Republic of Madagascar and the IMF

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MadagascarLetter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding

Antananarivo, December 4, 2002

The following item is a Letter of Intent of the government of Madagascar, which describes the policies that Madagascar intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Madagascar, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

Use the free Adobe Acrobat Reader to view Tables 1-4.

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Köhler:

1. The attached Memorandum on Economic and Financial Policies describes the policies and measures that the government of Madagascar has adopted and pursued since July 2002, in the wake of the severe political crisis that affected the country in the first half of this year, and describes in detail Madagascar's economic and financial policy for the remainder of this year and for 2003. The government requests that this document serves as the basis for the Fund's completion of the second review under the Poverty Reduction and Growth Facility (PRGF) approved on March 1, 2001. The government requests a waiver for nonobservance of the performance criteria for end-December 2001 regarding the net domestic assets of the central bank, net domestic financing of the government, and fiscal revenue, in view of the steps the government has taken since June to strengthen fiscal management and establish principles of good governance at all levels, which we believe are key to establishing a strong foundation for growth. The government also requests a waiver for the accumulation of payments arrears on the external debt in early 2002, owing to the freeze of external reserves of the central bank; these arrears have been settled in June-July, as soon as the reserves were released.

2. Given the interruption in the implementation of the PRGF-supported program during the first half of 2002, the government of Madagascar requests that the arrangement be extended through end-November 2004. The third review of the arrangement is expected to be completed by end-May 2003, with subsequent reviews occurring every six months. The government of Madagascar will continue to provide the Fund with any information deemed necessary to monitor program implementation.

3. The government wishes to request additional interim assistance under the enhanced HIPC Initiative for the period January 1, 2003-December 31, 2003.

4. The government of Madagascar believes that the policies described in the attached Memorandum are sufficient to achieve the program objectives, but is prepared to take any additional steps that may become necessary to achieve these objectives.

Sincerely yours,

Benjamin Andriamparany Radavidson
Minister of Economy, Finance, and the Budget


Memorandum on Economic and Financial Policies for 2002-2003

December 4, 2002

I. Introduction and Economic and Financial Developments in 2001

1. For several years, Madagascar has been implementing a program of macroeconomic and structural reforms aimed at restoring domestic and external viability, boosting growth, and reducing poverty. After achieving favorable results in terms of growth and reduction of domestic and external imbalances in the 1997-2000 period, the authorities adopted a medium-term economic and financial program supported by a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF). Following the first review in December 2001, the implementation of the program was interrupted by a serious political crisis. With the resolution of the crisis in July 2002, the new government began a recovery effort, with donors assistance, within a revamped framework of good governance and enhanced participation, bolstered by reforms designed to accelerate the process of growth and poverty reduction.

2. The economic and financial program for 2001 yielded satisfactory macroeconomic results. Real GDP growth reached 6 percent, following an average growth rate of 4.2 percent in the preceding four years. The year-on-year inflation rate, measured by the consumer price index (CPI), fell to 4.8 percent at end-2001. The external current account deficit (including official transfers) fell from 5.6 percent of GDP in 2000 to 1.3 percent of GDP in 2001, owing to a 20 percent export growth in SDR terms, including a sharp rise in traditional exports and a twofold increase in the Export Processing Zone's (EPZ) exports, which were boosted by the entry into force of the U.S. African Growth and Opportunity Act (AGOA) in early 2001. The central bank's external reserves increased from the equivalent of 10.2 weeks of imports of goods and services at end-2000 to 14.4 weeks at end-2001, substantially exceeding program targets.

3. Despite favorable results in terms of growth, revenue developments in 2001 were disappointing, especially in the second half of the year. In particular, fiscal revenue in 2001 amounted to only 10 percent of GDP (FMG 3,029 billion) in contrast to the program target of 11.9 percent of GDP. The shortfall was mainly due to customs revenue, and can be attributed to the impact on custom revenue of the unexpected appreciation of the Malagasy franc, administrative weaknesses especially in secondary ports, identified frauds with an estimated cost of FMG 60 billion in lost revenue ( 0.2 percent of GDP), and to the poor performance of the tax receipts on petroleum products (FMG 272 billion instead of the projected FMG 443 billion).

4. On the expenditure side, current spending on goods and services exceeded program projections by FMG 34 billion (0.1 percent of GDP), entirely on account of expenditure through the presidential special funds (FMG 171 billion instead of the projected FMG 2.8 billion); other current spending (other than HIPC initiative financed) remained below budget by FMG 90 billion, while the priority HIPC-financed current expenditure were below budget by FMG 44 billion (FMG 82 billion executed as against FMG 126 billion programmed). However, both the domestically- and externally- financed components of capital expenditure remained well below the projections, with total capital expenditures reaching FMG 2,181 billion (7.2 percent of GDP) instead of the projected FMG 2,995 billion (10 percent of GDP). Consequently, the budget deficit (on a commitment basis, and excluding grants), despite having widened from 6.4 percent of GDP in 2000 to 8.1 percent of GDP in 2001, remained below the programmed amount.

5. With regard to expenditure for structural reforms, in 2001 an appropriation of FMG 100 billion for petroleum product subsidies was used to help SOLIMA pay customs duties (FMG 50 billion) and domestic VAT (FMG 15 billion) and to repay a portion of the central bank (BCM) advances for petroleum purchases (FMG 35 billion). Despite this subsidy, SOLIMA's debt to the BCM continued to grow in 2001, allowing the company to reduce its debt toward private suppliers; this debt amounts at present to US$51 million. An audit of the accounts of SOLIMA for 2000 and 2001 is under way (see para 29). Privatization receipts fell below the revised estimates (FMG 104 billion instead of FMG 200 billion), because of lower than expected receipts from the sale of SOLIMA storage facilities and service stations.

