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International Monetary Fund
Observations of the Interim Consultation Mission
September 10, 2001
1. Economic growth in 2000 was satisfactory, despite a drop in agricultural production caused by drought and a deceleration in the rate of growth of tourism after an exceptional year in 1999. Inflation remained stable. A flexible exchange rate policy, prudent fiscal and monetary policies, and increased opening of the economy prevented robust growth from placing excessive pressure on domestic resources.
2. The strong performance of exports suggests that the structural reforms implemented in recent years are bearing fruit. Those reforms are in fact at the source of the increased productivity and improved competitiveness in the export sector. The year 2000 was, however, marked by a widening current account deficit of the balance of payments. This resulted in part from cyclical factors, such as low grain production, a drop in olive oil exports, a rise in the price of petroleum products, and an appreciation of the dollar, but it also appears to be the result of a structural transformation in the Tunisian economy. The reduction in tariffs under the Association Agreement with the European Union (AAEU) has helped to integrate the Tunisian economy into the world economy and, at the same time, made economic growth more dependent on the external sector. The deterioration of the external current balance could be interpreted favorably, if it is seen as a symptom of the development and diversification of the Tunisian economy. It does, however, pose challenges in terms of macroeconomic policy: in the short term, this deficit must be financed without relying on foreign exchange reserves; and, in the medium term, sufficient savings must be generated to reduce the deficit of the external current account.
I. OUTLOOK FOR 2001
3. A strong manufacturing sector and a solid performance in the tourism sector is expected to raise real GDP growth to approximately 5.5 percent in 2001, even though continued drought will weaken growth in the agricultural sector. Good inflation results for the first half of the year are in line with the inflation target just under 3 percent on average for the year, despite a significant rise in the price of subsidized goods (produits compensés).
4. Preliminary data for the first seven months of the year confirm the acceleration of export growth observed in 2000. Nonetheless, robust domestic demand will drive up import levels (particularly raw materials and durable goods), which will make it difficult to reduce the deficit of the external current account below 4 percent of GDP. This level is not sustainable over the medium term because, barring a drop in the import coverage of foreign reserves, it would lead to a significant increase in external debt relative to GDP. Indeed, without recourse to the international financial markets in February, foreign exchange reserves would have continued to fall. Further borrowing on international financial markets should make it possible to reach a satisfactory level of reserves by year-end. However, the staff believes that, as a result, external debt in relation to GDP would rise in 2001.
5. The budget objectives for 2001 appear to have been met. Tax revenue, which benefited from strong imports, robust economic activity, and better tax collection efforts, will be significantly higher than budget estimates. Therefore, despite the reduction in external tariffs, tax revenues should remain stable or perhaps rise in 2001 as a percent of GDP. Spending has been in line with budget projections. If total receipts exceed projections, the surplus should be used to reduce the deficit below the target of 2.9 percent of GDP, as set forth in the budget law (loi de finances), as this would help to ease pressures on the balance of payments.
6. After allowing net domestic assets to rise in 2000 to offset a drop in net foreign assets, the Central Bank has implemented a more active monetary policy since the second quarter of this year, thanks to the adoption in recent months of a number of measures aimed at strengthening monetary management. The reduction in refinancing accorded to commercial banks at credit auctions has led to a rise in the money market rate, which, for the first time in years, has risen significantly above the auction rate. This illustrates the authorities' strict management of monetary conditions. Monetary restraint is justified in the current situation, although it has not yet had an effect on the growth of M4, which in the first half of the year was higher than projected in the Central Bank's 2001 monetary program. While this reflects in part government borrowing on international markets, monetary developments should still be monitored closely to ensure that the M4 growth objective is met. This will be important both to reduce pressures on the external balance and to preserve the credibility of monetary policy objectives.
7. In due time, further consideration should be given to the choice of the most appropriate monetary policy objective as the remaining liquid treasury bills come to maturity. It will also be important to improve the central bank's ability to project and monitor liquidity conditions. Technical assistance from the Fund in this area is available.
8. The more flexible approach to exchange rate policy has benefited export performance. The central bank has allowed the dinar to depreciate more than required to maintain the real exchange rate in order to compensate for the impact of the reduction in external tariffs. This should produce a favorable impact on the external balance. However, to support this policy, the authorities must continue to pursue prudent monetary and fiscal policies. It is important to note that action on the exchange rate front is not a substitute for the fiscal adjustment needed to redress external imbalances.
