Preliminary Findings of the 1999 Article IV Consultation Mission -- Tunisia
June 16, 1999
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Tunisia -- Preliminary Findings of the 1999 Article IV Consultation Mission
June 16, 1999
1. Tunisia's economic performance remains highly satisfactory in a difficult international environment characterized by the fallout from the financial crisis that hit the emerging market economies and by the slackening of growth in Europe, the country's main export market. Despite these difficulties, growth reached 5 percent in 1998, with inflation stabilizing at around 3 percent per annum.
2. This economic performance was achieved through prudent and consistent macroeconomic policy management, grounded in a medium-term framework and effective policy coordination. Strong policy coordination has contributed to the clarity of objectives and the effective implementation of the government's economic strategy. The importance ascribed by the authorities to social development and to the growth of the country's human capital is also a determining factor in Tunisia's economic success. The objective of raising living standards to the level of industrial countries while gradually reducing unemployment will require additional efforts, particularly in the area of structural reforms.
3. Gross fixed capital formation, especially in the manufacturing and government sectors, was the driving force behind the growth of aggregate demand in 1998. Conversely, the growth of export of goods and services slowed down (to 3.8 percent) as a result of lower sales of crude oil and food products. Although imports also grew more slowly than GDP, the external current account deficit widened slightly to 3.4 percent of GDP, owing chiefly to the terms of trade deterioration brought about by slower world growth in 1998.
4. Tunisia's strong performance in 1998 reflects the continued pursuit of a prudent macroeconomic policy, including, in particular, substantial fiscal consolidation. The budget deficit, excluding privatization receipts, was narrowed from 4.3 percent of GDP in 1997 to 3.2 percent in 1998 (below the target of 3.4 percent). Despite the effects of the dismantling of trade tariffs, fiscal revenue increased by 0.5 percent of GDP owing to the hike in the main VAT rate, the expansion of its base, and the introduction of 50 percent withholding at source for VAT due on sales to public administrations. Moreover, debt service declined by 0.4 percent of GDP and substantial privatization receipts (1.8 percent of GDP) made it unnecessary to tap international capital markets on unfavorable terms while limiting domestic financing of the fiscal deficit to 1.4 percent of GDP.
5. The monetary objectives set for 1998 were generally attained. The real effective exchange rate was kept unchanged, the inflation rate fell below target (3.1 percent instead of 3.7 percent), and the growth of M4 leveled off at 8.9 percent, slightly lower than the growth rate of nominal GDP. Moreover, M3 expanded moderately, offsetting the previous two years' sharp increases linked to the central bank's assumption of the arrears of the Cereal and Edible Oil Offices. The central bank intervention rate remained at its April 1997 level of 6.875 percent throughout 1998. In February 1999, following the observed drop in inflation, the president of the Republic announced a reduction of 100 basis points.
6. After two difficult years, the Tunisian Stock Exchange regained strength in 1998 as reforms were put in place to increase efficiency and transparency; these include introduction of a CAC40-type market index, based on stock market capitalization weights (TUNINDEX), and real-time price quotations on Reuters. Trade volume increased 57 percent during the year, with foreign investors accounting for half of the total trade volume. Market capitalization was 11 percent of GDP at the end of 1998, 20 percent of which was held by foreign investors.
7. Structural reforms progressed on several fronts:
· Banking sector: reform of the banking sector continued in the context of a structural adjustment program formulated with the World Bank, including the consolidation and restructuring of bad loans to public enterprises, the strengthening of the regulatory and prudential framework (adoption of a capital adequacy ratio of 8 percent applicable as of December 31, 1999 and reform of the banking law to establish universal banking), and merger of selected government-owned banks. The average capital-asset ratio rose from 6.3 percent in 1997 to 8.9 percent in 1998, with 2 banks instead of 3 not complying with the present minimum level of 5 percent.
· Industrial restructuring: the program to restructure private industrial enterprises launched in 1996 to prepare them for the liberalization of markets and European competition was quite successful, particularly among small- and medium-sized enterprise (SMEs). At end-May 1999, 521 enterprises out of the targeted 4,000 had received investment assistance. The total amount of investment generated amounted to TD 1,196 million. Another 500 companies are likely to submit restructuring plans by year's end.
· Privatization: following the sale of two large cement plants in 1998 for a total of TD 418 million, the volume of privatizations slowed markedly in 1999 because of delays in preparing the other cement plants for privatization.
· Liberalization and demonopolization: government withdrawal from the productive sectors continued with the granting of the first concession for the private production of electricity and the opening of certain port activities to competition.