6. The reduction of domestic arrears in 2001 amounted to FMG 27 billion instead of the FMG 115 billion programmed. At December 31, 2001, payments outstanding at the treasury totaled FMG 424 billion (1.4 percent of GDP) and VAT credits refunds payable by the government amounted to FMG 70 billion, including FMG 28 billion due to EPZ companies. Owing to the shortfall in revenue, privatization receipts, and external budgetary support (SDR 50 million, or 1.4 percent of GDP), the government's domestic borrowing in 2001 was larger than programmed by the equivalent of 0.7 percent of GDP (FMG 658 billion compared with FMG 452 billion programmed).

7. All the performance criteria and quantitative benchmarks for end-March, end-June, and end-September 2001 were met, with the exception of fiscal revenue for each period. The following performance criteria for end-December 2001 were not met: net domestic assets of the central bank, as its advances to SOLIMA were not repaid as expected; domestic financing of the government, partly on account of a large shortfall in external assistance; and fiscal revenue for the reasons indicated above. However, the performance criterion pertaining to the net foreign assets of the central bank was met by a sizable margin. All of the 2001 structural performance criteria and benchmarks were met, with the exception of the benchmark concerning the entry in operation of the customs software system ASYCUDA 3++, which was delayed because technical assistance was not received in time (Tables 1 and 2, attached).

II. Economic Developments in the First Part of 2002

8. The crisis triggered by the presidential elections of December 2001 brought the economy to a standstill, as the country was divided by roadblocks until end-June. Prices skyrocketed in the first six months of 2002 as a result of shortages of oil, electricity, and certain essential goods, and the blockade of the country's interior severely hampered production in the EPZ and in the secondary and tertiary sectors; some 80,000 workers were temporarily laid off. Tourism ground to a complete halt. The international reserves of the central bank were frozen from March to July by key depository institutions, leading to the closure of the interbank foreign exchange market. According to surveys of the EPZ, industrial production declined by about 80 percent in the first six months of 2002 compared with the same period in 2001; the latest full-year estimates for 2002 indicate that real GDP could fall by about 12 percent. Between December 2001 and May 2002 the consumer price index rose by 21 percent, reflecting a surge in transportation and food prices. When fuel again became available in June, prices started to fall. From May to September, the CPI declined by 6.2 percent; by December, inflation on a year-on-year basis is projected to decline to 12 percent, whereas the GDP deflator is projected to rise in 2002 by about 15 percent. The crisis has brought about an increase in poverty, a sharp fall in school enrollment and in the use of basic health services. To counter these trends, the government has adopted specific measures in September (see para. 18). Donors have intervened with additional humanitarian aid, in particular with free distribution of medicines.

9. The crisis seriously weakened the financial position of most private and public enterprises (especially Air Madagascar and the electricity and water company JIRAMA). The share of nonperforming loans in commercial banks' portfolios increased substantially in the first six months of 2002 (see para. 26).

10. Budgetary revenue fell sharply during the crisis owing to the contraction of economic activity, employment, and imports. In the first six months of the year, revenue totaled FMG 857 billion, a decrease of 44 percent from the same period in 2001. In particular, customs revenue amounted to FMG 333 billion, compared with FMG 766 billion in the same period of 2001. In the July-September period, the pace of both customs revenue and domestic tax receipts increased.

11. Indicative benchmarks for end-March 2002 were established under the PRGF-supported program. Preliminary results indicate that the benchmarks for net foreign assets and net domestic assets of the central bank and domestic financing of the government were met, whereas the benchmark for fiscal revenue was not observed. Because of the intense pressure facing the treasury in the first quarter and the freezing of external reserves, arrears towards certain multilateral and bilateral creditors were accumulated, resulting in a breach of the continued performance criterion on external arrears; all of these arrears were subsequently settled in June and July 2002.

12. In the first six months of the year, affected by the crisis, the authorities have not been able to implement the budget for 2002 , approved by parliament in December 2001, including the HIPC budget. Wages and pensions were paid regularly and significant resources were allocated for military operations, whereas other operating expenditures were kept to a minimum. Outstanding payment orders at the treasury at end-2001 (FMG 424 billion) could not be settled as planned in early 2002. Moreover, VAT credits refunds owed to enterprises continued to rise in the first part of the year, so that by end-September VAT arrears to EPZ companies and other companies amounted to FMG 97.5 billion and FMG 67.5 billion, respectively. A total of FMG 40 billion was paid to export processing companies in early October 2002, and the remainder of 57 billion was repaid in the first half of November. VAT credits of ordinary enterprises were repaid starting in November, and the process will be completed before end-December.

III. The Program for the Last Quarter of 2002 and for 2003

A. Objectives and Priority Actions for 2002

13. Following the reunification of the country in June 2002 and the removal of all roadblocks, the government devoted all its energies to overcoming the crisis and introducing far-reaching reforms aimed at achieving good governance and transparency. This effort is expected to restore the confidence of economic agents and users of public services, as well as pave the way for equitable and sustainable growth that will benefit the entire population and substantially reduce poverty. The central role of good governance in the country's development was underscored in the government's message to the donors community at the Friends of Madagascar meeting in Paris on July 26, 2002. The government is aware of the difficult challenges that it faces in seeking to revive the economy and reversing the effects of the crisis, but is confident that with appropriate economic policies, determined actions to ensure good governance, and donor support, it will be able to secure a solid recovery and sustained growth beginning in 2003, in a framework of financial stability. The incidence of poverty, which rose in 2002 because of the economic consequences of the crisis and the loss of jobs, is expected to fall again with new job creation and the efforts underway to speed up disbursements under several community-based development projects, which benefit from foreign assistance.

