Public Information Notice No. 04/127

Public Information Notice: IMF Concludes 2004 Article IV Consultation with Benin

November 12, 2004

On October 6 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Benin.¹

Background

Benin's economic performance over the period 2001-03 was strong. Real GDP growth averaged 5.3 percent, driven by growth in the cotton and services sectors. Inflation was low, averaging 2.6 percent per year. The external current deficit, which increased in 2002 owing to the unexpected drop in the world price of cotton, narrowed in 2003 as terms of trade improved. The real effective exchange rate, however, appreciated about 4 percent on average per year since end-2000, owing mainly to the decline of the U.S. dollar against the euro, to which the CFA franc is pegged.

Overall fiscal performance over the period was satisfactory. Revenue collection strengthened, mostly reflecting improvement in tax administration, although weaknesses in customs administration remained. Expenditures were kept in check; however, spending for health and education, as well as government investment, remained broadly below targets. Efforts were made to strengthen public expenditure management, particularly by putting in place an integrated computerized expenditure management system and a mechanism for tracking poverty-reducing expenditure.

A prudent monetary policy, conducted at the regional level by the Central Bank for West African States (BCEAO), helped maintain confidence in the currency and keep inflation low during the period. Following a strong expansion during 1998-2001, broad money contracted in 2002 and remained stable in 2003, largely reflecting developments in the balance of payments. In response to the rapid expansion of bank credit to the private sector in 2002-03, the BCEAO increased the reserve requirement in February 2004 from 9 to 13 percent. The financial health of the banking sector has continued to be sound.

Progress in the structural area was mixed. The liberalization of the cotton sector was pursued, mainly by undertaking the privatization of the cotton parastatal, SONAPRA, and assisting sector stakeholders establish an autonomous agency (CSPR) for managing the commercialization of seed cotton and settling input credit. However, the privatization of SONAPRA incurred delays and was not completed by mid-June 2004 as scheduled. Furthermore, the CSPR experienced cash flow problems, stemming from the sales of inputs conducted outside the legal framework established under the reform of the sector. Progress in other areas was also slow. In particular, the implementation of the divestiture program of public utilities and the Port of Cotonou did not progress significantly, and the civil service reform stalled due to strong opposition from trade unions and the parliament.

Benin's sound macroeconomic policies over the period helped it reach the completion point under the enhanced HIPC Initiative in March 2003. Debt relief obtained under the initiative was critical in reducing the debt-to-export ratio to 157.5 percent at the completion point; the debt ratio is expected to decline further to below the threshold of 150 percent from 2005 onward.

Sustained economic growth over the last ten years allowed Benin's per capita income to rise and most social indicators to improve steadily. However, as indicated in the poverty reduction strategy paper (PRSP) completed by the authorities in December 2002, these achievements did not translate into significant progress in poverty reduction. Against this background, the PRSP presents the authorities' objectives and priority measures for consolidating macroeconomic stability, reducing poverty, and making progress towards reaching the Millennium Development Goals (MDGs).

Macroeconomic performance since the beginning of 2004 has suffered from a poor cotton crop and the tightening of import restrictions by Nigeria. In the circumstances, the target for economic growth this year has been reduced from 6 percent in the original PRSP to 3 percent. The external current account deficit is expected to widen by ½ percentage points of GDP, owing mostly to lower-than-expected export of cotton and re export to Nigeria. To compensate for the shortfall in government revenue arising from weaker-than-envisaged activity in 2004, the authorities decided to strengthen tax and customs administrations and cut total expenditure by 1.4 percent of GDP, while protecting priority spending to the extent possible.

As part of the Article IV consultation, an assessment of the Fund's longer-term program engagement in Benin was prepared by the staff and discussed with the authorities.² The assessment concludes that, since 1993, Benin has made major progress in macroeconomic stabilization. It highlights that the diversification of the economy from cotton production has remained elusive. It underscores the need for Benin to increase the share of poverty-reducing expenditures in government spending, to accelerate structural reforms to raise productivity and improve service delivery, and to strengthen the judiciary system.

Executive Board Assessment

Executive Directors commended Benin's considerable progress toward macroeconomic stabilization over the past decade, which has helped sustain robust economic growth and placed Benin among the better-performing countries of the West African Economic and Monetary Union. Directors noted that Benin's strong economic growth and low inflation during 2001-03 continued to be underpinned by a broadly appropriate stance of macroeconomic policies. Directors stressed, however, that greater efforts are needed to reverse the decline in Benin's external competitiveness and to lower the economy's vulnerability to external shocks. In this connection, they called for more determined implementation of structural reforms, especially with respect to the cotton sector, privatization and private sector development, the civil service, and governance.

Directors noted that economic performance in 2004 has been adversely affected by a poor cotton crop and an intensification of import restrictions from a major trading partner, which has contributed to a revenue shortfall. They commended the planned introduction of revenue and expenditure measures aimed at limiting the deterioration of the fiscal position, while emphasizing that further measures may be necessary if weaknesses in revenue collection were to continue. Directors also encouraged the authorities to push ahead with their plans to strengthen the institutions in charge of seed cotton and input commercialization, and to pursue discussions with Nigeria to resolve outstanding trade issues.

