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Public Information Notice (PIN) No. 03/72
June 13, 2003
Corrected: June 20, 2003
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2002 Article IV Consultation with Cape Verde

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

On December 16, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Cape Verde.1

Background

In 1992, following the country's first multiparty elections, the new government launched a far-reaching economic reform program aimed at reducing the size of the public sector and promoting growth led by private sector exports. The reform agenda focused on privatization, trade and exchange liberalization, financial sector restructuring, tax reform, and price liberalization. Real GDP growth averaged about 7 percent a year in the period 1992-2000, but recurrent fiscal slippages undermined macroeconomic stability, first during 1992-96 and subsequently in 2000, resulting in a loss of international reserves, the accumulation of domestic and external payment arrears, a rapid increase in domestic debt, and a slowdown in economic growth.

The current government was elected in early 2001 and has focused on reducing internal and external imbalances, restoring order to public finances, regularizing domestic and external arrears, maintaining a tight monetary policy to rebuild international reserves, and implementing structural reforms to achieve a high rate of economic growth. Economic performance during the period July-December 2001 was monitored under a Fund staff-monitored program. On April 4, 2002, the Fund approved an arrangement under the Poverty Reduction and Growth Facility (PRGF), in support of the authorities' economic program for 2002-04. The government of Cape Verde's medium-term development strategy is set forth in the Interim Poverty Reduction Strategy Paper (I-PRSP), which focuses on combating poverty by promoting private-sector led economic growth, developing human capital through education and training, improving social and economic infrastructure, and promoting good governance. The I-PRSP was approved by the Boards of the Fund and the World Bank on April 4, 2001.

Economic performance in 2002 has been encouraging. Real economic growth and international reserves are higher, inflation lower, and the fiscal deficit smaller than originally projected. Real GDP growth is expected to rise to about 4 ½ percent in 2002, up slightly from 4 percent in 2001. The better-than-expected economic growth is being driven by exports of manufactured goods, tourism, and transportation services, all of which performed more favorably than envisaged in the first half of 2002, as did private transfers, which have helped support the domestic construction industry. Consumer price inflation (on an annual average basis) is projected at 1.7 percent for 2002 as a whole.

The fiscal deficit (including grants) is projected to fall to 2.0 percent of GDP in 2002, from 4.6 percent in 2001, reflecting a higher level of revenues and grants (as a share of GDP) and reductions in recurrent expenditures. Broad money has grown more rapidly than earlier envisaged, reflecting a stronger balance of payments position and, more recently, government borrowing from the banking system to repay domestic arrears. International reserves are well above target and, at end-September, stood at about 1.7 months of imports of goods and services, up from 1.0 month at end-2000. In May 2002, given the strong balance of payments position and low inflation rate, the Bank of Cape Verde lowered its refinance rate to 10.0 percent.

Fiscal and trade reforms encountered some delay. The value-added tax (VAT) and new customs tariff schedule were unanimously approved by the National Assembly in June 2002, but the reforms will not be in place until June 2003, as more time is needed to establish the administrative framework and to draft supporting regulations. On the positive side, three of four public expenditure reviews were completed, which will provide important inputs into Cape Verde's full Poverty Reduction Strategy Paper. In addition, a new central bank law was approved, establishing the independence of the Bank of Cape Verde, and two large loss-making public enterprises were liquidated. The social impact of the liquidations is being mitigated through the provision of financial support for former employees, with support from the World Bank.

Executive Board Assessment

Executive Directors commended the Cape Verde authorities for their strong efforts to restore macroeconomic stability by reducing the fiscal deficit substantially, keeping down inflation, regularizing domestic and external arrears, and strengthening international reserves. They also saw encouraging indications that economic growth is reviving. The challenge now facing the authorities is to consolidate the recent macroeconomic achievements and to further strengthen the foundations for growth through structural reforms to enhance private sector competitiveness, while tackling poverty by fostering human development and social services.