· Generalized food subsidies (compensation): the authorities continued to raise the prices of subsidized products in line with the objective of keeping a lid on budgetary subsidies.
8. Social indicators remain outstanding at the regional level, and the authorities' attention to social problems merits special mention. However, the unemployment rate is still high (15-16 percent) and graduates are increasingly unable to find work. Although the problem mainly affects new arrivals on the labor market, job losses are beginning to emerge as a cause of unemployment. The authorities have adopted measures to overcome the skills and information shortage that drives a wedge between job supply and demand. The computerized system to match job seekers and job offers, which is made available to the public through intranet, is state-of-the-art and could serve as an example to other countries.
9. It is expected that the positive macroeconomic results achieved in 1998 will be reinforced in 1999 with growth rising to 6.5 percent. This does not necessarily reflect an improvement in trend growth, but is explained to some extent by exceptional factors such as the good crop year and the diversion of Mediterranean tourism to Tunisia due to the war in the Balkans and security concerns in Turkey. Still, domestic demand remains very dynamic. Gross fixed capital formation (GFCF) is expected to increase by 12 percent (in volume terms) in 1999, boosting the investment rate to 26.3 percent of GDP. By contrast, the volume of exports of goods and services is expected to grow by only 4.2 percent. The projection of an unchanged inflation rate (3 percent) rests on the assumption that the sectoral negotiations in progress will result in far more modest wage increases than in 1996.
10. The external current account deficit is projected to widen slightly to 3.7 percent of GDP in 1999, despite an upturn in the terms of trade. Structural and cyclical factors alike account for this development, including Tunisia's relative cyclical position, the high investment rate, and the trend deterioration in the energy balance. One encouraging note, however, is the prospect for a further rise in the rate of domestic saving in 1999.
11. The prudent stance of fiscal policy is reaffirmed by the 1999 objectives and the measures deployed to achieve them. The 1999 Budget Law targets a fiscal deficit (excluding privatization receipts) in line with the objectives of the IXth Plan, i.e., 3.5 percent of GDP. This target is expected to be met inasmuch as nonbudgeted expenditures (particularly the civil service wage increase) are being offset by new tax measures (notably the increase in fuel excise taxes in April 1999) and the substantial savings realized on food subsidies due to the drop in import prices.
12. The authorities' pursuit of a prudent monetary policy in 1999 will allow for the noninflationary financing of growth. The expansion of M3 is projected at 9.6 percent, in line with the nominal GDP growth rate. Given the planned increase in net foreign assets of TD 265 million and the absence of new net credit to the government, this should allow credit to the economy to grow at a rate of 9.3 percent.
13. Owing to the deterioration of the current account balance, it will not be possible to aim at a very ambitious reserve target. Reserves are projected to reach the equivalent of 2.7 months of imports at c.i.f. prices by end-1999. This objective will make recourse to the international financial markets necessary before year's end. The country's good economic fundamentals should enable the Tunisian government to obtain more favorable financing conditions than those available last year, in the lower range of the band of rates currently offered to emerging market economies.
14. The IXth Plan objective of achieving trend growth of 6.5 percent and thereby ensuring a steady reduction of unemployment as of 2000 is within the authorities' reach. The government's strategy, based on increased investment in a context of social stability and preservation of macroeconomic equilibria, is an essential prerequisite. The mission believes that the growth objective will also require the acceleration of structural reforms and the strengthening of the private sector's role. In this context, six major challenges are identified:
· Strengthening the growth of exports and of the domestic tradeable sector in the face of growing competition, owing to the rollback of customs duties and the competitiveness gains of countries that compete with Tunisia on European markets. The weakening of export growth and the stabilization of Tunisia's market share in EU imports of manufactured goods show that this will not be an easy objective to attain.1
15. The integration of overall fiscal, monetary, exchange, and structural reform objectives and the prudent management of macroeconomic equilibria already constitute a major step toward meeting the six challenges mentioned above. We would like to stress in this context the stakes involved in each area of economic policy.
A. Government Finances
16. The fiscal deficit reduction objectives established under the IXth Plan will continue to guide the management of government finances. Additional savings are needed to finance the economy's investment needs without jeopardizing the stability of the external accounts, and to create a sufficient room for maneuver in the event of a shock affecting economic activity or the balance of payments. Budgetary retrenchment would also help offset the structural deterioration of the social security accounts linked to demographic factors.
17. The customs duties rollback will continue to limit the scope for fiscal tightening. Current discretionary spending has already been greatly reduced. The wage bill and interest alone account for 70 percent of current expenditure, and it will be difficult to scale them back in the short term. Lowering the fiscal deficit to 2 percent by 2001 will therefore require actions on several fronts.
