Public Information Notice No. 08/75

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

June 25, 2008

On June 16, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Benin.¹

Background

In the last two years, Benin has experienced a pickup in growth and low inflation supported by prudent fiscal policies and external debt relief. However, progress in addressing core economic vulnerabilities has fallen short of expectations, and the external environment has become less favorable with a strengthening CFA franc adding to competitiveness concerns and surging food and fuel prices accentuating a deterioration in the terms of trade. Against this background, real GDP growth reached 4.6 percent in 2007 underpinned by activity in the port, transport and commerce sectors on the strength of enhanced Cotonou port competitiveness; and by a favorable food harvest. These factors countered the adverse impact of a regional energy crisis and lower-than-programmed cotton output. As a result of comfortable local food availability, average inflation decelerated to 1.3 percent in 2007, below the West African Economic and Monetary Union (WAEMU) threshold of 3 percent. This helped to moderate appreciation of the real effective exchange rate (REER).

The external current account deficit widened because of terms of trade deterioration and real currency appreciation. However, thanks to large official capital grant inflows, the balance of payments recorded a sizable surplus. Driven by strong revenue mobilization, fiscal performance exceeded expectations in several respects, although public investment lagged owing to persistent absorptive capacity limitations. At 3 percent of GDP, the surplus on the narrowly defined primary fiscal balance was 2 percentage points above target. However, higher food and fuel prices are expected to contribute to a 2.3 percent of GDP increase in the import bill in 2008 and a widening of the current account deficit.

In 2007, broad money rose by 18 percent, substantially above nominal GDP growth, driven mostly by donor-supported increases in net foreign assets. Consistent with the improved budgetary situation and related increases in Treasury deposits in the banking system, net bank credit to the government contracted, allowing a 26 percent expansion of credit to the private sector, mostly for commerce, transportation, and telecommunications activities. Because of the strong credit expansion, the authorities kept the required reserve ratio at 15 percent to insure against potential inflationary and capital flight repercussions.

Despite further delays in structural reforms in the cotton and utilities sectors, a revival of port and other service activities, together with continued, albeit moderate, recovery in cotton production, is supporting a further strengthening of growth in 2008. Real GDP growth is expected to inch up to 5.3 percent. However, continuing upward pressures on oil and food prices are likely to reverse a recent easing of pressures on domestic prices, causing average inflation to increase to the upper bound of the WAEMU target (possibly beyond in case of pronounced world oil and food price increases), despite the supply of domestic foodstuffs remaining generally adequate.

The surplus on the narrowly defined primary budget is projected to decline to 0.5 percent of GDP in 2008 reflecting, in part, revenue losses from fiscal measures to address rising oil and food prices. Nevertheless, fiscal prospects continue to benefit from expenditure and revenue measures aimed at restoring fiscal discipline and expanding the fiscal space in the post-Multilateral Debt Relief Initiative (MDRI) era. These measures are aimed at achieving enhanced monitoring of treasury operations, further improving governance in the revenue agencies, and consolidating hard-won gains in fiscal and customs administration over the last years with technical assistance from the Fund's Fiscal Affairs Department.

Benin's medium-term economic prospects seem generally favorable, although growth is likely to continue to fall short of what is required to rapidly reduce poverty. Economic activity will remain heavily dependent on performance in the port and cotton sectors, with a pickup in construction and public works supporting domestic demand as the government rebuilds the economic and social infrastructure. Cotton production and export growth are projected to remain below potential in view of slow progress in sector reform and imports of oil and capital goods would grow moderately in real terms due to capacity limitations, but also reflecting high world prices. Consistent with likely developments in the latter, the terms of trade are projected to further deteriorate.