Directors considered that macroeconomic policies appropriately aim at further reducing the fiscal deficit over the medium term, while using available scope for easing monetary policy to gradually reduce domestic interest rates consistent with continued low inflation. They noted that given the openness of Cape Verde's economy, it will remain important to reduce interest rates cautiously. The primary objective of monetary policy should remain to further accumulate international reserves from their still low level, while sustained fiscal consolidation and the steadfast implementation of structural reforms to enhance competitiveness will be key to support the sustainability of the balance of payments, and gradually reduce aid dependency over the long term. These policies will also be essential to ensure the continued adequacy of the exchange rate peg of the Cape Verde escudo to the euro. Director underscored the importance of closely monitoring monetary and exchange rate developments in the period ahead.

Directors noted the modest increase in the fiscal deficit projected for 2003, following the recent substantial expenditure cuts, and taking into account the anticipated higher external financing. They urged the authorities to stand ready to step up revenue mobilization and expenditure restraint efforts in case of a shortfall in foreign financing.

Looking ahead, Directors underscored the critical importance of implementing the VAT, the new customs tariffs, and the automatic pricing mechanism for retail petroleum products in a timely manner to ensure that fiscal consolidation can be sustained. They also encouraged the authorities to identify the numerous tax exemptions which currently result in significant revenue losses, and to develop a comprehensive strategy for substantially reducing them over time. Directors also looked forward to the implementation of plans to redirect public expenditures toward social development and infrastructure, address remaining public weaknesses in budget management with assistance from a budget advisor, and carry out a comprehensive and transparent audit of domestic arrears. They encouraged the authorities to continue working toward the conclusion of negotiations on the rescheduling of remaining external arrears in order to fully normalize relations with creditors.

Directors welcomed the progress in implementing structural reforms, including the approval of a new central bank law, new custom tariffs, and the liquidation of two large, loss-making public enterprises. They encouraged the authorities to continue to cooperate closely with the World Bank and bilateral donors in addressing the challenges ahead. This will include the privatization of remaining public enterprises, the reform and regulation of utilities, the promotion of competition in the financial market, the further strengthening of financial sector supervision, and continued development of the tourism sector. Directors commended the authorities for further strengthening the framework to combat money laundering and the financing of terrorism and welcomed the approval of recent legislation.

Directors supported the authorities' intention to mitigate the social impact of reforms by providing financial assistance to the employees who are adversely affected by the liquidation of large public enterprises.

Directors observed that Cape Verde's statistical systems remain weak, especially with regard to the national accounts. They encouraged the authorities to complete the remaining steps necessary for participation in the GDDS, which would bolster their efforts to build statistical capacity and help secure technical assistance.



Table 1. Cape Verde: Selected Economic Indicators, 1998-2002


 

1998

1999

2000

2001

2002
Proj.


Domestic economy

         

Real GDP

8.0

8.9

6.6

4.0

4.6

Real GDP (per capita)

5.2

7.1

4.4

1.8

2.3

Consumer price index (annual average)

4.4

4.4

-2.4

3.7

1.7

           

Gross domestic investment

19.9

19.8

18.7

17.4

19.8

Gross national savings

7.8

6.9

7.5

6.6

9.3

           

External economy

         

Export, f.ob. (in local currency, annual percentage change)

-2.9

16.4

26.2

19.8

4.6

Imports, f.o.b. (in local currency, annual percentage change)

14.8

21.5

6.1

11.7

5.6

Current account balance, excl. grants (in millions of U.S. dollars)

-112.6

-100.5

-84.2

-79.2

-95.2

Current account balance, excl. grants (in percent of GDP)

-21.5

-17.3

-15.3

-14.6

-14.7

Capital and financial account (in millions of U.S. dollars)

55.6

130.4

34.4

69.3

72.9

Debt service (in percent of exports of goods and nonfactor services)

11.3

30.2

28.2

19.2

17.0

External debt (in percent of GDP)

45.2

53.8

61.4

64.9

63.9

Real effective exchange rate (end of period, percentage change)

-2.5

8.4

-7.3

-2.7

-0.1

           

Financial variables

         

Government revenues

33.0

27.8

27.0

27.3

29.6

Total grants

13.4

7.3

6.2

4.9

6.0

Current expenditure

21.2

23.5

27.5

22.1

20.9

Overall fiscal deficit (incl. grants)

-4.0

-13.0

-20.4

-4.6

-2.0

Broad money (annual percentage change)

2.5

15.4

12.9

9.8

13.2


Sources: Cape Verdean authorities; and IMF staff estimates and projections.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.




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