Cape Verde and the IMF
Press Release: IMF Completes Fourth Review Under Cape Verde's PRGF Arrangement and Approves US$2 Million Disbursement
August 30, 2004
Country's Policy Intentions Documents
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Cape VerdeLetter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding
Mr. Rodrigo de Rato
Dear Mr. Rato:
On April 10, 2002, the Executive Board of the IMF approved a three-year arrangement for Cape Verde under the Poverty Reduction and Growth Facility (PRGF) in the amount of SDR 8.64 million (90 percent of quota). The purpose of this letter is to inform you of the progress in implementing the second-year economic program, and to request the fifth loan disbursement upon completion of the fourth review under the arrangement.
The attached memorandum of economic and financial policies (MEFP) supplements the MEFPs of March 11, 2002; December 6, 2002; June 9, 2003; and December 2, 2003. It sets out the objectives and policies the government of Cape Verde will pursue during the remainder of 2004.
Cape Verde's economic performance in 2003 was generally better than envisaged under the program. As discussed more fully in the MEFP, however, transitional issues delayed the effectiveness of October's tightening of monetary policy, and the performance criteria for end-December 2003 on net domestic assets of the central bank and on net international reserves were not observed. In addition, the performance criterion on the contracting of nonconcessional debt was not observed by a small margin as a result of a loan that we were not aware had only a 34 percent grant element.
While we have continued to observe the structural performance criteria,
our structural reform agenda suffered some delays during October-March.
However, as noted in the attached MEFP, we are regaining
this momentum and will accelerate the structural reform agenda during
the remainder of 2004.
The government believes that the measures and policies set forth in the attached memorandum are adequate to achieve its program objectives, but will take any further action that may prove necessary for this purpose. For as long as Cape Verde has outstanding financial obligations to the Fund arising from the loans under the arrangement, the government will consult with the Fund, at the initiative of the government or whenever the Managing Director requests consultation, on Cape Verde's economic and financial policies.
The government authorizes the Fund to provide this letter, the attached memorandum, and the associated staff report to all interested parties that request them, including through the Fund's external website.
1. Cape Verde's ongoing program of economic stabilization and reform is being supported by an arrangement under the Poverty Reduction and Growth Facility (PRGF) covering the period 2002-04. Consistent with the goals set out in our memorandum of economic and financial policies dated March 11, 2002, and updated most recently on December 2, 2003, this supplementary memorandum reviews the implementation of the program in 2003 and early 2004, and sets forth the government's policies through December 2004.
II. Economic and Policy Developments through March 2004
2. Economic performance in 2003 was broadly in line with the program. Preliminary data suggest that real GDP grew by 5.3 percent, led by strong rebounds in agriculture and tourism. With the resulting decline in food prices, the consumer price index rose by only 1.2 percent on average during the year.
3. Fiscal policy was implemented broadly as programmed. The fiscal deficit (including grants) was 3.3 percent of GDP, notably lower than targeted, and the primary recurrent surplus was 4.0 percent of GDP, also better than envisaged. With revenues developing in line with expectations, the better overall fiscal performance reflected lower recurrent and capital outlays. The value-added tax (VAT) was introduced in January 2004, with a single rate of 15 percent. At the same time, the new import tariff structure came into effect, reducing the number of tariff bands to seven and eliminating the customs fee. The reduction in corporate income tax rate from 35 to 30 percent also became effective January 1, 2004. In executing the public investment program, the government contracted a loan to construct a health facility that it believed, on the basis of commercial interest reference rates (CIRRs) prevailing during loan negotiations, to be concessional. By the time of signing in March 2004, declining CIRRs had reduced the grant element to 34 percent, leading to the nonobservance of the limit on the contracting of nonconcessional external debt.
4. The results of the end-October tightening of monetary policy can be clearly seen in slower credit growth and stronger international reserve accumulation thus far in 2004. However, transitional factors, notably lending commitments by banks already made at the time the reserve requirement was raisedpostponed the effectiveness of the tightening and resulted in the non-observance of the quantitative performance criteria on net domestic assets (NDA) of the central bank and on net international reserves for December 2003 (Table 1).