18. On the revenue side, additional efforts to boost tax revenues must be made to offset forgone customs revenue and stabilize the tax revenue/GDP ratio. The action taken to boost the tax collection in 1998-99 is a step in the right direction; it should be backed up with other administrative measures, particularly better-targeted tax audits. However, administrative measures alone will not suffice to offset the revenue forgone as a result of the customs duties rollback. As tax rates are already quite high (for both VAT and direct taxes), measures will have to focus on expanding the tax base, particularly by reducing those tax exemptions whose effectiveness may be questionable.2 In any case, it would be useful to assess_systematically and as fully as possible_the medium-term fiscal costs of tax exemptions in order to better gauge their effectiveness.
B. Inflation, Wage Policy and Exchange Rate Policy
24. Given that exchange rate policy has been assigned to maintaining the economy's price competitiveness, the reduction of inflation and its stabilization at a low rate have to rely essentially on prudent wage and monetary policies. The wage increases of 1996-1998 (5-8 percent per year, depending on the sector) were more than likely accompanied by substantial gains in labor productivity, resulting in an annual structural inflation rate of close to 3 percent. Similarly, inflationary trends over the next three years will be largely determined by the wage increases under negotiation in 1999 and the productivity gains achieved over the period covered by the agreements. Against this background, the monetary policy framework sets the growth rate of the money supply and of credit compatible with the estimated inflation path, without actually setting an inflation target.
25. As the authorities have stressed, this price setting process has a number of advantages from a macroeconomic standpoint. First, tripartite wage negotiations (involving social partners and the government) guarantee a considerable degree of social stability, which is itself a source of productivity gains. Second, by maintaining a stable effective real exchange rate, the authorities avoid any loss in competitiveness connected with a surge in wage costs_from the point of view of enterprises, the outcome of wage negotiations is less of a constraint for competitiveness to the extent that they know that any resulting price increase will be accommodated by a depreciation of the exchange rate.
26. However, this process is not without disadvantages. Real exchange rate targeting, even if pursued flexibly, does not compensate for competitiveness shocks that are not associated with relative changes in consumer prices. For example, the dismantling of trade tariffs or the lifting of quotas on the textile exports of Tunisia's competitors in third markets is equivalent to an appreciation of the real exchange rate. They could therefore justify additional adjustments in the exchange rate. Under these circumstances, it would seem appropriate to introduce factors other than relative consumer price in determining the appropriate level for the exchange rate. A more accurate assessment of the competitiveness of the Tunisian economy could be based, for example, on changes in Tunisia's export market share relative to that of its major competitors. Similarly, it would be useful to monitor an indicator of unit labor costs in the sectors exposed to international competition. The establishment of the Center for Industrial Forecasting Studies (CEPI), responsible for conducting analyses of sectoral competitiveness, is an important step in this direction, but a more comprehensive approach would also be desirable.
27. The current system of negotiating sectoral wages over a three-year period has some advantages and should be maintained. However, in order for wage increases to be anchored on anticipated inflation and expected productivity gains, it would be advisable to establish more clearly the authorities' inflation targets over the period covered by the wage negotiations. Furthermore, in a context of greater openness to international competition and increased risks for enterprises, it is important to give individual enterprises some leeway (within sectoral collective agreements) to adapt the terms of remuneration of labor to their profitability conditions.
28. Lastly, in light of the substantial improvements in real wages recorded over the past three years and also of the constraints that deficit reduction will impose in the years to come, it would be advisable to contain wage increases in the upcoming public sector negotiations.
C. Monetary Policy
29. Monetary policy has supported the marked reduction in inflation observed since the beginning of the 1990s, by setting prudent annual growth paths for credit to the economy and for monetary aggregates. The monetary authorities have actually focused on the growth rate of credit to the economy as the primary intermediate objective, while ensuring that monetary growth was compatible with nominal GDP growth.
30. However, in the coming year innovations on the capital markets (e.g., introduction of fungible Treasury bonds (BTAs) and, eventually, of short-term fungible Treasury notes (BTCAs), added incentives for companies to be listed on the stock exchange, and development of mutual funds) and the inclusion of development banks in the monetary statistics may destabilize the monetary aggregates. The M4 aggregate has already lost its significance with the maturing of traditional short-term treasury paper (BTC) which is included in this aggregate. A broader liquidity aggregate could usefully replace M4, by including mutual fund shares, all Treasury bills and bonds. In the meantime, changes in M2 should provide a better measure of potential inflationary pressures. In any event, it would be useful to monitor additional indicators to improve monetary policy control: for example, the index of nonadministered prices (excluding energy and food) could provide a useful measure of underlying inflation, and a real estate price index could help gauge any excessive increase in asset prices.