14. To promote the recovery and assist economic agents who sustained heavy losses and/or lost their working capital during the crisis, the government decided in July to introduce a series of fiscal measures, that were implemented over the following months. These temporary measures include: allowing the payment of the corporate income tax (IBS) on 2001 earnings to be spread out over the year 2002; suspension of the IBS advance payment for 2002; and suspension of the 3 percent IBS advance payment at customs. Also with a view to improving the cash flow situation of companies, a major effort was launched in August to accelerate the settlement of outstanding payment orders at the treasury, as well as the reimbursement of VAT credits. As a result, outstanding payment orders at the treasury were reduced by FMG 300 billion (1 percent of GDP) between end-June and October 15, 2002, and were fully paid in November. Pending the finalization of a new mechanism regarding the VAT obligations of the EPZ companies, that would allow to offset payments due on imports with credits on exports, a temporary measure has entered in effect at end-October which defers for three months the payment of VAT on imports. Moreover, to facilitate the operations of export processing enterprises and promote their integration with local production, including artisanal production, customs duties on textile sector inputs (fabrics, accessories, and production equipment) were eliminated effective November 7, by presidential decree.

15. The presidential decree of November 7 introduces important customs tariff reductions in order to promote economic recovery; thus the tariff on fertilizer, agricultural inputs, and farm equipment, and on iron and steel products, certain construction materials, cement and paper has been brought to zero. The tariff on certain equipment goods and raw materials has also been reduced, to the new maximum rate of 25 percent ( previously 30 percent) or below. To offset partly the cost of these measures, estimated at FMG 28 billion on an annual basis (0.1 percent of GDP) the excises on cigarettes and motor oil have been raised.

16. To prevent delays in the payments by the government of duties and taxes on externally financed public procurement contracts, the procedures for the payment by the government of taxes, including the VAT, will be revised before end-January 2003. This new mechanism will be reviewed before end-June 2003 in consultation with the Fiscal Affairs Department of the Fund . New regulations will be adopted before end-June 2003, in consultation with the Fund's Fiscal Affairs Department, authorizing the deferment of the VAT payments obligations on imported capital goods. Measures have also been designed to help enterprises reconstitute their working capital; accordingly, a bank loan guarantee fund is being set up with donor assistance, which will begin operations in January 2003.

17. The government has also decided to make additional resources available to rural and urban municipalities using appropriations originally earmarked for regional districts. Accordingly, transfers to urban and rural municipalities amounting to FMG 29 billion were carried out before end-October. In 2003 these allocations will be increased to about FMG 80 billion.

18. The crisis severely affected the most vulnerable groups and reduced their possibility to access schools and health care centers. To counter this negative impact, the government has decided to waive school fees for a six month period starting in October. Health care and drugs provided in the public health centers have been set free of charge for a transitory six month period. The cost of these measures is estimated at FMG 63 billion (0.2 percent of GDP), and is covered by the HIPC budget.

B. Public Finance and Good Governance

19. Given the importance of repaying the large domestic arrears outstanding, and the need to bolster the financial position of public enterprises providing essential services, the government is aware of the need to be very prudent in managing expenditure for the remainder of the year. The latest estimates for 2002 indicate that budget revenue could total FMG 2,250 billion (7.3 percent of GDP, as against 10 percent of GDP in 2001), of which FMG 950 billion would come from customs and FMG 1,150 billion from domestic taxes. Current expenditure will be limited to FMG 3,250 billion, or 10.5 percent of GDP, compared with 10.2 percent in 2001. Investment expenditure is estimated at FMG 1,150 billion, or 3.7 percent of GDP, of which FMG 910 billion is to be externally financed. The domestically financed investment expenditure component (FMG 242 billion) will be used primarily to pay the taxes and duties on externally financed projects, which is essential for successful project implementation. These amounts include additional expenditure of FMG 318 billion financed with the debt relief under the HIPC Initiative, with an allocation agreed with donors giving priority to education, health, nutrition, road maintenance, drinkable water, and crop protection. The budget deficit (on a commitment basis, excluding grants) is expected to be limited to 7.7 percent of GDP.

20. External budgetary assistance in 2002 is projected at US$105 million (encompassing the third tranche drawing of US$42.5 million under the World Bank Second Structural Adjustment Credit, SAC II, disbursements under the World Bank Emergency Economic Recovery Credit, EERC, of US$20 million, European Union disbursements of €35 million, French emergency assistance of €6 million, and aid from Mauritius of US$1 million); of the Bank EERC the equivalent of approximately US$20 million will be on lent to public enterprises undergoing reorganization pending their privatization (Air Madagascar, Réseau Nord de Chemins de Fer, and HASYMA). This budgetary assistance is additional to the World Bank disbursements already received in 2002 (second tranche of the SAC II totaling US$30 million in January 2002 and an additional tranche of US$10 million for cyclone damage in July 2002). Privatization receipts are expected to total FMG 50 billion, since the sale of the state telephone company TELMA is expected to be finalized in early 2003. In view of the expected assistance, net repayment of domestic arrears in 2002 could attain an amount close to FMG 200 billion, or 0.6 percent of GDP.

21. The government is determined to improve fiscal management at all levels and to introduce the principles of good governance in order to remedy past deficiencies. The key measures already taken include: (i) appointment of new managers in all customs offices; (ii) recovery of duties payable on imports in 2001; (iii) the audits by the State Inspectorate General of the 2001 expenditures through the special fund of the office of the president, finalized in October 2002, and of the 2001 HIPC expenditures; (iv) establishment of an anti-corruption board to help draft appropriate legislation in this area as well as create an anti-corruption agency. The National Statistical Institute has been put in charge of the preparation of a report on the physical execution of priority expenditure financed by the HIPC budget in 2002. In addition, the ongoing strengthening of control agencies such as the Audit Court (Cour des Comptes), the Directorate-General for Expenditure Commitment Control (Control des Dépenses Engagés, CDE), and the State Inspectorate-General (Inspection Général de l'Etat) will continue with donor assistance.

