Mission Concluding Statement 

Union of the Comoros -- Concluding Statement for the 2006 Article IV Consultation IMF Mission

July 26, 2006

1. An IMF staff team visited the Union of the Comoros during July 12—26, 2006 to conduct the 2006 Article IV consultation discussions. The mission would like to thank the authorities for their warm welcome and excellent collaboration. The discussions focused on a medium-term reform strategy aimed at raising economic growth and improving the delivery of public services. The mission also discussed a package of short-term policy measures to address the sharp deterioration in public finances in the first half of 2006.

A. Economic Retrospective 2001-05

2. Economic growth has remained lackluster and narrowly based. Comoros has not experienced the sharp economic upturn recorded in most of Sub-Saharan Africa since the mid-1990s, with real GDP growth of just half of the regional average during 2001-05. On a per-capita basis, real GDP has gradually declined over the past two decades. The poor growth record reflects some of the country's inherent disadvantages, including the small size of the local market, very high transport costs, and environmental factors, such as deforestation and volcanic eruptions. Economic activity is largely confined to subsistence agriculture, production of three export crops, import-related commerce, and government services. Fishing and tourism are well below potential, while manufacturing is almost non-existent.

3. High dependence on a narrow export base and external aid has made Comoros particularly vulnerable to external shocks. Emigrants' remittances have financed consumer imports and provided a buffer against terms of trade shocks. Political instability and frequent inter-island tensions have undermined institutional capacity and led to a sharp reduction in donor assistance, resulting in a rapid accumulation of external debt well above the HIPC threshold, and arrears to external creditors.

4. Membership in the Zone Franc arrangement has been the economy's main anchor of stability. The hard peg and safeguards of the arrangement have kept international reserves at a comfortable level and inflation in the single digits, and have provided discipline for fiscal policy by restraining central bank credit to government. At the same time, fiscal policy has been highly constrained by the large wage bill and lack of access to financing, thus limiting the envelope for urgently needed social expenditure and public investment and contributing to chronic accumulation of wage arrears in the public sector.

B. Recent Economics Developments

5. In 2005, macroeconomic stability was maintained in the face of a sharp deterioration in the terms of trade caused by the collapse of vanilla prices and rising international oil prices. Nonetheless, real GDP growth picked up on account of trade-related services and tourism. Inflation remained modest despite higher transport costs for imported consumer products and higher retail prices for fuel. A surge in remittances partly offset the sharp deterioration in the external trade balance. Fiscal performance improved in 2005, with an increase in the domestic primary surplus and a net reduction in wage arrears to public employees for the first time in years.

6. The first half of 2006 was marked by an economic slowdown and a sharp deterioration of public finances. Fiscal revenues declined by 13 percent compared to the same period in 2005, in large part due to a weakening of customs administration and interference with public enterprise management in the run up of the presidential elections and power transfer. In addition, the revenue-sharing mechanism between the Union and the island governments was severely disrupted. Salary arrears and borrowing from the central bank increased sharply, while the domestic primary balance became negative. The loosening of the fiscal stance, combined with a marked deterioration in the financial health of public enterprises, contributed to an increase in the trade deficit and a loss in net international reserves.

C. Near-Term Outlook and Policies

7. The near-term economic outlook is clouded by significant economic weaknesses and external vulnerabilities. Economic growth for 2006 is projected to fall well below last year's rate, reflecting the continued crisis of the vanilla sector and a sharp decline in high-end tourism. Inflation is likely to remain modest, despite rising transport costs for imports and recent increases in domestic fuel prices. The trade deficit is expected to widen relative to 2005, on account of continuing difficulties in the vanilla sector and strong import growth resulting from fiscal loosening and higher remittances.

8. The government appointed in May 2006 by the new Union President underlined the severity of the fiscal situation it had inherited. It concurred with the mission that the main policy priority was to bolster revenues after the large shortfall in the first half of 2006, with a focus on strengthening revenue administration and restoring inter-island cooperation. In late June, the four Ministers of Finances of the Union and Island governments reached an agreement to improve the revenue-sharing mechanism by ensuring that all revenues are channeled through a single account and that wages are paid regularly at all levels of government. The agreement also strengthens transparency and inter-island coordination in revenue administration.

9. The mission discussed with the authorities a set of additional near-term measures focused on bolstering fiscal revenues, while containing expenditure, strengthening budgetary control, and improving the financial health of public enterprises. There was agreement that restoring fiscal revenues will be critical for achieving the authorities' priority objective of significantly reducing the stock of wage arrears, although external budget support would also be needed. The mission stressed that close cooperation between the Union and Island governments will be essential for achieving the authorities revised full-year fiscal objectives. It also stressed the importance of prudent central bank credit policies to prevent an erosion of international reserves.

D. Key Medium-Term Economic Challenges

10. The new government has endorsed Comoros' Interim Poverty Reduction and Growth Strategy (I-PRSP). The I-PRSP sets out a clear development vision, combining increased private-sector led economic growth with improved provision of public services. The mission discussed with the authorities a medium-term economic reform strategy, based on the I-PRSP.

11. The new government has centered its reform strategy around the need to improve governance and raise transparency of public institutions. It has already taken actions to strengthen management and supervision of public enterprises and revenue agencies. The mission underlined the importance of strengthening inter-island cooperation and raising transparency of fiscal operations in Comoros' complex decentralized structure of public finances, with many functions replicated at the Union and Island level.

12. Improving public finances will be critical for achieving the I-PRSP's objectives. The authorities aim to strengthen revenue administration and reform the civil service to make room for higher public investment and social spending. They underlined the importance of higher external assistance, in line with pledges made during a donor roundtable in December 2005, to finance urgently needed social spending, public investment, and technical assistance. In addition, comprehensive debt relief under the enhanced HIPC initiative and MDRI would be required to bring debt to a sustainable level.

13. Reforming state-owned enterprises will be important for public finances and economic growth. The precarious financial situation of the energy and water companies in particular has affected cash flow of other state enterprises and reduced fiscal revenues. The mission also underlined the need for reform of the state-owned telecommunications and hydrocarbons monopolies, and encouraged the authorities to advance their discussions with World Bank/IFC on the preparation of a sector reform strategy, including possible privatization.

14. Foreign direct investment will be critical for raising economic growth and reducing its large external imbalances. The authorities stressed their recent efforts to attract investors in the tourism and banking sectors. They discussed with the mission proposals to reform the investment code and simplify the tax and customs legislation, in order to create a more conducive investment climate.

15. To support the development of the local private sector and diversify the economy, it will be critical to enhance the availability of bank credit by promoting greater competition and services in the local financial sector. The central bank is in the process of adapting its banking supervision and liquidity management to the prospective entry of several foreign banks.

16. The authorities noted that their economic reform strategy could raise real GDP growth over the medium-term to an average of 4 percent a year, while significantly improving the country's infrastructure and social services. The mission concurred that their proposed reforms and objectives have the potential to boost economic growth, improve living conditions, and reduce poverty.