Mission Concluding Statements
Tunisia and the IMF
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INTERNATIONAL MONETARY FUND
Tunisia—Preliminary Conclusions of the Article IV
May 19, 2003
1. The IMF mission that visited Tunis from May 6-19, 2003 for consultations under Article IV of the Fund's Articles of Agreement would like to thank the Tunisian authorities for their warm welcome and the highly productive dialogue.
2. The resilience of the Tunisian economy, faced with a difficult international situation, a drop in tourism, and crops severely affected by drought, attest not only to the success of economic reforms undertaken in the last ten years, but also shows a sure hand in macroeconomic management. The pursuit of a prudent monetary policy coupled with the fiscal measures taken in 2002 have strengthened Tunisia's financial position and the external current account. This performance was also noticed by the financial markets, as evidenced by the favorable terms of the recent sovereign bond issue, the stability of interest rate spreads on the secondary market, and the higher rating assigned by specialized agencies, all this despite the outbreak of the military conflict in Iraq. Accordingly, the preparations begun by the authorities in consultation with Fund staff during the October 2002 interim mission, as well as the identification and adoption of economic policy measures designed to minimize the negative effects of the war on the Tunisian economy, have resulted in macroeconomic stability in an increasingly difficult environment.
3. Nevertheless, major challenges remain for Tunisia's economic policy. In the short term, Tunisia will need to position itself to take advantage of the global economic recovery following the current slowdown. In the medium term, two parallel objectives remain:
I. Short-Term Economic Outlook
4. The current uncertain world economic environment is likely to continue with business in Europe and the United States expected to recover only slowly. Nevertheless, the regional impact of the Iraqi conflict appears to be less severe than anticipated. The recovery of exports in the first four months of the year suggest the possibility of faster growth in the nonagricultural sector, which, together with a good harvest, would boost overall GDP growth to 5.5 percent in 2003, up from 1.7 percent in 2002.
5. Despite the assumption of stagnation in tourism flows, the pursuit of prudent fiscal and monetary policies in tandem with the recovery of exports is expected to lower the external current account deficit to 3.1 percent of GDP in 2003, compared with 3.5 percent in 2002.
6. The resources recently raised on the international markets, as well as the projected disbursement of two tranches of the World Bank ECAL III, are expected to finance the current account deficit and generate a balance of payments surplus. This will keep external reserves at three months of imports. The mission believes, however, that this level of reserves should be considered the minimum needed to guard against the ever-present risks in the international economic environment.
A. Fiscal Policy
7. The government continues to pursue a prudent fiscal policy. Despite the adverse economic conditions in 2002 and a wage hike stemming in part from the triennial wage negotiations, the budget deficit (excluding grants and privatization receipts) amounted to 3.5 percent of GDP, reflecting fiscal adjustment of 0.3 percent of GDP relative to the outturn for 2001.
8. The 2003 Budget Law projects a budget deficit of approximately 2.7 percent of GDP (excluding grants and privatization). However, preliminary first quarter results indicate that this target will be difficult to meet without additional measures. Tax receipts fell 1 percent in the first quarter compared with the same period in 2002, chiefly as a result of the slow growth in imports and investment. Moreover, the outlook for the year will depend on tourism and investment, which, in the first quarter of 2003, performed poorly. In addition, the budget will have to absorb a sizable increase in onlending (recorded as an expenditure).
9. To minimize deviations from Budget Law targets, the authorities are prepared to implement clearly defined measures in the event of slippage in the fiscal position. The mission applauds the authorities' determination in this regard and expects that the implementation of these measures would reduce the deficit to approximately 3.1 percent of GDP, a decrease of roughly 0.4 percent of GDP. The mission feels that this adjustment is sufficient for the current year, considering the lack of pressure on the external position, but views it as the minimum required for pursuing the important objective of reducing the public debt burden.
B. Monetary Policy
10. The Central Bank of Tunisia (BCT) has endeavored to make monetary policy more dynamic. In 2002, credit demand slackened in the wake of the economic slump. The BCT adjusted its monetary aggregates growth targets twice in response to persistent sluggishness in the economy. Credit to the economy, on the other hand, grew faster than nominal GDP in part by the easing in reserve requirements in 2002. The growth of credit did not lead to pressures on the external position, however, and inflation remained below 3 percent despite higher food prices related to the drought.