31. The authorities' objective to restore the level of foreign exchange reserves to the equivalent of three months of imports by the end of next year implies a significant increase in reserves in 2000. To the extent that Tunisia_s exposure to short-term capital flows remains minimal, the reserve level targeted by the authorities seems adequate in coping with possible balance of payments problems. Though the short-term debt may appear high in relation to the current level of reserves, a large portion of this external short-term debt consists of deposits of Tunisians residing abroad, which are relatively stable to the extent that they are counterpart to economic operations in Tunisia.
32. At present, the interest rate does not play a very active role in the conduct of monetary policy. Even though the recent reduction in the Central Bank repurchase rate is per se consistent with the stabilization of inflation at its present level, it does not appear to be linked directly to the attainment of the intermediate objectives of monetary policy. Furthermore, in the absence of an efficient interbank market, the money market rate fails to provide a true measure of the marginal cost of money. Consequently, attainment of the quantitative monetary and credit objectives relies partly on allocation mechanisms that are not necessarily market-determined.
33. Eventually, it would be desirable for the interest rate to play a more active role in credit allocation and to become the main instrument of monetary policy. This would also require that the monetary authorities accept wider fluctuations of the money market rate within a range defined by a floor rate (the repurchase rate) and a ceiling rate (end-of-day refinancing rate). By letting the money market rate fluctuate within a band defined by its intervention rates, the central bank would obtain useful information on market pressures, which would enable it to improve monetary control.
34. For interest rates to play a stronger role, the money market must be developed. Steps have already been taken to that end, with the introduction of auctioned fungible Treasury bonds (5- and 10-year maturities) in March 1999 and the adoption by the Council of Ministers of a revised Central Bank charter, which will enable the Bank to intervene more easily in the Treasury bill. This should enable the central bank to rely on open market operations and repurchase operations instead of the current ad hoc refinancing operations.
35. Other measures that would support the development of a money market include:
· Expanding the range of eligible guarantees for refinancing operations to all class 1 loans and, possibly, to Treasury bills.
· Introducing repurchase agreements to make interbank operations more secure.
· Making the market for negotiable securities (TCNs) more dynamic by removing some of the existing restrictions (e.g., requiring bank guarantees for commercial paper, prohibiting the repurchase of securities by the paying agent, restricting the secondary market to banks, requiring a minimum maturity of 90 days for certificates of deposit).
· Extending the coverage of the settlement/delivery system operated by STICODEVAM to central bank operations in Treasury bills and to other negotiable securities (commercial paper and certificates of deposit).
· Reducing restrictions on the remuneration of saving accounts of less than three months maturity.
D. Structural Reforms
36. The role of structural reforms in the growth strategy is two-tiered. On the one hand, they are necessary to increase the productivity of enterprises and therefore their international competitiveness. On the other, they increase returns to capital and thus stimulate investment.
37. It is also essential, in the transition to an open market economy, that the private sector be able to assess for itself the opportunities and to manage the risks inherent to greater openness and liberalization. The industrial restructuring (mise à niveau) and training/retraining programs are doubly effective in this regard: they increase productivity and prepare the private sector for competition. The government will continue to play an important role in strengthening the skills of the private sector and of the institutions that ensures the smooth functioning of a market economy.
38. However, increasing the dynamism of the Tunisian economy will require that the government move more quickly to reduce its direct involvement in the economy. Social considerations should not lead one to underestimate the latitude that exists for accelerating economic liberalization. Distortions induced by the differences in the pace of liberalization across sectors adversely affect the efficiency of the economy. In particular, we deem that government action needs to be more decisive in the following areas:
· Privatization and demonopolization. Though the process of privatization continues, Tunisia_s lag by international standards could penalize growth. The mission hopes that the delays observed in 1999 in major privatization operations will be made up for in 2000-01. An accelerated pace of privatization and the opening up of the capital of public enterprises to private partners (both national and foreign) as well as the exposure to competition of sectors that are still under state monopoly (such as telecommunications) are crucial for a number of reasons. Over and above the positive impact on the productivity of the sectors exposed to competition and opened to private initiative, privatization and demonopolization have a positive fallout on the whole economy in terms of lower factor costs. Moreover, by enhancing opportunities for foreign direct investment, privatization and liberalization can ease the financing of the external current account deficit. Increased foreign share holdings would also accelerate the transfer of technology and modernize management methods. Lastly, the transfer of public enterprises to the private sector would ensure the profitability of their investments (which are currently experiencing very robust growth) and the solidity of the underlying bank financing. This process also calls for the liberalization of prices and profit margins in the sectors that are opened to competition.