5. The government's structural reform agenda has been subject to some delays, but we have recently taken actions to accelerate its implementation in the areas of economic regulation and privatization.
6. The government is making substantial progress in identifying and repaying old domestic arrears and previously disputed claims. A special commission has been established to determine the government's liabilities to Electra (the electricity and water utility), including obligations arising from the non-adjustment of electricity tariffs during 2000-2002, when world oil prices increased significantly. The World Bank is providing technical assistance for this project. Once the findings of the commission have been finalized, the government will agree with Electra on a schedule of repayment. In the meantime, the government made a good-faith payment of CVEsc 260 million to Electra in the second quarter of 2004. In addition, the government has reached an agreement with Cape Verde Telecom to swap CVEsc 240 million in payments arrears to be offset by an equivalent amount of non-tax arrears. We have identified CVEsc 287 million in payment arrears to construction companies which we propose to partially offset with an estimated CVEsc 174 million in tax arrears owed to government, with the balance to be paid in cash. The government is currently negotiating with the suppliers to confirm these claims. We have also proposed to offset payments arrears to Shell Oil of CVEsc 277 million against CVEsc 389 in overdue tax payments, resulting in a net payment to government. We have verified obligations of CVEsc 739 million to a commercial bank for unpaid interest subsidies and other fees. Finally, the government owes substantial amounts to the private pension fund (INPS), which will be regularized in the context of the growth and competitiveness project, supported by the World Bank.
III. The Program for July-December 2004
7. Our fiscal and monetary policies for 2004 are based on a projected real GDP growth rate of 5.5 percent and an average inflation rate of 1 percent. The external current account (excluding official grants) is projected to expand somewhat to about 15 percent of GDP, based on relatively strong import growth and a cautious outlook for private transfers. Monetary policy will be directed toward achieving an increase in gross international reserves from 1.8 to 2.0 months of imports.
A. Fiscal Policy
8. The fiscal program for 2004 reaffirms the government's commitment to expand education, health, and security services, while providing the necessary support to monetary policy. Revenue is projected to rise by 12 percent to CVEsc 19.6 billion (22.5 percent of GDP), reflecting the collection of the tax and non-tax arrears, strong growth in import-based taxes (including the VAT), the elimination of exemptions to the previous consumption tax, and the incorporation of the budgets of autonomous agencies into the national budget. Total expenditure will be as laid out in our previous memorandum and confirmed in the 2004 budget approved by the National Assembly, rising to CVEsc 28.2 billion (32.2 percent of GDP), with much of the increase in current spending allocated to hiring new teachers, doctors, and security personnel, and raising their pay scale. Capital spending, particularly for donor-funded projects, is also expected to rise. Thus, the fiscal deficit (excluding grants) will rise relative to 2003, but it will be lower than indicated in our previous memorandum. The primary recurrent surplus is programmed to remain broadly constant in nominal terms. Net official financing (including grants) already committed and a modest amount of domestic bank financing will enable the government to reduce domestic arrears by about 1.2 percent of GDP. The program is fully financed. If the government succeeds in securing more than the CVEsc 2.5 billion (€ 23 million) in budget support already committed, it will use the first CVEsc 0.2 billion to pay down additional domestic arrears and use any remaining balance to reduce domestic bank financing and increase international reserves.
9. Given the introduction of the VAT and the new import tariff structure, the government does not intend to introduce any new taxes this year. We will focus our efforts on ensuring that the VAT department has sufficient resources to enforce VAT compliance, provide the necessary information and customer relations services, and provide VAT refunds on a timely basis. As a program benchmark, a VAT Service and Information Unit will be fully functional by September 2004 to assist taxpayers to comply with the law. In addition, VAT processing offices in charge of registering taxpayers, receiving tax forms, and compiling data will be fully functional in the four main districts, and at least 10,000 taxpayers will be registered by that time. This will be a benchmark for end-December.
