Public Information Notice No. 03/07

Public Information Notice: IMF Concludes 2002 Article IV Consultation with Madagascar

January 9, 2003

On December 23, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Madagascar.¹

Background

Since the mid-1990s to end-2001, Madagascar had made significant progress in terms of macroeconomic stabilization and structural reform. Over the period 1997-2001 the growth rate of real GDP averaged 4 ¾ per cent, while inflation remained subdued. Madagascar's balance of payments position strengthened, spurred by foreign direct investment in the export processing zone and growth in nontraditional exports, permitting a significant improvement in the country's international reserves position. Over the same five-year period, the public finances improved and significant progress was made on an ambitious public enterprise and regulatory reform agenda.

Notwithstanding these achievements, poverty remains pervasive despite some recent reductions in urban poverty, and growth prospects constrained by structural impediments and governance-related problems. Moreover, weaknesses in tax administration limit the government's ability to mobilize revenue, leaving Madagascar with limited resources for poverty reduction and dependent on foreign assistance.

Macroeconomic developments in 2001 were encouraging. Real GDP rose by 6 percent, resulting in a further increase in real per capita GDP, and the 12-month rate of inflation was reduced significantly, declining from over 8 ½ percent at end-2000 to 4 ¾ percent in December 2001. In 2001, the authorities satisfactorily implemented envisaged reforms in the area of budgetary management, treasury accounting, tax administration, and public enterprise reform. However, fiscal performance in 2001, and particularly over the second half of the year, fell substantially short of target, owing largely to weaknesses in the customs administration.

The political crisis during the first six months of 2002 entailed substantial economic costs. Blockades brought industrial production to a virtual halt and most employees of export processing zone enterprises were laid-off during the first half of the year. The Malagasy authorities estimate that real GDP in 2002 could drop by as much as 12 percent. Inflation, which rose to over 20 percent at the height of the crisis, but which has been declining since June, is projected at 12 percent for end-2002. The crisis has led to a deterioration of the balance of payments and fiscal situations, with revenues and expenditures both down sharply. Income poverty has been estimated to have increased from 69 percent in 2001 to 75 percent in 2002, and the utilization of health services has dropped sharply.

The new Malagasy authorities, starting in July, have moved to ameliorate the situation with the introduction of various temporary tax measures to promote economic recovery and financial support measures designed to alleviate the impact of the crisis on the most vulnerable social groups, including the suspension of user fees for health and educational services. Following a July conference where donors pledged significant assistance, the authorities have been able to clear all of the external payments arrears and a significant proportion of the domestic arrears that had built up during the crisis. The authorities and donors have made the development of infrastucture and the social sectors key priorities, and have accelerated the public investment program beginning at mid-year. Since the reopening of the foreign exchange market in August, the exchange rate of the Malagasy franc has been relatively stable while official reserves have strengthened.

The authorities anticipate an economic recovery next year when real GDP is projected to increase by about 8 percent, led by a pick-up in exports and foreign-financed investment spending.

Executive Board Assessment

Executive Directors noted that following strong performance in 2001, the political crisis of the first half of 2002 had severely affected economic activity. The almost complete shutdown of the export processing sector had increased unemployment, and blockages in the transportation network had impaired the marketing of agricultural output, causing a fall in real income. Directors commended the actions taken by the new government to spur economic recovery through prioritization of expenditures, faster implementation of foreign-financed investment projects, and the adoption of measures to boost confidence and encourage the return of private investors. They also welcomed the measures taken, with donor assistance, to alleviate the increased poverty caused by the crisis and to provide incentives for the poor to utilize the public health and education services. These policies were beginning to re-establish confidence, as seen in the recent upturn in economic activity and tax revenues. In the medium term, the authorities will need to consolidate the progress made in reinvigorating private sector growth and the export processing sector, and in improving the efficiency of the tax system and customs administration. Directors considered it crucial that the authorities work to ensure the optimization of debt relief expected under the enhanced HIPC Initiative, in particular by focusing resources freed through debt relief on measures to improve social conditions and reduce poverty, especially in the rural areas, which had notably not benefited from the broad progress that had been made in poverty alleviation in the 1990s.

Directors welcomed the authorities' determination, as shown by the recent establishment of an anti-corruption commission, to fight corruption and increase transparency, which are essential to stimulate private investment and growth. They also welcomed the steps taken at the government level to implement better control and monitoring mechanisms, as well as the strengthening of the Audit Court, the Directorate-General for Expenditure Commitment Control, and the State Inspectorate-General. Directors urged the authorities to pursue vigorously the ongoing reforms of the judicial system and commercial law.

Directors noted the reduction of customs tariffs on a number of key intermediate products and equipment, aimed at stimulating recovery. In this regard, they underscored the importance of undertaking tax policy changes in a comprehensive framework, accompanied by strengthened tax administration so as to maintain revenues. Directors therefore welcomed the steps taken to strengthen customs administration. A few Directors considered that the reduction in customs duties might have waited until steps were taken to improve enforcement of the tax code. A few other Directors considered that stronger efforts to incorporate the artisanal gem stone mining industry into the formal economy had the potential to raise fiscal revenues.

On the expenditure side, Directors underscored the importance of improving the targeting of pro-poor expenditures, and strengthening budgetary reporting and treasury accounting to ensure that adequate controls on spending are in place. They commended the authorities for their efforts to reduce rapidly domestic arrears. Directors welcomed the authorities' decision to move forward on social and development project execution, which will strengthen social services and increase productivity and incomes especially in rural areas.

Directors agreed with the authorities that monetary policy should be geared to containing inflationary pressures, while ensuring that government borrowing would not pre-empt appropriate levels of credit to the private sector as it recovered from the effects of the 2002 political crisis.

Directors considered that the banking system had weathered the political crisis well, continuing its operations and ensuring the functioning of the payments system. However, they noted with concern the increase in nonperforming loans, as the financial situation of many borrowers had been negatively affected by the crisis. Directors recommended that the quality of bank loans be monitored closely, and that banks increase their loan loss provisioning as needed. They welcomed the measures taken by the bank supervisory agency to monitor the compliance of the banks with the legislation on anti-money laundering and combating the financing of terrorism.

Directors considered the authorities' policy of allowing the exchange rate of the Malagasy franc to float as broadly appropriate, as the excessive appreciation of 2000 and 2001 has been partly reversed and wage rates in particular remain competitive.

Directors drew attention to the burden placed on the national budget of underperforming and inefficient state enterprises, in particular the cotton and sugar companies. They considered that privatization of these and other state enterprises would both remove a drain on the budget and help to spur private sector development and enhance prospects for job creation in the medium term.

Directors regretted that despite the good economic performance in recent years, poverty remains pervasive, and that no appreciable decline in poverty has occurred in rural areas. This called for more intensive and comprehensive efforts to improve productivity in agriculture, diversify the production base, and build rural infrastructure, including roads, schools, and clinics. Directors urged the authorities to effectively monitor outcomes to ensure the development of human capital and investment in infrastructure to support private sector growth. They recommended that the authorities take advantage of the opportunity provided by the PRSP process to prioritize carefully the reform agenda, and to formulate medium-term development plans, including specific poverty reduction programs, in a coherent macroeconomic framework.

Madagascar's statistical database is considered adequate for surveillance and program monitoring. Nonetheless, Directors noted that weaknesses remain in terms of data quality, coverage, and timeliness, and urged the authorities to correct them, where necessary with technical assistance.