22. A wide-ranging effort will be undertaken to improve the efficiency of the customs administration, particularly to curtail fraud, while at the same time streamlining customs clearance procedures and minimizing unnecessary controls which are burdensome for economic operators. Accordingly, strict instructions have been given to customs agents to discontinue practices that slow down customs clearance. The computerization of customs will be accelerated with the installation of ASYCUDA 3++ in all main customs offices. The new contract with a pre-shipment inspection company will be finalized by end-March 2003 and a timetable will be established for settling arrears under the previous contract with BIVAC, which expired in 2001.

23. The treasury continues its efforts to expedite the preparation of monthly treasury balances; the balances for the year 2000 will be completed by end-2002 and those for 2001 and 2002 will be prepared in 2003. Starting in early 2004, the monthly closing balances will be prepared on a timely basis. The delays in the preparation of the budget execution laws (lois de règlement) will be eliminated, and the draft budget execution law for 1999 will be forwarded to the Audit Court before end-2002. The draft budget execution laws for 2000 and 2001 will be submitted to the Audit Court in 2003.

24. To expedite the expenditure commitment procedures and increase the speed of budget execution, the CDE has established a one-stop window in each ministry, which either grants or denies approval for the commitment of expenditure within 48 hours. To improve budget execution at the expenditure verification and authorization stage, the provincial budget directorates will be strengthened with support from the World Bank and other donors. Quarterly budget execution reports, now limited to the Ministries of Education and Health, will be extended in 2003 to include the Ministries of Public Works, Rural Development, Water and Forests, and Justice. Quarterly execution reports will be prepared of the expenditures in the HIPC budget, starting with a report on 2002 expenditures, which will be finalized before end-March 2003. In addition, with World Bank assistance, the medium-term objective is to establish an integrated fiscal management system, based on reliable data reporting procedures.

C. Balance of Payments and External Debt

25. Regarding balance of payments developments in 2002, available information on EPZ enterprises indicates that business is gradually reviving, with 49 of 142 enterprises having resumed operations, at least partially. The pace of recovery will depend on the ability to obtain new purchase orders from foreign clients, after the interruption of business activity early in the year. Overall, exports could shrink by as much as 46 percent between 2001 and 2002, with a strong decline in EPZ exports. Vanilla exports are expected to contract by 16 percent because of a decrease in volume. Imports are recovering only gradually, including imports of petroleum products, as household consumption and business inventory rebuilding remain weak. According to provisional estimates, the current account deficit, including grants, could amount to 4.5 percent of GDP, compared with 1.3 percent in 2001. Despite the external assistance expected in the final months of the year, the central bank's net external reserves could contract by approximately SDR 30 million during the year, compared with a decrease of SDR 73 million in the first nine months of the year. The government is in the process of finalizing the bilateral agreement with Paris Club creditors, on the basis of the Agreed Minutes of March 2001.

D. Monetary Policy and the Banking System

26. The money supply remained stable in the first eight months of 2002 and the demand for bank credit was weak, including in the third quarter, leading to a 7.6 percent reduction in bank lending over the eight months. The demand for credit to the economy could revive in the final months of the year. To facilitate such a recovery, on October 21, 2002 the central bank lowered the required reserve ratio on demand deposits from 24 percent to 18 percent , and on time deposits from 3 percent to 2 percent. The treasury bills market reopened on October 23, 2002 and interest rates rose above the levels attained in January 2002 before the market closed (for four-week bills from 5.5 to 11 percent, for 12-week bills from 8.9 to 11.9 percent, and for 24 weeks bills from 9.1 to 12.7 percent). Money growth for the year 2002 is projected at 11.9 percent, which would imply a decrease in the velocity of circulation. During the year, the share of nonperforming loans in the banks' portfolios increased (from 9.3 percent of loans at end-2001 to 13.8 percent at end-August 2002), owing to the difficulties economic agents encountered during the crisis. This will necessitate additional provisioning by banks, negatively affecting their 2002 earnings.

27. The monetary authorities will continue to pursue a flexible exchange rate policy, and the central bank will intervene on the exchange market solely to achieve its external reserves objectives and to minimize temporary exchange rate fluctuations. In their exchange policy, the authorities will take account of export developments and of the pace of recovery of the Export Processing Zone's activity, and will strive to preserve the competitiveness of the Malagasy economy.

28. The central bank is in the process of implementing an action plan designed to strengthen its internal organization and controls. Accordingly, in the coming months the central bank will develop a risk-based plan of internal audits of its departments, will carry out by end-June 2003 an audit of its foreign assets management system, and, with Fund technical assistance, will strengthen the management of its foreign reserves. The central bank will strive to improve the presentation of its accounts, based on internationally accepted accounting principles. The Bank Supervision Commission will receive technical assistance for the establishment of an early warning system of banks management. The central bank's board of directors will meet before end-January 2003 to review and approve the 2000 and 2001 accounts of the institution, and the accounts will be published by end-February 2003.

29. SOLIMA's debts to the central bank amounted to US$52 million at end-August 2002, owing to the nonpayment of letters of credits for petroleum imports in 2000 and 2001. The 2003 Budget Law will provide for these debts to be assumed by the government, and a repayment schedule will be drawn up. SOLIMA's accounts for 2000 will be closed and examined by the company's auditors by end-December 2002, and the 2001 accounts by end-June 2003. Before end-2002 accounts will be prepared presenting the sources and uses of funds in 2001. The general meeting of the company's shareholders will examine the 2000 accounts before end- February 2003, and the 2001 accounts before end-July 2003.