11. The aim of monetary policy in 2003 is to align aggregate credit growth with economic growth in a context of stable inflation. Although an easing of liquidity conditions now seems justified by the slow growth in monetary aggregates, the decline in the inflation rate in the first quarter, and the improved outlook for the foreign balance, the BCT must remain vigilant and modify its approach should demand pressures arise.
II. Medium-Term Outlook
12. The medium-term scenario reflects the government's ambitious objectives in terms of growth and the creation of employment. The slump in economic growth in 2002 highlights the need for measures aimed at maintaining sustained growth in the medium term and reducing the vulnerability of the Tunisian economy to exogenous shocks. At present, the job creation needed to reduce unemployment and significantly boost per capita income will require an acceleration in growth to an annual average of 6.5 percent in the 2004-2008 period. However, the enhanced productivity and investment required to achieve these objectives pose major challenges.
13. Public savings, like private savings, are expected to contribute to investment needs. For Tunisia to avoid higher levels of external debt and, consequently, reduce its vulnerability to exogenous shocks, the mobilization of foreign savings should focus on foreign direct investment. This can be accomplished only by significantly accelerating the structural reform process, particularly in the financial sector, as this will yield significant productivity gains.
14. To attain these objectives, the mission recommends action on two fronts:
A. Strengthening of Macroeconomic Policies
15. The increasing openness of the Tunisian economy, including the gradual liberalization of capital movements, will change the structural and institutional environment for policy making. To contain the risks and maximize the benefits of this openness, macroeconomic policies must be strengthened. Indeed, with the eventual removal of capital controls, an independent monetary policy can succeed only when the dinar is floated. Conversely, a floating exchange rate policy will work only if monetary policy becomes the nominal anchor for the economy. Price stability must therefore be the primary objective of monetary policy and the exchange rate should fulfill the function of ensuring external equilibrium.
Monetary Policy Framework
16. Acting on the recommendations of Fund staff, the BCT has taken several steps toward making monetary policy more dynamic. In particular, the operational framework for liquidity forecasting was significantly strengthened, enabling the BCT to calibrate its monetary interventions more accurately. The monetary instruments were also enhanced: three-month tenders for repurchase agreements were introduced; government securities are used more extensively as collateral than in the past in refinancing operations; open market operations were conducted for the first time; and the BCT's policy-related rates are now set exclusively by its board of directors. It will be necessary to strengthen monetary policy and ensure that it is implemented more dynamically, as a prerequisite to greater capital account opening.
Current framework and monetary policy instruments
17. Monetary policy decisions to achieve the inflation and external position targets have so far been based on growth in credit to the economy because of its close correlation with these targets. The BCT determines the overall volume of refinancing required in order to achieve its intermediate target. It also tries to affect the marginal cost of the banks' resources by varying the cost of the funds available to the banking system to satisfy the reserve requirement. To do this, it combines seven-day refinancing tenders with more costly refinancing in the form of three-month repurchase agreements, and, if necessary, reduces the overall volume of refinancing to achieve the intermediate target.
18. This approach seems to have yielded the expected results, as evidenced by the fact that inflation and the external position are under control. However, this approach also requires interest rate flexibility, which could be constrained by certain monetary policy procedures and instruments, such as fine-tuning operations. Greater interest rate flexibility could be further hampered by the fact that some banks are still in need of restructuring. As the interest rate and base money targets may be incompatible objectives, a clarification of the monetary policy framework and an adaptation of instruments are, for the present, both foreseeable and necessary in the short-term.
Clarification of the framework and adaptation of instruments
19. The mission and BCT staff note that the relationship between central bank refinancing of commercial banks and credit to the economy is unstable, unlike the relationship between base money and M3. Owing to the phasing out of transferable Treasury bills, which had obscured the relationship between M3 and inflation, M3 is expected once more to serve as a good indicator of future inflation. The mission believes that M3 should be adopted as an intermediate monetary policy target and base money as the operational target, owing to its more direct and predictable relationship with M3 than interest rates. Eventually, when the financial markets in general, and the money and exchange markets in particular, are more fully developed, a monetary policy framework targeting inflation more directly, with an interest rate as an operational variable, could be envisaged.
