Public Information Notice No. 04/55

Public Information Notice: IMF Concludes 2004 Article IV Consultation with the Union of the Comoros

May 14, 2004

On April 30, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Union of the Comoros.¹

Background

Following a number of secessionist moves since independence in 1974, Comoros² overwhelmingly approved a new constitution in December 2001. The constitution provides for wide-ranging autonomy to the islands, but relies on the establishment of by-laws for the definition of specific decentralization arrangements, including on financial autonomy and the civil service. A number of attempts in 2002 and 2003 to establish such by-laws failed to produce universally accepted results. However, on December 20, 2003, a Transition Agreement on elections and critical arrangements for economic management was reached under the auspices of the African Union. The agreement is strongly supported by the international community and has given rise to the establishment of a multidonor trust fund for the implementation of the transitional arrangements.

Implementation of the Transition Agreement has proved to be difficult despite extensive discussions on the modalities and the definition of actions to be taken by the Union and island governments. In addition, the elections held for the island assemblies in March and the national assembly in April 2004 diverted attention from the task of implementing coherent budget policies, including actions on the contentious issue of revenue sharing.

Economic developments during 2003 were adversely affected by the difficult relationship between the Union and island governments. The related disputes about competencies and resources prevented the design and implementation of coherent economic policies, brought to a virtual standstill structural reforms, and undermined confidence at home and abroad, with adverse consequences for private investment and foreign aid. As a result, the Comoros' real per capita income declined for the sixth year in a row. Inflation increased from 3.3 percent in 2002 to 4.5 percent in 2003, notwithstanding a sizable strengthening of the Comorian franc. The rise in inflation was mainly related to increases in import duties on selected commodities introduced by the Union government. The external current account benefited from a sizable improvement in the terms of trade but declines in tourism receipts and official and private transfers in the event led to a widening of the external current account deficit (including official transfers) from 2.3 percent of GDP in 2002 to 4.4 percent in 2003. However, at some 11 months of imports of goods and services, the Comoros' foreign reserves position is still at a comfortable level.

Fiscal policies resulted in a primary deficit for the consolidated Union and island governments of 3 percent of GDP in 2003, compared with 4 percent in 2002, while a primary surplus would have been required for a move toward sustainability. The external debt, at more than 500 percent of exports of goods and services in net present value terms, is not sustainable. It has been accompanied by a continued accumulation of payments arrears. The establishment of a prudent consolidated national budget for 2003 failed because of continued disputes between governments about revenue sharing and the delineation of expenditure competencies. The Union government, being confronted with the threat of strikes, granted two step increases in the salary scales for civil servants, which had been frozen since 1994. It also undertook a number of investments in economic infrastructure. The consolidated fiscal deficit was in part raised as a result of the attempt by the Ngazidja government to establish its own administration without having reached an agreement with the Union on the transfer of competencies. In contrast, fiscal policy in Anjouan produced a small surplus (permitting the repayment of some salary arrears) mainly because of a significant strengthening of revenue administration and collection.

Monetary policy remained narrowly circumscribed by the Comoros' membership in the franc zone and the related fixed exchange rate vis-à-vis the euro. These arrangements have provided a firm monetary anchor for the country and imposed a coherent framework on the management and operations of the central bank, including a strict limit on lending to government.

While there are virtually no quantitative trade restrictions, tariff levels on imports in the Comoros are relatively high by international and African standards, with an average tariff rate of 38.9 percent in 2001. The rate has increased further as a result of the import duties on cars and the surtaxes on rice, tobacco, and alcohol that were introduced in mid-2003. However, given the virtual absence of local production of most goods concerned, virtually all tariffs serve revenue purposes and are not an expression of protectionist policies of the government.

Executive Board Assessment

Directors noted that political tensions between the Union and island governments have disrupted the implementation of macro-economic policies and structural reforms. As a result, the economic performance of the Comoros has remained below its potential, and little progress has been made toward reducing poverty. Directors underscored the urgency of pursuing a coherent strategy for the economic development of the country, and hoped this would be facilitated soon by the resolution of the political difficulties.

Directors urged that the Transition Agreement of December 20, 2003 be fully implemented to achieve the decentralization objectives of the new constitution. They noted that, in the economic area, this would require adherence to the undertakings on revenue sharing, effective joint administration of the customs office, and gradual transfer of competencies and civil service staff to the island governments.

Directors called on the authorities to pursue fiscal policies compatible with debt sustainability. To that effect, they stressed the need for close cooperation between Union and island administrations on the basis of a transparent budget process and information sharing. Directors felt that fiscal policy should aim at achieving a balanced position for the consolidated public finances. In this context, they emphasized the need to advance with structural reforms in tax policy, tax administration, and expenditure management. On the revenue side, this will require a substantial strengthening of revenue administration and widening of the tax base. Directors therefore stressed the need to move toward a simpler and more efficient tax system and to streamline tax administration. In this connection, they encouraged the authorities to eliminate discretionary import tariff exemptions and to consider replacing import tariffs by a broad-based consumption tax. On the expenditure side, Directors urged tight expenditure control to avoid duplication of spending by the different levels of government. They saw no room for increases in wages, and advised the authorities to focus expenditure on areas of high priority with the aim of achieving the Millennium Development Goals.

Directors urged the authorities to ensure that decentralization is consistent with sound economic management for the country as a whole. They noted that, given the country's limited human and financial resources, attainment of this objective will require the development of effective and affordable economic institutions. They therefore encouraged the authorities to establish central economic management institutions to exploit economies of scale, particularly in revenue administration, public administration and statistics. Directors also stressed that institutional arrangements will have to be developed to guide the budget process and ensure the implementation of common external sector policies. In this connection, Directors encouraged the authorities to harmonize external tariffs between the Union and Anjouan. They also supported technical assistance from the Fund to help build capacity in economic management—particularly to establish a well designed and integrated budget process and to implement revenue and expenditure reforms.

Directors were of the view that membership of the Comoros in the franc zone has served the country well and should be maintained. Above all, it has provided a firm monetary anchor, curtailed the scope for inflationary financing, and contributed to low inflation. Directors encouraged trade liberalization in line with the objectives of the regional grouping, COMESA.

Directors welcomed the central bank's efforts to enforce and strengthen prudential regulation and supervision. They supported plans to develop a competitive financial sector, but cautioned that measures taken in this area must not compromise financial sector stability and soundness. Directors urged the authorities to promulgate legislation giving the central bank supervisory authority over microfinance institutions.

Directors believed that economic performance could be significantly improved by relying on private initiative and increasing the efficiency of public enterprises. They called for a review of the process of setting producer prices for the country's main export products to ensure that adequate incentives are in place for increasing production in areas where the country possesses a comparative advantage. Regarding public enterprises, Directors welcomed recent measures to reduce the illegal use of electricity and strengthen the collection of utility bills. Nevertheless, they considered that much more is needed to improve the performance of public enterprises, including better internal controls and the production of regular financial reports.

Directors expressed concern about continued weaknesses in the compilation and dissemination of statistics. They urged the authorities to establish a national statistics office and an efficient statistical system to ensure the production and dissemination of accurate and timely data. In addition, Directors called for increased accountability and transparency at all levels of government.

Directors encouraged the Comorian authorities to make efforts to improve economic management, including the establishment of a consolidated budget and strengthening of data collection and reporting to the Fund, so as to be able to move ahead with early discussion on a staff-monitored program.