II. OUTLOOK FOR 2002 AND FOR THE MEDIUM TERM
9. In order for the Tunisian economy to achieve a higher level of growth, the authorities need to:
· Foster productivity growth by accelerating the reform and liberalization processes already under way; and
· Reduce the deficit of the external current account to ensure that it does not become an obstacle to higher growth.
10. Regarding structural reforms, the measures envisaged by the government in the context of the Economic Adjustment Loan (ECAL) III negotiated with the World Bank, the African Development Bank (AfDB), and the European Union (EU), are likely to lead to major productivity gains.
11. Increased domestic savings are needed to remove the obstacles posed by the external deficit on growth. While structural reforms, particularly in the financial field, do help to improve private savings, this takes time and is difficult to quantify. In fact, the most effective way to raise the domestic resources available to finance investment is to increase public savings. Therefore, the mission feels strongly that the tenth plan undertake a larger medium-term fiscal adjustment than is currently projected. In particular, the mission believes it is essential for the 2002 draft budget law to target a significant reduction in the deficit to give a strong signal that the widening current account deficit in 1999 and 2000 was temporary and that the government is prepared to take action to bring the external current account deficit to a level that does not imply an increase in external debt. In this regard, the mission is pleased with the authorities' intention to reduce the budget deficit in 2002 by one half-percentage point of GDP.
A. Structural Reforms
12. Among the many structural reforms launched, the mission would like to stress the importance of continuing the reform effort in the following areas:
· The reform of the banking and financial sectors, taking into account the recommendations from the Financial Sector Assessment Program (FSAP): the continued restructuring of the sector, which has already led to significant improvements, should be accompanied by a change in the credit culture.
· Privatization: the public offer for granting the second mobile phone license should be issued again in order to open the sector to competition and improve the quality of telecommunications services.
· Multilateral trade liberalization: the reduction in tariffs in the context of the AAEU should be accompanied by reductions in customs duties for countries outside of the European Union in order to reduce the risk of trade diversion. To this end, efforts aimed at enhancing economic integration in North African (Maghreb) countries should be intensified.
B. Public Finances
13. Although the budget position has improved, particularly as a result of tax collection efforts and the increase in the price of subsidized goods, fiscal adjustment needs to continue over the medium term, bearing in mind the following points:
· The rise in the price of petroleum products on international markets has led to a noticeable drop in petroleum revenues allocated to the budget. The decision to only partially adjust domestic prices has led to profit losses at the distribution level in the context of a gradual decline in Tunisian petroleum resources. If the price of petroleum products remains close to current levels, the contribution of petroleum revenues to the budget will decline over time. Therefore, domestic prices will have to be brought gradually in line with world prices and consideration should be give to the adoption of an automatic adjustment mechanism.
· The impact of trade liberalization on revenues has not been fully felt since high import growth has largely offset the impact of the drop in customs duties on customs receipts. Should the pace of growth decline, the impact of tariff reductions on customs receipts will have to be offset by a broadening of the tax base.
· The wage bill remains very high at 11.7 percent of GDP in 2001. It will be difficult to generate the public savings needed without reducing this ratio. On the basis of the growth objectives outlined in preliminary projections for the tenth plan, it appears that it would be possible to reduce this ratio while maintaining public employment at current levels, even in presence of increasing real wages. Furthermore, the review of public expenditures planned in cooperation with the World Bank is an excellent opportunity to identify possibilities for redeployment and reduction in government operations that could generate greater saving, without affecting the quality of public services.
III. OTHER OBSERVATIONS
14. The mission congratulates the authorities for their subscription to the SDDS in June 2001, which is an important step towards greater transparency in economic policies.
15. The mission congratulates the authorities for their participation in the FSAP, currently being finalized by the World Bank and the International Monetary Fund. Implementation of the main FSAP recommendations could be discussed during the next Article IV mission.
16. The mission warmly congratulates the authorities for their decision to publish these preliminary conclusions.
17. It was agreed to hold the next Article IV consultations discussions in February 2002.