20. Regarding monetary policy implementation, bank liquidity management should be modified so as to calibrate BCT monetary interventions to meet the base money target. Accordingly, the time horizon for liquidity forecasting should be extended and the annual programming exercise broken down into monthly forecasts. However, this will require better projections of government cash flow. In addition, the pursuit of the base money operational target is not a static exercise. It should be monitored continually to assess the appropriateness of deviations from the monetary program. Monetary policy will be more transparent if deviations from the program and the reasons for monetary policy actions are explained to the public.
21. The volume of liquidity injected into the system by the BCT should be in line with the monetary program. The BCT should then let the market recycle this liquidity. Regarding the coordination of refinancing instruments and interest rates management, the BCT should rely either on the marginal refinancing facility and a permanent short-term deposit facility, limiting fine-tuning monetary operations to ease extreme deviations from liquidity targets. Less frequent interventions on the market by the BCT will allow the market to develop more fully.
Exchange Rate Policy
22. The pursuit of a more flexible exchange rate policy has led to a slight depreciation of the dinar in real effective terms. This has benefited Tunisian exporters. The authorities based their decisions in this regard on several competitiveness indicators. The mission believes that this policy fits well with the authorities' plan to float the dinar in the medium term. It encourages the authorities to continue moving in this direction and to implement the measures already identified for deepening the exchange market. On this subject, the mission is pleased to note the advanced state of preparation for eliminating the obligation to clear foreign exchange positions, phasing out the obligation to surrender a portion of export receipts, opening the treasury bill market to foreign investors, and easing the requirements for opening foreign exchange offices. The mission strongly urges the authorities to adopt all of these measures, which will contribute to deepening the spot and forward exchange markets.
23. The dinar's increasing flexibility underscores the importance of monitoring changes in the financial position of the "Exchange Equalization Fund," to avoid significant losses that could result in potential government liabilities.
24. The experience of the last two years illustrates the need to tackle budget rigidities. The difficult economic circumstances of 2002 and 2003 necessitated supplementary measures to meet budget law targets. The government's ability to respond to shocks continues to be limited by the sizable share of wage expenditure and interest payments in the budget. Wages are projected to exceed more than 12 percent of GDP in 2003—including contributions to the Social Security Fund (CSS)—and 50 percent of total revenue. This is too high. These constraints force the government to cut investment expenditure and draw on the resources of public enterprises to meet its objectives. This approach is unsustainable given the role of public investment in growth. Moreover, enterprises' profits should be used to finance their own future investments and are not guaranteed over time.
25. The mission recommends focusing fiscal policy efforts on reducing these rigidities, especially as customs receipts will continue to dwindle with the dismantling of tariffs. In particular, it will be essential to reduce the government wage bill by limiting new hires and meeting new staffing needs through personnel redeployment. This action is also essential to send a clear signal that the public sector is no longer willing to absorb excess employment demand, which must henceforth be satisfied by increased private sector activity.
26. The mission believes that the level of public debt in Tunisia is still high. This is borne out by the credit rating agencies, which indicated that Tunisia has a very high level of public debt (61 percent of GDP) among countries with the same rating. Medium-term fiscal policy should therefore focus on systematically reducing the public deficit with a view to lowering the level of government debt and enabling the government to contribute to domestic saving needs.
B. Structural Reforms
27. The challenges Tunisia faces to boost productivity and attract investment call for the acceleration of structural reforms. Accordingly, the mission is pleased to note the implementation of major reforms in the context of the ECAL III program with the World Bank, the African Development Bank, and the European Union, particularly the privatization of the Union Internationale des Banques (UIB), the preparation for privatizing Banque du Sud (BS), the insurance sector restructuring, and the preparation for phasing out import monopolies.