30. A financial and operational audit of the postal checking center (centre des cheques postaux - CCP) will be undertaken by end-March 2003. The purpose of the audit will be to make recommendations on the management of CCPs, including separation of the funds of CCPs and the post office, and any other measures necessary to ensure the viability of the CCP system.

E. Structural Reforms

31. The weakening of the financial position of the major public enterprises, reflecting the crisis of early 2002 as well as serious management deficiencies, requires that a vigorous restructuring program be put in place for the key enterprises, aiming at opening up their capital and/or their privatization; these enterprises play a key role in transport and rural development. Regarding Air Madagascar, the government made recourse in June, in consultation with the World Bank, to a Lufthansa Consulting team , which in September concluded a two-year management contract with the company; the objective is to improve management efficiency and generate a positive cash flow, so as to permit the privatization of the company. Improvement in operating results will allow to reduce the debt burden. The government, for its part, will inject additional equity (equivalent to US$10 million in 2002 and US$7 million in 2003), and creditors are expected to approve debt reduction arrangements. At end-September 2002 a concession was granted to a new private company with government participation for operating the northern railroad system (Réseau Nord de Chemins de Fer). The main shareholder of the concession company is the South African firm COMAZAR. The contribution of the government for rehabilitation investments and severance pay will amount to FMG 55 billion in 2002 and FMG 32 billion in 2003. Negotiations with the prospective buyers of the telecommunications company TELMA on the terms of the sale agreement are underway, and the sale is scheduled to be completed in the first quarter of 2003. As for the cotton company HASYMA, decisions will be taken shortly on the strategy for opening up the company's capital, which has become urgent given its inadequate capital and the accumulation of debts, including to cotton farmers. The government will assume responsibility for settling the debts to farmers, amounting to FMG 13 billion in 2002 and FMG 10 billion in 2003. For the sugar sector, which is in urgent need of revamping following the steep declines in production in recent years, efforts are under way to achieve the structural rehabilitation of the sugar company SIRAMA, with government assistance to the company expected to total FMG 28 billion in 2003.

32. As the management of the electricity and water company JIRAMA has been seriously weakened by its inability to recover claims on public entities such as local governments and the university, as well as by the recent increase in the price of diesel oil, the priority is now to settle the company's arrears to fuel suppliers and improve its cash flow so as to ensure its proper functioning. This will necessitate (i) an appropriate tariff policy, which will reflect also the recent increase in gas oil prices; to that end a tariff study is underway, and a tariff adjustment will be introduced no later than end-February 2003; and (ii) the recovery of JIRAMA's claims on public entities (university, local governments), which will require government intervention in the framework of a cross arrears compensation arrangement with the oil companies. This arrangement will offset oil companies claims on JIRAMA, other state enterprises, and the central government for gasoline and fuel consumption, with import duties and taxes payable for the first half of 2002. This offsetting arrangement has been concluded in early December 2002. The government will be attentive not to accumulate arrears on fuel consumption, while local authorities financial management will be strengthened, to avoid incurring new arrears toward JIRAMA. An operational audit of JIRAMA will be carried out in the coming months by a team of consultants, with World Bank assistance, who will issue comprehensive recommendations for managerial improvement. Moreover, to ensure that the electricity sector is properly managed and that the marketing of electricity produced by private operators is competitive and transparent, the electricity sector regulatory agency established by law will become fully operational during the month of January 2003.

F. Economic Growth and Fiscal and Monetary Objectives for 2003

33. The recovery of economic activity, including in the EPZ, and the resumption of investment (private and public) are expected to generate real GDP growth of approximately 7.8 percent in 2003. A sharp upturn is expected in the construction sector owing to the increased rate of execution of a number of externally financed projects including construction and rehabilitation. Consumer price inflation is expected to continue falling, to about 5 percent on a 12-month basis by end-2003. The increase in the GDP deflator in 2003 is projected at 3.8 percent. Exports are projected to increase by about 32 percent in SDR terms, particularly as a result of recovery in apparel production. A drop is expected in the vanilla export price, which could lead to a decrease in vanilla exports in value terms. Imports are expected to increase by approximately 32 percent in SDRs, mainly because of the recovery of investment. As a result, the external current account deficit (including grants) is projected to widen to 5.7 percent of GDP, and the central bank's net official reserves are expected to increase by about SDR 23 million, partly as a result of the expected recovery of foreign direct investment.

34. The 2003 Budget Law is under preparation; it will be adopted by presidential decree (ordonnance) before end-2002 and ratified by the National Assembly which will be elected on December 15, 2002. The budgetary framework has been designed taking into account the effort to strengthen tax and customs administration and the external assistance expected for projects and budgetary support. On the revenue side, the government intends to reduce evasion significantly by strengthening customs administration (introduction of ASYCUDA 3++; new contract with an inspection company; enhanced controls; cross checks with the domestic tax offices) and tax administration (prohibition of sales without invoices; cross checks). Customs receipts are expected to reach FMG 1,620 billion (an increase of 11.5 percent from 2001). Domestic tax receipts could reach FMG 1,890 billion, up from FMG 1,460 billion in 2001; this increase reflects in part larger VAT receipts because of the rapid growth of externally financed public investment. The collection of the unified tax on small businesses (impôt synthétique), which had been suspended in 2001, is projected to yield FMG 68 billion (0.2 percent of GDP). Total budgetary revenue is expected to amount to 10.5 percent of GDP, compared with 10 percent of GDP in 2001 and 11.7 percent in 2000. Revenue performance in the first half of the year will be analyzed in July 2003; should the annual target appear difficult to achieve, the government will consider the adoption of new revenue measures, or will offset the expected revenue shortfall by curtailing from July new expenditure commitment.