Directors endorsed the authorities' revised medium-term macroeconomic targets, which they found to be in line with the PRSP's overall objective of raising economic growth in order to reduce poverty and achieve the Millennium Development Goals. They stressed that achievement of this objective will require an acceleration of structural reforms and the continuation of prudent macroeconomic policies. Directors commended the authorities' efforts to strengthen the PRSP, and encouraged rapid completion of the first annual progress report on the implementation of the poverty reduction strategy. Directors welcomed the regular policy dialogue that the authorities have initiated with the donor community, which is an important step toward increased donor harmonization. While calling for the continued involvement of the donor community in Benin's development effort—including through the provision of appropriate technical assistance—Directors emphasized that the authorities need to address the weak implementation capacity that hampers the execution of social expenditures and undermines the potential benefits that could accrue to Benin from higher aid inflows.

Directors called for continued efforts in the medium term to boost revenue collection and increase the level and quality of poverty-reducing spending, while curbing nonpriority expenditure. In this regard, they urged the authorities to step up the implementation of the action plans to improve tax and customs administrations. They also underscored the need to ensure that budgetary allocations reflect PRSP priorities, to refrain from granting further wage increases before the introduction of a new compensation system, and to limit wasteful spending on public utilities. Directors stressed that public expenditure management should be strengthened so as to improve the monitoring of budget execution, streamline budget procedures, and enhance transparency and the tracking of poverty-reducing outlays. Directors encouraged the authorities to continue and deepen the decentralization process, while ensuring that it does not weaken central government accounts and that expenditure management at the local level is strengthened.

Directors emphasized the importance of accelerating structural reforms to make the economy more competitive and improve the delivery of services to the population. They urged the authorities to establish a credible agenda for the divestiture of public utilities, to adopt and implement a new administrative and civil service management reform, and to rapidly involve the private sector in the management of the Port of Cotonou. They also encouraged the authorities to start preparing the next steps of the cotton sector reform to ensure a transparent and successful transition to a fully competitive system. Directors also stressed the need to improve the business environment through determined implementation of the strategy to fight corruption, the strengthening of the judiciary system, and the enhancement of governance and transparency at the customs department. They emphasized that these reforms are essential to improve Benin's competitiveness in the context of the fixed exchange rate.

Directors noted Benin's high dependence on cotton exports and on trade with Nigeria, and encouraged the authorities to intensify their efforts to promote export diversification while maintaining a liberal trade and exchange system. At the same time, it was noted that Benin's poverty reduction efforts would benefit greatly from increased access to industrial countries' markets. Directors welcomed the conclusion of the debt sustainability analysis that Benin's external debt remains sustainable, and urged the authorities to take the necessary action to keep the external debt on a sustainable path, including by pursuing a prudent debt-management policy.

Directors welcomed Benin's commitment to strengthening the financial sector. They encouraged the continued efforts to ensure compliance with the regional banking commission's prudential ratios and to deepen financial intermediation, including through the strengthening of the legal and judicial system and addressing land titling issues.

Directors also welcomed the authorities' support for the rehabilitation of microfinance institutions and their commitment to intensifying the supervision of this sector.

Directors welcomed the candid exchange of views between Fund staff and the authorities regarding the ex post assessment (EPA) of Benin's longer-term engagement with the Fund. They concurred that the EPA provides useful lessons for future program design and implementation.

Directors agreed that Benin's prolonged use of Fund resources reflected the extensive and complex nature of the reforms required to reinforce the foundations for sustained private-sector-led growth and poverty reduction. They considered that Fund-supported programs since 1993 had appropriately focused on economic and financial stabilization, and on structural reforms essential to liberalize the economy and raise growth. Directors agreed that the Fund's involvement has helped the authorities build capacity, particularly in tax administration, and mobilize concessional resources from the international community. They expressed concern, however, that there has not been significant progress in poverty reduction. They also noted that while initial efforts to liberalize the economy and reduce government intervention were successful, further reforms, including the divestiture program for public utilities and the civil service reform, incurred protracted delays.

Directors concurred that the main challenge for Benin is to achieve sustained higher growth and reduce poverty, while preserving macroeconomic stability and reducing the economy's vulnerability to external shocks. They stressed that reaching these objectives will require continuation of fiscal consolidation, while increasing the level and quality of poverty-reducing outlays, and enhanced efforts to implement the reform agenda.

Directors agreed that a further PRGF arrangement with low access would help Benin to continue to address the remaining challenges that lie ahead, including through securing the necessary concessional financial support, and would provide a framework for a sound policy response in case of external shocks. Directors stressed that the program supported by any such arrangement should incorporate the lessons learnt from the EPA, should set out clear objectives on the structural front, and should integrate the PRSP into a sound multi-year macroeconomic framework. A broader aim would be for Benin eventually to exit from the use of Fund resources.