10. We have had some difficulties finding a consultant to undertake a comprehensive assessment of the cost of all tax exemptions and fiscal incentives, despite donor funding. However, we will endeavor to complete the assessment by end-June 2004 in time to inform the National Assembly debate on tax policies for 2005. The government is on track to begin submitting quarterly reports of fiscal operations to the National Assembly by end-June. Furthermore, submission of the report of fiscal operations for the first half of 2004 to the National Assembly by end-September 2004 will be a benchmark under the program.
B. Monetary and Financial Sector Policies
11. Given the importance of international reserve coverage to investor confidence and the sustainability of the exchange rate peg, the Bank of Cape Verde (BCV) will not ease monetary policy until a clear upward trend in reserves has been established. Broad money growth is to remain near 8 percent through 2004, in line with nominal GDP. Growth in credit to the economy is projected to expand on the order of 10 percent for the year, resulting in an average growth of 12.5 percent during 2002-04.
12. The BCV began auctioning its own bills in 2003 to manage bank liquidity. However, the lack of competition in the banking system inhibits the effectiveness of indirect monetary instruments. The BCV has already begun to analyze the possibilities of reducing the unremunerated reserve requirement, currently 19 percent, without affecting bank liquidity and has requested technical assistance from the IMF in this endeavor. The BCV will continue to monitor financial institutions through its monthly off-site reporting system. Work is also underway on a new regulation to limit the open foreign exchange positions of commercial banks and steps are being taken to complete compliance with the Fund's safeguards assessment report.
13. The BCV and the government are working to create the conditions for a reduction of interest rates on domestic bank credit without endangering the balance of payments. Fundamental to this objective is continued fiscal prudence to minimize government recourse to domestic bank credit. The BCV's efforts to reduce the level of unremunerated reserves, together with donor-supported programs to improve commercial banks' ability to assess project risks, will help reduce the costs of financial intermediation. The regional chambers of commerce, with donor assistance, are helping their members strengthen financial transparency, which will improve their prospects for gaining access to commercial bank credit. Finally, the government and the BCV will continue to promote financial sector competition by licensing qualified banks and other financial institutions.
C. Enterprise Reform
14. Private-sector-led economic growth is a crucial component of Cape Verde's poverty reduction strategy and external viability. Critical to this element of the strategy is the reform of large enterprises providing public services that are either owned or regulated by the state. These enterprises have imposed unnecessary costs both on the budget and on the private sector. While substantial progress in reforming these companies has been made already, additional steps will be taken during 2004 that will serve as benchmarks and performance criteria (where indicated) for the PRGF-supported program:
IV. The PRSP and Medium-Term Macroeconomic
15. A draft PRSP was completed in mid-April 2004. A process of national consultation on the draft is now underway, and the government intends to produce a final (PRSP) by the third quarter of 2004. The foundations of the government's strategy remain:
16. In support of the PRSP, the government has begun to develop a medium-term expenditure framework for 2005-07 with assistance from our development partners. The key macroeconomic assumptions underpinning this framework are broadly consistent with those of the PRGF arrangement set forth in our previous memorandum: (i) real GDP growth on the order of 5-7 percent; (ii) inflation between 2 percent and 3 percent; and (iii) a gradual increase in gross international reserves to the equivalent of 2½-3 months of imports of goods and services. Broad money is projected to grow broadly in line with nominal GDP, and credit to the economy would need to grow somewhat more rapidly to provide the necessary support to the private sector. The government anticipates the need for additional budget support during this period and will convene a donor conference in the second half of 2004 to seek the support of our development partners.
V. Program Monitoring
17. Program implementation through the end of December 2004 will be monitored according to the performance criteria and benchmarks presented in Tables 3 and 4. The definition of the variables monitored as quantitative performance criteria and benchmarks and reporting requirements are set out in the attached technical memorandum of understanding (TMU). The TMU is substantially unchanged from the TMU for the third review of the PRGF, but incorporates revised projections for the flows on which the program adjusters will be based. The fifth review will be conducted by December 15, 2004 and the sixth review, for the last disbursement, will be conducted by March 16, 2005.
1. This memorandum sets out the understandings between the Cape Verdean authorities and the IMF staff regarding the definition of the quantitative performance criteria and indicative targets and reporting requirements under the second annual program supported by the Poverty Reduction and Growth Facility (PRGF) arrangement.