In the structural area, key medium-term challenges for the authorities are to (i) complete a comprehensive cotton sector reform strategy by end-2008 and ensure an early implementation of recommendations, (ii) bring to the point of sale the state-owned Telecommunications company (Benin Telecoms) in the last quarter of 2009, (iii) finalize before end-2009 restructuring of the parastatal national electricity company (SBEE) and develop a reform strategy for the company thereafter. Efforts to further enhance port competitiveness are continuing, aimed to ensure that the newly recruited external port expert and auditor become fully operational and to start operation of the port's one-stop window for customs procedures clearance in 2008. Other elements of the structural reform agenda include donor-supported initiatives to improve the efficiency of the legal and land tenure systems, and to facilitate credit assess to small and medium-sized enterprises.

A revised Poverty Reduction Strategy Paper (PRSP II) was completed in 2007. It places a renewed emphasis on private sector-led economic growth; the authorities are expected to issue a first annual progress report in the coming weeks.

Executive Board Assessment

Executive Directors commended Benin's satisfactory economic performance over the last two years, marked by low inflation and strengthening economic growth. Directors noted that Benin was the only WAEMU member country in 2007 to meet the monetary union's convergence criterion on the basic fiscal balance.

At the same time, Directors observed that growth continues to fall short of levels required to achieve significant progress in poverty alleviation, and that core economic vulnerabilities remain. In particular, rising commodity and food prices are fuelling inflationary pressures, the external current account is widening because of terms of trade deterioration and real currency appreciation, and Benin's weak absorptive capacity hampers efforts to boost growth.

Noting the slow progress of structural reform, Directors called on the authorities to invigorate the reform process—particularly in the cotton and public utility sectors—in order to reduce Benin's vulnerability to shocks, strengthen external competitiveness, improve the business environment, and further boost economic growth to accelerate progress toward the Millennium Development Goals. This will also help unlock donor financing. In this regard, Directors were encouraged by the authorities' renewed commitment to engage in a comprehensive reform agenda.

Directors noted that the fiscal measures taken to address rising food and fuel prices—namely, reduction of tariffs on certain food and oil imports and subsidies to the electricity company—have weakened Benin's budgetary position in 2008. They called on the authorities to limit the scope and duration of these measures, and supported an early transition to well-targeted and more fiscally sustainable safety net measures. Directors encouraged the donor community to provide additional assistance to help Benin cope with the food and fuel price shock. In this regard, most Directors supported an augmentation of Fund financing to Benin, while some Directors expressed reservations given Benin's strong international reserve position.

Directors commended the authorities' prudent fiscal stance and the implementation of measures to improve revenue collection and control public spending. They called for further improvements in public expenditure management, and reiterated that reform of the civil service pension fund will be essential for achieving medium-term fiscal sustainability. Directors encouraged the authorities to remove the ceiling on wages as progress is made on wage management. At the same time, Directors emphasized that project design and implementation capacity needs to be strengthened to permit higher and more efficient development and social spending.

Directors welcomed the authorities' commitment to maintaining prudent borrowing policies in order to preserve external debt sustainability. However, they expressed concern that substantial borrowing has been undertaken in regional financial markets at high interest rates, only to result in an accumulation of funds in the banking system because of capacity constraints on spending.

Directors looked forward to the finalization of the comprehensive reform strategy being prepared for the cotton sector, and encouraged that the strategy be expeditiously implemented once it is completed. They called on the authorities to adhere to the new restructuring timetable for the telecommunications and electricity companies. Directors welcomed the achievements in port reform, including planned introduction of a one-stop window for customs clearance, which should help improve port management and enhance customs effectiveness. Directors also encouraged timely implementation of measures to strengthen the judicial and land tenure systems and to facilitate further access to credit for small and medium-sized enterprises.

Directors noted the weaknesses in banking sector indicators, including low capitalization, maturity mismatches, and high concentrations of credit and non-performing loans. They welcomed the authorities' endorsement of key recommendations from the recent WAEMU Financial Sector Assessment Program (FSAP) mission to improve financial sector regulation and supervision. Directors supported the recent regional agreement to strengthen the supervisory authority of the regional Banking Commission, and welcomed the regional central bank's efforts to ensure timely observance of agreed higher bank minimum capital requirements.

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. This PIN summarizes the views of the Executive Board as expressed during the 6/16/2008 Executive Board discussion based on the staff report.