28. The mission wishes to stress, however, the need to tackle other structural reforms as well, to enhance the productivity of the Tunisian economy and to create an investment-friendly environment. Reforms are needed in three areas:
29. The mission notes with satisfaction the ongoing implementation of the agreement with the European Union, negotiations with the WTO for further tariff dismantling, initiatives aimed at harmonizing the various regional and bilateral trade agreements, as well as the implementation of the electronic "Tunisie Trade Net" system linking the various parties involved in international trade. It regrets, however, the poor rating Tunisia received in the IMF's trade restrictiveness index, but encourages the authorities to seek global integration beyond the European Union. In this regard, the following measures are priorities:
30. In addition to the beneficial effects of attracting new investment, these measures would improve customs administration and limit trade diversion. The IMF stands ready to provide the authorities with technical assistance on these issues.
Identical Treatment of the Off-shore and On-shore Sectors
31. The mission is pleased with the success of the off-shore sector. It believes that the competitiveness of Tunisian businesses has increased and that their success depends marginally on the incentives offered under this system. The mission favors a strategy of gradually creating a level playing field for all enterprises. The disparate treatment of the off-shore and on-shore sectors is at the root of a disconnect between the two sectors and leaves the on-shore sector less prepared to face international competition.
32. The mission recommends phasing out this institutional separation, especially since it is becoming more and more difficult to justify in a context of increasing economic integration. Accordingly, and although it is pleased to see an effort to align the systems by 2007 through the taxation of 50 percent of export profits and increase in the minimum tax rate, the mission prefers the implementation of a simpler and more transparent system. In particular, it supports simplification of the administrative procedures applied to the on-shore sector, especially by eliminating the release authorization request and the technical import controls.
Financial System Reform
33. Significant progress was made in reorganizing banks in 2002. The privatization of UIB and the advanced preparation to privatize the BS are encouraging signs. Privatization is expected to improve the management of these banks. Nevertheless, the slowdown in economic activity in 2002 had an adverse effect on banks' financial positions. The level of non-performing loans has increased, particularly in public banks. Moreover, the rate of provisioning of bad debts has decreased although write-offs and transfers of NPLs to the asset recovery components contributed to this decline. The mission believes that this difficult period is temporary and is unlikely to halt the reform process.
34. Public banks continue to weigh on the system, with more than half of the downgraded claims relative to a smaller proportion of loans. Under the circumstances, it is essential to expedite the enforcement of guarantees covering bad debts, increase provisioning, and rethink the government's role in the financial sector. The privatization of development banks could begin at once. Loan loss provisions should also be fully tax deductible to encourage a higher level of provisioning.
35. The mission notes with satisfaction the efforts already made and those underway to implement the recommendations of the Financial Sector Assessment Program. Regarding monetary policy, the central bank has improved its transparency practices by publishing a monthly report on the meetings of its board of directors and the conclusions of the periodic meetings with banks. In the area of bank reforms, the BCT has received technical assistance for the establishment of a deposit insurance system; the regulations on the consolidation necessary for consolidated supervision are at a very advanced stage; and a draft law on money laundering and the financing of terrorism is being prepared with the help of France and the IMF. Discussions on the establishment of a mechanism for cooperation among the various financial system supervisory agencies to strengthen their coordination are in progress. On this subject, the mission believes that a liaison committee for the various agencies, which would respect their independence and for which the BCT would serve as secretariat, would be useful. The committee's operating procedures and the methods of cooperation among the agencies could be spelled out in a framework agreement.
36. The mission believes that strengthening public debt management in cooperation with the World Bank would contribute greatly to the growth of the financial markets. In particular, this would permit the emergence of a yield curve.
C. Other Issues
37. The mission wishes to commend the authorities on the steps taken to increase the transparency of economic policy, and, in particular, their decision to continue publishing the preliminary conclusions of the mission and the final consultation report, as well as their approval for the mission to hold a press conference.
38. The authorities have made significant efforts to improve the quality of statistical data, which has enabled Tunisia to subscribe to the IMF's Special Data Dissemination Standard (SDDS). The mission notes that the efforts of the "observatoire de la conjuncture" to centralize and analyze statistical data could lead to improved data dissemination.
39. It was agreed that the next interim staff visit will take place in October 2003.
IMF EXTERNAL RELATIONS DEPARTMENT