A. Government Finances
2. Total government revenue is defined as the sum of all tax and nontax revenues, domestic capital participation, and net lending, cumulative since the start of the calendar year, excluding privatization proceeds and external grants. Tax revenue and nontax revenue are defined in accordance with the Government Finance Statistics Manual (GFS) 1986, Section IV.A.1.
3. The floor on the primary current fiscal balance cumulative from the beginning of calendar-year 2004 constitutes an indicative performance target. The primary current fiscal balance is defined as the difference between total government revenue (defined above in para. 1) and current primary expenditures on a commitment basis. Current primary expenditures equal total government expenditures on a commitment basis less interest obligations on external and domestic debt, capital expenditures, extraordinary expenditures on social emergency measures, and retrenchment payments made as part of the public enterprise privatization and liquidation reform.
4. For the purposed of this memorandum, privatization proceeds will be understood to mean all monies received by the government from the sale or concessioning of a public company, organization, or facility to a private company or companies, organization(s), or individual(s), as well as any proceeds generated from the liquidation of a public company, less restructuring costs.
5. Reporting requirements. Data on the implementation of the budget compiled by the Ministry of Finance and Economic Planning will be provided on a quarterly basis, to be submitted not later than five weeks after the end of each quarter, including (i) government revenue by category, including external budget support grants; (ii) government expenditure, including primary current expenditure, domestic and external interest payments, and capital expenditure, including domestic capital expenditure and estimates of externally financed capital expenditure; (iii) the gross payment and gross accumulation of domestic payments arrears; (iv) external loan receipts and principal payments; (v) external arrears payments and accumulation; (vi) bank and nonbank financing; (vii) privatization receipts; and (viii) any other revenue, expenditure, or financing not included above.
B. Net Domestic Assets of the Central Bank
6. The ceiling on the cumulative change, from the beginning of calendar-year 2004, in net domestic assets of the Bank of Cape Verde (BCV) constitutes a performance criterion. Net domestic assets (NDA) of the BCV are defined as reserve money minus net foreign assets of the BCV, evaluated at the program exchange rates presented below. The program ceilings for NDA will be adjusted downward (upward) by the cumulative downward (upward) deviations in external debt service and upward (downward) by the cumulative downward (upward) deviations in nonproject external financial assistance relative to program assumptions. For purposes of calculating the adjusters, these flows will be valued at current exchange rates. Reserve money comprises bank reserves and deposits of the monetary institutions and private sector with the central bank, as well as cash in circulation.
7. Reporting requirements. The preliminary monthly balance sheets of the BCV and the consolidated commercial banks will be transmitted on a monthly basis, with a maximum delay of five weeks. The definitive version of the monthly balance sheet of the BCV will be provided as soon as available.
C. Net Bank Credit to the Central Government
8. The ceiling on the cumulative change, from the beginning of calendar-year 2004, in net credit to the central government from the banking system constitutes a performance criterion. Net credit to the central government from the banking system (NCCG) is defined as the overall position of the main central government institutions vis-à-vis the banking systemthat is, the stock of all outstanding claims on the central government (loans, advances, and all other government debt instruments, such as long-term government securities) held by the central bank and by commercial banks, less all deposits held by the central government with the central bank and with commercial banks, as they are reported monthly by the BCV to the IMF. The INPS (the social security agency) is not included in central government accounts. Net bank credit to the central government excludes claims on the Trust Fund (TCMFs).
9. Claims on the central government held by the central bank comprise the following items: (i) crédito conta corrente OGE; (ii) Tesouro público protocolo; (iii) títulos governo centralobrigações nova serie; (iv) créditos a regularizar m/n e m/e; (v) outros créditos ao governo; and (vi) any other claims, or claims on the central government to be regularized, held by the central bank.
10. Deposits held by the central government with the central bank comprise the following items: (i) depósitos do governo centraldepósitos a ordem m/n; (ii) depósitos do governo centraldepósitos a ordem m/e; and (iii) outros depositos do governo central.