35. Current expenditure will be maintained at a level equivalent to 10.2 percent of GDP as in 2001, including priority expenditure of approximately FMG 239 billion (0.7 percent of GDP) financed by debt relief under the HIPC Initiative (an additional FMG 124 billion in debt relief will be allocated to investment expenditure). The wage bill will reflect an increase in wages of 12 percent, and additional allowances for teachers in rural areas and for the security forces. Externally financed investment expenditure are projected at FMG 1,700 billion (4.9 percent of GDP, compared with 4.1 percent in 2001). Domestically financed investment expenditure are budgeted at FMG 800 billion (2.3 percent of GDP). Transfers to municipalities will be increased. The budget deficit (commitment basis, excluding grants) will decline to 7.4 percent of GDP, from 7.7 projected for 2002 and 8.1 percent in 2001.

36. Already identified external budgetary support (excluding projects financing) will amount to the equivalent of US$ 65 million, including US$30 million in World Bank emergency credit, and €35 million from the European Union; a residual gap equivalent to US$45 million could be covered by bilateral donors and the AfDB. PRGF disbursements from the IMF will be channeled through the central bank. Banking system credit and nonbank lending to the government will be small in view of the need for bank financing to revitalize the private sector. Privatization receipts are projected to reach FMG 133 billion, including the proceeds of the sale of TELMA. Within this financing framework, domestic payments arrears could be reduced by approximately FMG 300 billion or 1 percent of GDP.

37. The monetary policy objectives for 2003 are to reduce inflation while at the same time ensuring adequate expansion of credit to the private sector, which is essential for recovery. Increases in the central bank's external reserves and net bank credit to government would contribute to expanding the money supply by 4.7 percent and 3.6 percent, respectively. A 15 1/2 percent increase in credit to the economy (excluding the impact of the government assumption of central bank claims on SOLIMA) would be equivalent to 5.6 percent of beginning-period money supply, and would be compatible with a monetary expansion of 12.5 percent during the year, in line with the expected growth of nominal GDP.

G. Preparation of the Poverty Reduction Strategy Paper

38. The Poverty Reduction Strategy Paper (PRSP), currently under preparation, presents an in-depth diagnostic analysis of trends in poverty in recent years, the main focuses of the proposed poverty reduction strategy, the key medium-term objectives, and the costs of programs needed to achieve the objective. The action programs will be prioritized on the basis of the available financing, and all actions will be properly budgeted. The final content of the PRSP will be reviewed by a national workshop to be held in January 2003 in Antananarivo and will be submitted for discussion by the new National Assembly in its first session in early 2003, before being adopted by the government and forwarded to the donor community. The government hopes to be able to attain the completion point under the HIPC Initiative in early 2004, after one year of implementation of the PRSP.

IV. Program Monitoring

39. The program supported by the PRGF arrangement will be monitored through semiannual reviews, quantitative and structural performance criteria, quantitative and structural benchmarks, and quarterly monitoring indicators. The third review of the program is to be completed by the Fund's Executive Board by end-May 2003 and will focus on observance of the performance criteria for end-December 2002 and on economic and financial developments in the final months of 2002 and the initial months of 2003. The fourth review is to be completed by the Fund's Executive Board by end-November 2003 and will focus on observance of the performance criteria for end-June 2003, economic and financial developments in 2003, and the macroeconomic and fiscal targets for 2004. The performance criteria established for end-December 2002 and end-June 2003 (see Table 3, attached) pertain to the BCM's net foreign and domestic assets, domestic financing of the budget deficit (bank financing, nonbank financing, deposits of treasury correspondents, privatization receipts, and domestic arrears), fiscal revenue, the nonaccumulation of external arrears, and a ceiling on nonconcessional external government borrowing. The targets for these variables for end-March and end-September 2003 constitute benchmarks for program monitoring. The provisional targets established for end-December 2003 for these variables will be revised during the third review.

40. The following structural performance criteria and benchmarks have been established (see Table 4, attached): (i) by end-June 2003 new regulations will be adopted, in consultation with the Fiscal Affairs Department of the Fund, introducing a system authorizing the deferment of the VAT payment obligation until the monthly declaration following the import; (ii) the treasury's monthly balances up to end-2001 will be prepared before end-June 2003; (iii) the draft budget execution laws for 2000 and 2001 will be submitted to the Audit Court by end-December 2003; (iv) an activity plan for the central bank's internal audit department will be drawn up by end-March 2003, together with an organizational chart defining how the internal audit department will report to the various organs of the bank; (v) an internal audit of the management of central bank reserves will be conducted by end-June 2003; (vi) the general shareholders meeting of the oil company SOLIMA will examine the accounts for 2000 before end-February 2003, and those for 2001 before end-July 2003. The measures mentioned in (i) and (iii) constitute performance criteria under the arrangement; the other measures constitute benchmarks, the nonobservance of which will trigger consultations with Fund staff.

41. The following measure will constitute a prior action for completing the second review under the PRGF arrangement with the IMF: the JIRAMA's debts to private sector petroleum suppliers will be offset with these suppliers tax obligations.

Technical Memorandum on Monitoring the 2002-2003 Program Supported by the Arrangement under the Poverty Reduction and Growth Facility (PRGF)

1. This technical memorandum defines the variables used to establish the quantitative performance criteria and benchmarks for the program, how they are calculated, and any adjustments deemed necessary. It also explains the monitoring variables, that is, external financed assistance and direct investment flows connected with the privatization of public enterprises. Unless otherwise indicated, in the case of stocks variables for end-December 2002 are expressed as cumulative variations from December 31, 2001, and in the case of flows as cumulative flows from January 1, 2002. Variables for 2003 are expressed as cumulated variations from December 31, 2002 in case of stocks, and cumulated flows from January 1, 2003 in case of flows. The objectives for end-March and end-September 2003 are benchmarks; those for end-December 2002 and end-June 2003 are performance criteria. Objectives for end-December 2003 are indicatives and will be revised during the third review of the program.