· Trade policy. It would be advisable to move up the last phases of trade tariff dismantling in order to limit the distortions created by the increase in the effective rate of protection that accompanied the first phase of trade liberalization with the European Union. These distortions can be costly not only in terms of efficiency losses but also in terms of the subsequent cost of reconversion of human and capital resources, diverted to sectors benefiting from a temporary increase in the rate of effective protection. It would also be useful to widen tariff reduction across-the-board, on a multilateral basis, to avoid distortions deriving from trade diversion. The mission regrets that steps toward the planned lowering of the average tariff rate to 25 percent were not taken by the budget law of 1999 and recommends that a plan to that effect be adopted as soon as possible so that measures can be implemented by 2000. The authorities have begun a process of regional trade liberalization. The mission encourages Tunisia to continue in this direction by taking advantage of the political opening up in neighboring countries, with a view to establishing a genuine single market in the Arab Maghreb Union. This will enhance Tunisia_s attractiveness to foreign direct investors.
· Strengthening the banking system. The efforts under way in this area, and particularly the measures taken in 1998-99, have considerably strengthened the soundness of the banking system, though bad loans to the private sector still amount to 22 percent of GDP. The adoption of regulatory and tax measures facilitating the recovery of collateral, the write-off of nonperforming loans and provisioning have created the conditions for reabsorbing, over time, the burden of these bad loans. Meanwhile, new credit will be extended on a more informed basis once the central bank database on banks' clients (Centrale d'ínformation) becomes operational. Still, it would be useful to further simplify the unduly lengthy procedures for the court-ordered liquidation of companies, as envisaged in the draft amendment of the 1995 law on rehabilitating problem companies. In any case, it is essential that the government avoid assuming responsibility for remaining or new nonperforming loans. It is important in this connection to strengthen the credit culture at all levels. The recent initiative to cancel the debt of small farmers is justified from a social point of view, but it is important to ensure that the conditions that led to the problem in the first place do not recur. The mission was reassured by the proposed reforms directed at making assistance to farmers more transparent. The banking system should also pursue its modernization and improve its risk management practices. This process can be accelerated by privatizing public banks and attracting foreign partners.
· Education and employment. The government_s attention to the social needs of the population continues to be one of Tunisia_s assets. The industrial restructuring called for by the opening up of the Tunisian economy to foreign competition will lead to some job losses. The existing mechanisms for reintegration into the workforce should thus be expanded to limit the duration of unemployment. In addition, the emphasis on reducing the rate of school failure should enable the school system to better meet employers' need of skilled labor.
39. Tunisia has been concerned by the Y2K problem since 1997, and has put in place all the necessary structures to prepare the country for a smooth transition to January 1, 2000. The financial sector, government agencies, and all infrastructure are practically ready. Only small- and medium-sized enterprises have not as yet taken the necessary steps and will have to adjust by the end of this year or in the first months of 2000.
40. The mission congratulates the authorities for their initiatives to increase the transparency of economic policies and, in particular, for the decision to publish this document and the final report on the Article IV consultation.
41. The participation of Tunisia, as a pilot case among emerging countries, in the economic policy transparency exercise, a joint IMF-World Bank effort, should enhance the positive assessment of Tunisia in financial markets.
42. The goal of transparency has led the authorities to undertake a reform of the national statistics system, as provided by the law of April 13, 1999. The authorities have also decided to subscribe to the IMF special data dissemination standard by 2000. This will provide to international financial operators reliable information that is updated regularly and meets international standards. For this, it will be necessary to conduct an annual employment survey of households and to draw up quarterly national accounts.
43. The mission takes note of the authorities_ desire to obtain technical assistance in the areas of domestic debt management, external debt monitoring, and tax administration.
44. It was agreed that the next Article IV consultation will take place within the standard 12 months cycle.
1 It should be pointed out here that competitiveness gains may be achieved through a shift toward exported goods with greater value added. In the textile sector, for example, the upstream integration of production would increase the value added content of a given volume of exports. The enhancement of competitiveness would, in this case, be reflected in a smaller volume of imports.
2 For example, full exemption from corporate income tax (IS) has no particular effect on foreign investment, if the rate applicable in Tunisia is no higher than the rate in force in the company's country of origin. Generally speaking, and in the absence of a specific bilateral agreement, untaxed profits repatriated by a company are in fact taxed at the foreign country's rate. The IS exemption amounts, in this case, to a simple transfer of Tunisian tax revenues to the budget of the country of origin.