11. Claims on the central government held by the commercial banks comprise the following items: (i) obrigações do Tesouro; (ii) bilhetes do Tesouro; (iii) protocolos; (iv) empréstimos; (v) outros títulos; (vi) outros créditos; and (vii) any other claims, or claims on the central government to be regularized, held by the commercial banks.
12. Deposits held by the central government with the commercial banks comprise the following items: (i) dep. governo central em m/nD.G.T.; (ii) dep. governo central em m/nserviços autónomos; (iii) dep. governo central em m/nfundos autónomos; (iv) dep. governo central em m/nprojectos de investimentos; (v) dep. governo central em m/nfundos de contrapartida; (vi) dep. governo central em m/ninstitutos c/autonomia administ. e financeira excepto INPS; (vii) dep. governo central em m/e; and (viii) outros passivos com o governo.
13. The program ceilings for the NCCG will be adjusted downward (upward) by the cumulative downward (upward) deviations in external debt service and upward (downward) by the cumulative downward (upward) deviations in nonproject external financial assistance relative to program assumptions. For purposes of calculating the adjusters, these flows will be valued at current exchange rates. In addition, the ceilings for the NCCG will be adjusted downward by the shortfall in cash payments of domestic arrears relative to program assumptions.
14. Reporting requirements. The preliminary monthly balance sheets of the BCV and the consolidated commercial banks will be transmitted on a monthly basis, with a maximum delay of five weeks. The definitive version of the monthly balance sheet of the BCV will be provided as soon as available.
D. Ceiling on Nonconcessional External Debt Contracted
15. Under the program, ceilings on medium- and long-term, as well as on short-term, nonconcessional external debt constitute performance criteria. These performance criteria are on a continuous basis. Nonconcessional external debt is defined as debt contracted or guaranteed by the central government with a grant element of less than 35 percent, calculated using currency-specific commercial interest reference rates (CIRRs) published by the Development Assistance Committee of the Organization for Economic Cooperation and Development (OECD). Debt rescheduling and debt reorganization are excluded from the limits on nonconcessional external debt. The limits on new nonconcessional external debt contracted or guaranteed by the central government (excluding borrowing from the Fund) are specified in Tables 1 and 3 of the memorandum of economic and financial policies. The definition of short-term nonconcessional external debt excludes normal short-term (less than one year) import-related financing. The Portuguese government's precautionary credit line in support of the exchange rate peg is also excluded from the definition of nonconcessional external debt. In addition, the central government will not guarantee any external debt contracted by state enterprises and will maintain the policy of not guaranteeing private sector external debt. The performance criterion on medium- and long-term nonconcessional external indebtedness applies not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-(00/85), 8/24/00) but also to commitments contracted or guaranteed for which value has not been received. With respect to the performance criterion on short-term nonconcessional external indebtedness, the term "debt" has the meaning set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-(00/85), 8/24/00).
16. Reporting requirements. The government of Cape Verde will consult with Fund staff before assuming any liabilities in circumstances where they are uncertain whether the instrument in question falls under the performance criterion. Details of all new external debt (including government guarantees), indicating terms of debt and creditors, will be provided on a quarterly basis within five weeks of the end of each quarter.
E. Net International Reserves of the Central Bank
17. The floor on the cumulative change, from the beginning of calendar-year 2003, in net international reserves (NIR) of the BCV constitutes a performance criterion under the program. The NIR of the BCV are defined as gross international reserves of the BCV net of its short-term external liabilities, calculated at the program exchange rates described below. Gross reserves of the BCV are those that are readily available (i.e., liquid and marketable and free of any pledges or encumberments), controlled by the BCV and held for the purposes of meeting balance of payments needs and intervening in foreign exchange markets. They include gold, holdings of SDRs, the reserve position at the IMF, holdings of foreign exchange and traveler's checks, demand and short-term deposits at foreign banks abroad, fixed-term deposits abroad that can be liquidated without penalty, and any holdings of investment-grade securities. External liabilities of the BCV comprise liabilities to nonresidents contracted by the BCV with an original maturity of less than a year, any net off-balance-sheet position of the BCV (futures, forwards, swaps, or options) with either resident and nonresidents, any arrears on principal and interest to external creditors and suppliers, and purchases from the IMF. The program floors for the NIR will be adjusted upward (downward) by the cumulative downward (upward) deviations in external debt service and downward (upward) by the cumulative downward (upward) deviations in nonproject external financial assistance relative to program assumptions. For purposes of calculating the adjusters, these flows will be valued at current exchange rates.