I. Quantitative Criteria 1

A. Ceiling on External Payments Arrears

2. This variable is expressed in terms of the stock of arrears. There will be no net accumulation of new arrears, meaning that there should be nil variation over the period considered. 2 External payments arrears are defined as nonpayment in full of interest and principal obligations due to all non-resident creditors, excluding arrears resulting from nonpayment of debt service for which rescheduling negotiations are under way.

B. Ceiling on Nonconcessional External Borrowing 3


3. The nonaccumulation of nonconcessional debt contracted or guaranteed by the government is a performance criterion to be observed at all times. Nonconcessional external debt is defined as having a grant element of less than 35 percent. Under the program, nonconcessional debt includes financial leasing and any other instrument giving rights to a current financial liability, under a contractual arrangement by the government of Madagascar or guaranteed by the government of Madagascar, but excludes debt contracted under rescheduling agreements and normal import-related credits of less than one year. A definition of debt is contained in point 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt, adopted by the Executive Board, on August 24, 2000. To this definition must be added all commitments contracted or guaranteed for which value has not been received.

Calculation method

4. Calculation of the degree of concessionality of new external borrowing is based on the 10-year average of the OECD's commercial interest reference rate (CIRR) for loans with maturities greater than 15 years and the six-month average CIRR for loans maturing in less than 15 years.

C. Floor for Net Foreign Assets (NFA) of the Central Bank of Madagascar


5. NFA are defined as the difference between gross international reserves and all foreign liabilities of the Central Bank of Madagascar (BCM), including debt to the IMF and other short- and long-term liabilities of the BCM. Gross international reserves are defined as reserve assets readily available to and controlled by the BCM for direct financing of payments imbalances, excluding assets that are pledged, or collateralized, or otherwise encumbered.

Calculation method

6. For purposes of calculating this criterion, NFA must be converted into Malagasy Francs (FMG) at the end-of-period exchange rates for the reference period established in the program (program exchange rate).

D. Ceiling on Net Domestic Assets (NDA) of the Central Bank of Madagascar


7. The BCM's NDA include net credit to the government, credit to enterprises and individuals, claims on banks, liabilities to banks in the form of central bank deposit auctions (appels d'offres négatifs), and the other items net, excluding the foreign exchange adjustment item.

8. Foreign exchange deposits must be converted into FMG at the end-of-period program exchange rate.

E. Ceiling on the Net Domestic Financing Requirements
of the Central Government (CG)


9. Net domestic financing requirements of the central government are defined as the sum of (a) the variation in the net claims on the central government of the BCM, the commercial banks, the nonbanking system, and treasury correspondents; (b) domestic or foreign receipts from privatization operations as defined in Section III-B, paragraph 22 below; and (c) the variation in central government domestic or external payments 4 arrears. Central government (CG) corresponds to the scope of operations of the treasury as indicated in the General treasury Operations table (Opérations globales du Trésor, or OGT) .The change in deposits of the treasury correspondents (correspondants du Trésor) is considered a component of domestic financing.

10. The variation in domestic payments arrears consists of the amount to be recommitted and net payments delays (clearings, items in process of payment, expenditure committed but with no payments order issued), as defined in the OGT.

11. Net bank claims consist of BCM and commercial bank claims on the CG, including auctioned treasury bills (BTAs), and other treasury bills and liabilities, net of CG deposits with the BCM and commercial banks, including foreign currency deposits. The change in net bank claims is defined excluding the impact of exchange rate changes on net bank claims on the government.

12. Nonbank claims consist of BTAs and other treasury bills (BTs) and bonds placed with nonbank institutions and the public. The valuation of nonbank claims is based on the change in outstanding conventional treasury bills (maturities of 1 to 5 years), auctioned treasury bills (maturities of 1 month to 3 years), and outstanding domestic government loans.

Calculation method

13. Deposits and debt to the BCM in foreign exchange must be converted into FMG at the end of period program exchange rate.

14. BTAs must be posted at their net value at time of issue.

F. Floor on Tax Revenue

15. Tax revenue includes that received by the treasury, but also suspense items, including those related to the public investment program.

II. Indicative Limits or Ceilings

A. Ceiling on Reserve Money


16. Reserve money consists of notes and coins issued and demand deposits of commercial banks with the BCM (including both required and excess reserves).

17. Central bank deposit auctions (appels d'offres négatifs) are excluded from reserve money and are classified in NDA.

B. Ceiling on Broad Money


18. Broad money (M3) includes notes and coins in circulation, demand and time deposits with commercial banks, including foreign currency deposits of residents, and bonds issued by banks.

Calculation method

19. Foreign currency deposits must be converted into FMG at the end-of-period exchange rates for the reference period established in the program.

III. Monitoring Variables and Memorandum Items

A. Projected Balance of Payments Assistance


20. External financial assistance is defined as loans and grants (nonproject) provided as structural adjustment financing and resulting in funds available to the treasury. It excludes the assistance that gives rise to counterpart funds for the treasury with a delay longer than one year.

Calculation method

21. Financial assistance in foreign exchange must be converted into FMG at the program exchange rate. Assistance in kind must be posted when the counterpart funds are deposited with the treasury.

B. Projected Investment Flows Connected with
the Privatization of Public Enterprises


22. The cost of privatization operations is included above the line in central government operations. Apart from covering reform-related costs, gross receipts from the privatization of public enterprises (PEs) will be used to reduce outstanding domestic debt.

