Public Information Notice No. 08/149

Public Information Notice: IMF Executive Board Concludes the 2008 Article IV Consultation with Comoros

December 24, 2008

On December 15, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Union of the Comoros.¹

Background

The Union of Comoros' economic performance has weakened since 2006, due to a precarious political environment, and against a backdrop of tensions in the global economy. In 2007, real GDP grew a scanty 0.5 percent, compared with an annual average of 2.5 percent during 1999-2006. Business activities, especially imports, were hard hit by political tensions with the island of Anjouan and limited credit availability—as the country's sole commercial bank curtailed operations in the wake of a disputed lawsuit. Economic activity remained subdued in the first half of 2008, and real GDP growth is likely to stagnate at 0.5 percent in 2008. In addition to a further decline in the terms of trade, growth is held back by a difficult energy crisis. Inflation rose sharply to an average of 4.5 percent in 2007 and is projected to accelerate to 6 percent at the end-2008, driven by higher food and fuel prices early in the year.

Fiscal performance has deteriorated further in 2007-08, although corrective measures are being taken for 2009 and the medium term. The domestic primary fiscal deficit increased to 2.2 percent of GDP in 2007. Third-quarter revenue and current spending outturns for 2008, including for wages, appear to be as targeted under the revised 2008 budget, suggesting that the domestic primary fiscal deficit will rise to 2.7 percent of GDP in 2008. In the absence of adequate aid disbursements, new domestic and external payment arrears are being accumulated as sizable external debt service obligations fall due.

Monetary policy remains prudent. Money supply increased by a modest 1.1 percent in 2007, with declining domestic credit offsetting gains in net foreign assets. Reflecting increased financial intermediation, broad money growth is to accelerate to around 7 percent in 2008, matching that of nominal GDP.

In the face of steady real appreciation of the euro-pegged Comoros franc, and with the terms-of-trade declining by an annual average of 16 percent in the last three years, the external current account deficit rose to the equivalent of 6.7 percent of GDP in 2007, up from 6.1 percent in 2006. The deficit is projected to widen further to 8.7 percent of GDP in 2008—mostly on account of higher energy and food prices in the initial months of the year. The external debt, projected at 236 percent of exports in net present value terms at end-2008, is judged to be unsustainable. Addressing this problem will require comprehensive debt relief under the enhanced Highly Indebted Poor Countries (HIPC) and Multilateral Debt Relief Initiatives (MDRI).

Growth is likely to remain relatively subdued over the medium term in the absence of major investment in agriculture, which represents over 50 percent of total value added, and despite some revival of activity in tourism and donor-funded public works. As pressures on food and fuel prices ease up, inflation is projected to decline to a trend 3-percent annual average, anchored by the exchange rate peg.

In the next several years, the external current account deficit is projected to widen to 10-11 percent of GDP, reflecting limited export volume gains and relatively strong worker remittances-funded imports, following the end of the political conflict. Foreign direct investment (FDI) is expected to increase in line with identified investment projects in banking and tourism, including major revamping of some vacation resorts on the island of Ngazidja. Consistent with these developments, external reserves are projected to decline to 5-6  months of imports.

As a result of heightened prudence in fiscal policy, the deficit on the domestic primary budget balance is projected to gradually decline to about 1 percent of GDP by 2011 (2.2 percent in 2007), reflecting improved revenue performance and better control over spending, with a focus on the wage bill. This will be key to accommodating some higher pro-growth and pro-poor expenditures.

In the structural area, key medium-term challenges for the authorities are to (i) maintain and strengthen interisland cooperation, (ii) address structural impediments to medium-term expenditure viability, and (iii) begin removing core economic distortions. The authorities have introduced and will maintain a flexible pricing mechanism for fuel prices over the medium term. They are seeking World Bank assistance in assessing the financial health of state-owned enterprises to inform a reform strategy for the sector. Other structural reforms are aimed at enhancing the efficiency of public administration. These include the adoption of organic frameworks that set the appropriate structure and optimal level of staffing for the civil service and, more generally, a comprehensive civil service reform to improve public service delivery while reducing staffing to levels compatible with medium-term budget viability.

The full Poverty Reduction Strategy Paper (PRSP) is expected to be completed by end-March 2009. Comoros' Interim PRSP (I-PRSP, 2006-09) was considered by the Boards of the IMF and World Bank in May 2006.

Executive Board Assessment

Executive Directors noted that after a long period of political instability, that had taken a severe toll on various economic and social indicators, the return to political stability is allowing the authorities to address deep-rooted macroeconomic distortions and structural rigidities. In addition, the economy has been confronted with the impact of recent food and fuel price shocks. Directors welcomed therefore the authorities' intention to implement a broad-ranging macroeconomic and structural reform program aimed at achieving fiscal sustainability, while improving the investment climate and strengthening institutions and governance.

Directors considered the authorities' fiscal consolidation efforts to be properly focused on restoring inter-island cooperation, mobilizing revenue, containing the wage bill, and refocusing spending on pro-growth and poverty-reducing programs. They welcomed the introduction of measures to improve customs and tax administration, refocus civil service recruitment policies, and streamline government ministerial portfolios. Directors recognized that Comoros' fiscal prospects remain difficult as illustrated by sizeable financing requirements for 2009 and beyond and by unsustainable public debt levels. They urged additional donor financing to support the authorities' efforts, while encouraging prudent public debt management.

They noted that the exchange rate peg continues to anchor macroeconomic stability, and the staff's assessment that the real effective exchange rate is in line with economic fundamentals. Recognizing nonetheless the erosion of external competitiveness and narrow export base, they supported the authorities' plans to bolster the export sector and diversify the economy.

Executive Directors encouraged the authorities to vigorously implement their structural reform agenda in order to place the Comoros economy on a more rapid growth path. Accordingly, they welcomed the recent upward revisions of petroleum products prices and electricity tariffs, following several years of a freeze, and the establishment of a flexible-pricing mechanism for fuel products; these actions should make power supply more reliable, easing a key constraint on growth. Directors endorsed the authorities' plans to reform public enterprises and improve the business environment, particularly in the agricultural sector, by streamlining business licensing requirements and strengthening investor protection and the legal system. They emphasized that an early completion of the PRSP would help set clearer priorities for the structural reforms and identify needs for technical and financial assistance.

Directors underscored the importance of enhancing financial intermediation to facilitate private sector growth and development. They welcomed the recent decision to allow entry of additional foreign commercial banks. Directors also stressed the importance of enhancing financial sector supervision. A few Directors called for a strengthening of the Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) framework and in this context, they welcomed the recent parliamentary approval of AML/CFT legislation. Directors supported the ongoing reforms of the central bank's statutes aimed at enhancing its independence, and encouraged the authorities to address all areas identified in the 2007 safeguards assessment.

Successful implementation of the EPCA-supported program would in the view of Directors permit a follow on the Poverty Reduction and Growth Facility (PRGF) arrangement and progress toward HIPC and MDRI debt relief, which would be essential to restore public debt sustainability and would contribute importantly to creating fiscal space for poverty-reducing expenditures.