18. Reporting requirements. A table on the NIR prepared by the BCV will be transmitted on weekly basis, with a maximum delay of two weeks.
F. Nonaccumulation of New Domestic Payments Arrears
19. As part of the program, the government will not accumulate any new domestic payments arrears. This will be monitored through the monthly execution of the cash-flow plan and the corresponding release of budget appropriations. For programming purposes, a domestic payment obligation to suppliers is deemed to be in arrears if it has not been paid within the normal grace period of 60 days (30 days for government salaries and debt service) or such other period as has been contractually agreed with the supplier after the verified delivery of the concerned goods and services, unless the amount or the timing of the payment is subject to good faith negotiations between the government and the creditor.
20. Reporting requirements. The Ministry of Finance and Economic Planning, through the D.G.T., will submit on a quarterly basis a detailed table of the stock of domestic payments arrears, including the accumulation, payment, rescheduling and write-off of domestic payments arrears during the quarter. The data are to be provided within four weeks after the end of the quarter.
G. Nonaccumulation of External Payments Arrears
21. As part of the program, the government will not accumulate any new external payments arrears on a continuous basis. This will be monitored through the monthly execution of the cash-flow plan and the corresponding release of budget appropriations.
22. External arrears are defined as total external debt-service obligations of the government that have not been paid by the time they are due, unless the definition of an arrear has been defined contractually between the government and creditor. External arrears exclude arrears on external debt, pending the conclusion of debt-rescheduling agreements.
23. Reporting requirements. Data on (i) debt-service payments; and (ii) external arrears accumulation and payments will be transmitted on a quarterly basis by the Ministry of Finance and Economic Planning, within five weeks of the end of each quarter. In addition, the government will inform the Fund staff immediately of any accumulation of external arrears.
H. Program Exchange Rates and Nonproject Budgetary Support
24. Performance under the program will be assessed based on program exchange rates. Foreign currency amounts will be evaluated at the following program exchange rates:
CVEsc 110.3 = €1; CVEsc 87.3 = USD 1.00; and CVEsc 129.7 = SDR 1.
25. The 2004 program assumes the following nonproject budget support during 2004: (i) €2.5 million from the European Union in the third quarter of 2004 and €3 million in the fourth quarter of 2004; (ii) US$15 million from the World Bank in the fourth quarter of 2004; (iii) US$3.0 million from the African Development Bank, in the fourth quarter of 2004; (iv) €3 million from the Netherlands in the second quarter of 2004, as stipulated in the TMU for the Third Review; and (v) the repayment during the first quarter of 2004 of the outstanding €1 million from the Portuguese credit facility drawn in 2003 and the drawing of €5 million from the Portuguese credit facility in the first quarter of 2004, as stipulated in the TMU for the Third Review; €4 million of the Portuguese credit line drawings will be repaid in the fourth quarter of 2004.
II. Other Data Requirements for Program-Monitoring Purposes
26. Data on exports and imports, including volume and prices and compiled by the Director of Customs and the BCV, will be transmitted on a quarterly basis within five weeks after the end of each quarter. A preliminary quarterly balance of payments, compiled by the BCV, will be forwarded within five weeks after the end of each quarter.
27. The monthly disaggregated consumer price index for Cape Verde, compiled by the National Institute of Statistics (INE), will be transmitted monthly, within five weeks after the end of each month.
28. Documentation of all measures taken by the government to meet performance criteria or indicative benchmarks under the program will be transmitted to the Fund staff within one week after the day of implementation.
1 See Table 1 of the memorandum on economic and financial policies (MEFP).
2 The data source used to evaluate the performance criteria on net domestic credit to the central government, net domestic assets of the central bank, and net international reserves will be the Cabo VerdePanorama Bancario tables prepared monthly by the Bank of Cape Verde (BCV) Statistics and Research Department and forwarded electronically to the IMF African and Statistics Departments.