IV. Adjusters

A. Excess/Shortfall in External Financial Assistance

23. In the case of excess net external financing (external financial assistance less public debt service on a cash basis) over the amount programmed (i) the floor on the BCM's NFA will adjusted upward; (ii) the ceiling on the BCM's NDA will be adjusted downward (the adjustment will be converted into FMG at the exchange rate used in the operation); and (iii) the ceiling on the net domestic financing requirements of the central government
(Section I-E) will be adjusted downward (the adjustment will be converted into FMG at the exchange rate used in the operation).

24. In the case of a shortfall in net external financing at end-December 2002, against the programmed amount, and at end-March, end-June, end-September, and end-December 2003, the floors and ceilings will be adjusted as follows: by a maximum of SDR 40 million for the year 2002; by a maximum of SDR 12 million for the first quarter 2003; by a maximum of SDR 45 million for the first half of 2003; by a maximum of SDR 55 million for the first nine months of 2003 and for the full year 2003, according to the following method: (i) the floor on the BCM's NFA will be adjusted downward by the amount indicated above; (ii) the ceiling on the BCM's NDA will be adjusted upward by the same amount (the adjustment will be converted at the program exchange rate); and (iii) the ceiling on the central government's net domestic financing requirements (Section I-E) will be adjusted upward and capped at the above-mentioned maximum amount (the adjustment will be converted to FMG at the program exchange rate) .

B. Privatization-Related Transactions

25. Adjustments will be made for any deviation in (a) privatization receipts; and (b) current privatization-related expenditure. The floor on net foreign assets for end-December 2002 will be adjusted upward or downward by a maximum of SDR 12 million from the programmed floor if disbursed foreign resources from privatizations net of (b) are higher or lower than programmed. The adjustment will be limited to a maximum of SDR 5 million for the periods from end-2002 to end- March, end-June, end-September and end-December 2003. Similarly, the BCM's NDA will be adjusted downward or upward (at the average exchange rate of the pertinent quarter). The ceiling on domestic government financing will be adjusted to take account of any discrepancies between actual privatization-related expenditures and those programmed (upward adjustment if expenditure exceeds the amount programmed and downward, in the opposite case, up to the difference reported).

C. Program Exchange Rate

26. Amounts of external assistance and debt service denominated in SDRs will be converted into FMG at the exchanged rate of FMG 8,972= SDR 1 for the fourth quarter of 2002 and at the FMG/SDR rate respectively of 9,108, 9,240, 9,372, 9,514 for each of the four quarters of 2003. Corresponding amounts denominated in US$ and Euros will be converted in FMGs applying the rate of 1.32 US dollars per SDR and 0.98 US dollars per Euro, and the FMG/SDR rate indicated above.

V. Consultations with Fund Staff on the Performance Criterion
for NFA and the Broad Money Benchmark

27. In case that demand for money is stronger than expected and the exchange rate appreciates, the central bank should intervene on the interbank foreign exchange market (MID) to offset this appreciation, taking into account programmed limits (floor/ceiling) on the accumulation of net foreign assets and the level of broad money. Given the program's target, if broad money growth since end-December 2002 exceeds 15 percent on an annual basis, and/or if the level of net foreign assets exceeds the programmed level by more than 5 percent of broad money at end-2002, the authorities will consult Fund staff on measures to be taken in the context of exchange market and monetary policy management.

VI. Information and Data to be Supplied to Fund Staff

28. The Malagasy authorities will provide Fund staff with the following information and data according to the schedule provided, either directly (e-mail or facsimile) or through the Fund's resident mission.

A. The Central Bank of Madagascar will report the following statistics

29. Monthly:

  • market results of treasury bill auctions, including the bid level, the bids accepted or rejected, and the level of interest rates;

  • data on the secondary treasury bill market, including volumes of transactions and yields;

  • information on monetary developments, as required by the Statistics Department of the Fund (STA);

  • monthly balances of the BCM and deposit money banks;

  • classification of commercial bank loans by economic sector;

  • money market operations and rates;

  • changes in bank liquidity (required reserves and free reserves);

  • the foreign exchange cash flow table, including foreign debt operations; and

  • table of interbank foreign exchange operations on the interbank foreign exchange market (MID);

30. Quarterly:

  • data on foreign trade (exports and imports).

B. The Ministry of Economy, Finance and the Budget will report, as appropriate, the following information:

31. Monthly:

  • OGT data on a cash and commitment basis and the related tables;

  • expenditure on structural reform;

  • central government revenue and expenditure, including short-term treasury on-lending;

  • treasury liabilities (statutory advances and operations on the treasury bill market);

  • central government capital expenditure;

  • external public debt operations (debt contracted and publicly guaranteed, settlement of external payments arrears, and operations of public enterprises) and debt service paid;

  • traditional, modern and combined Malagasy price indices; and

  • indicators of sectoral economic activity.

32. Moreover, information on important measures adopted by the government in the economic and social areas that would have an impact on program development, changes in legislation, including laws passed by the National Assembly and new rules established by the Banking Supervision Commission (CSBF), and any other pertinent legislation will be reported to Fund staff on a timely basis for consultation or information, as appropriate.


Mr. Gaston Ravelojaona
Central Bank of Madagascar

Mr. Henri Bernard Razakariasa
Secretary General
Ministry of Economy, Finance, and Budget

1 These criteria are performance criteria for end -December 2002 and end-June 2003 and benchmarks for end-March and end-September 2003.
2 To be observed continuously.
3 To be observed continuously.
4 These external payments arrears are defined as the amount of gross payments arrears less arrears eligible for debt relief, that is, the amount of arrears that must eventually be settled in cash.