards. The banking system was integrated into the SWIFT international payments system, effective end-January 1999.
26. The monetary program for 1999 assumes growth in credit to the economy of approximately 12 percent, and no increase in net bank credit to the central government; the anticipated growth of net external assets of the banking system (3 percent of beginning-of-period money stock) is consistent with a growth of the money stock of about 6.5 percent. Performance criteria for end-April 1999 have been established during the review discussions, and are shown in the attached table. Quantitative targets for end-June, end-September, and end-December 1999 have also been established for net bank credit to the central government, excluding changes in project-related deposits, net domestic assets of the central bank, and net external assets of the banking system. The targets for end-June and end-September 1999 constitute performance criteria; the targets for end-December 1999 constitute indicators of program execution.
27. Strengthening the private sector is one of the key objectives of the government's overall strategy. To this end, key actions involve strengthening the regulatory and judicial system and the services that support the private sector (the Chamber of Commerce and the Export Promotion Agency, PROMEX); streamlining tax concessions; establishing a stock exchange in Praia, which should begin operation in the first half of 1999; and improving financial intermediation, as a result of the more efficient new payments system. These actions are being implemented with the assistance from the World Bank and other donors.
28. In addition to the quarterly performance criteria for end-June, end-September, and end-December 1999, additional performance criteria, to be observed on a continuous basis, are constituted by the nonaccumulation of new external arrears, with the exception of those incurred pending rescheduling discussions; and no contracting or guaranteeing by the government of external loans on nonconcessional terms, with the exception of normal short-term trade financing. The following measures will constitute structural performance criteria: (a) the adoption by the government of legislation authorizing the privatization of the ports, Cabmar/Cabnave, and TACV before end-November 1999; (b) the conversion in TCMFs of government securities equivalent to CVEsc 8.9 billion as a minimum before end-June 1999; and (c) conversion of such securities equivalent to a cumulative minimum of CVEsc 1.39 billion before end-September 1999.
29. The third review of the program will take place before end-November 1999. It will focus on program execution during 1999, and on the budget for the year 2000.
1The medium-term strategy is present in the memorandum attached to my letter of January 30, 1998.
2GDP estimates were revised upward for 1994-96, following the publication of a new series of national accounts up to 1996. In particular, 1996 GDP was revised upward by 16 percent. GDP for 1998 was estimated provisionally at CVEsc 48.7 billion, against CVEsc 43 billion envisaged in the program. The ratios indicated in this document refer to the new data.