IMF Executive Board Concludes 2009 Article IV Consultation with the State of Eritrea

Public Information Notice (PIN) No. 09/133
December 11, 2009

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On December 7, 2009, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the State of Eritrea.1

Background

Eritrea’s economic performance has weakened since the last consultation discussions held in January 2008. A series of exogenous shocks have taken a heavy toll on an already stretched economy. First, Eritrea experienced a severe drought in 2008, which resulted in a harvest that was one-fourth of that of the previous year, and necessitated emergency imports of food. Second, as a net importer of food and oil products, Eritrea was hard hit the same year by the international food and oil price crises. Finally, while the global financial crisis has so far bypassed Eritrea, the world-wide recession is likely to dampen the possible revival of remittances from the diaspora.

In spite of these adverse developments, the authorities have endeavored to protect the most vulnerable segments of the population and to implement their long-term development policies. They maintain an extensive social safety net, and are investing in three priority areas: (i) food security and agricultural production; (ii) infrastructure development; and (iii) human resources development.

As a result of the exogenous shocks, the economy sharply contracted in 2008, and inflation surged to double digits. To mitigate the impact of the shocks on the population, the authorities increased social subsidies and transfers. The ensuing fiscal deficit further burdened an already fragile domestic banking system. With the return of rains in 2009, agriculture is expected to rebound, and growth is projected to reach an estimated 3½ percent. Though the budget deficit is projected to improve in 2009, it will remain excessive, and inflation is forecast to hold in the double digits.

Monetary policy has continued to accommodate the budget deficit. The reliance on monetary financing of the budget deficit has resulted in a rapid expansion of broad money and has fueled inflation. Shortages of foreign exchange, falling remittances, and heavy government borrowing from the banking sector have hindered private sector activity. Negative real interest rates have stymied financial intermediation and weakened the stability of banks. IMF staff analysis suggests that the exchange rate is overvalued, indirectly confirmed by a growing parallel market exchange rate. Domestic and external debt levels are deemed unsustainable.

The medium-term outlook presents development challenges and may entail risks. In spite of progress toward certain Millennium Development Goals, poverty reduction has been thwarted by subdued growth and high inflation. Continued fiscal and domestic imbalances under current policies would impose an increased burden on the population. Conversely, the coming on stream of a major mine and of a cement factory in 2010 will have positive contributions to economic performance over the medium term.

Executive Board Assessment

Executive Directors noted that Eritrea’s economic performance weakened in 2008 in the wake of international food and oil price hikes, a severe drought, and the global economic crisis. They commended the authorities’ efforts to mitigate the impact on the most vulnerable segments of the population. Real growth is expected to rebound in 2009, but inflation is projected to remain high. Directors noted that low growth and high inflation have undermined poverty reduction in Eritrea—despite commendable progress toward the Millennium Development Goals in primary education and health, as well as in infrastructure development. They encouraged the authorities to take decisive and prompt actions to arrest the weak economic performance, to address large financial imbalances, and to place the economy on a path of sustained growth with poverty reduction.

Directors called on the authorities to reduce the large fiscal deficits that have been at the root of economic instability in Eritrea. They encouraged the authorities to implement comprehensive fiscal and structural reforms, and welcomed the authorities’ interest in requesting technical assistance from the IMF to improve public financial management and revenue administration, and adopt a medium-term expenditure framework. A few Directors recommended further reductions in defense spending to strengthen the fiscal position and release resources for development.

Directors expressed concern that the latest debt sustainability assessment shows Eritrea to be in external debt distress, accompanied by a very high level of domestic debt. They advised the authorities to reduce the need for further borrowing and to re-engage with the donor community, seeking grant or highly concessional external financing. Such renewed relationships will help provide the assistance—including debt relief under the enhanced Heavily Indebted Poor Countries Initiative and the Multilateral Debt Relief Initiative—necessary to help restore debt sustainability. A few Directors recommended using part of the revenue from the Bisha mine toward reducing domestic debt.

Directors regretted that the conduct of monetary policy continues to be dominated by the government’s large financing needs, fueling inflation, and curtailing credit to the private sector. Restoring the independence of monetary policy was viewed as critical, along with efforts to strengthen the banking sector and reduce distortions in financial intermediation. A few Directors encouraged the authorities to pass and implement Anti Money Laundering/Combating the Financing of Terrorism legislation.

Directors underscored the importance of liberalizing the exchange and trade systems to mitigate the foreign currency shortage, revive remittances, and reinvigorate private sector activity. They recommended reinstating the franco-valuta scheme. Directors noted the staff’s assessment that the real exchange rate is significantly overvalued, while also noting the deficiencies in data and assessment methodologies. They generally concurred that a gradual correction in the misalignment should be part of a comprehensive reform plan.

Directors encouraged the authorities to publish the budget and macroeconomic data to bolster transparency and economic accountability, utilizing technical assistance from the Fund, including from East African Regional Technical Assistance Center (AFRITAC). They also encouraged the authorities to address the serious data shortcomings that hamper Fund surveillance.

Eritrea: Selected Economic and Financial Indicators, 2005–09

 
  2005 2006 2007 2008 2009
 

 

 

 

Est. Proj.
 
           

National income and prices

(Annual percent change)

GDP at constant market prices

2.6 -1.0 1.4 -9.8 3.6

Consumer price index, period average

12.5 15.1 9.3 19.9 34.7

Consumer price index, end of period

18.5 9.0 12.6 30.2 30.2
           

Central government operations

(Percent of GDP)

Total revenue and grants

35.3 27.1 24.3 21.0 15.7

Revenue

25.9 23.0 21.2 18.2 13.1

External grants

9.3 4.1 3.1 2.8 2.6

Expenditure and net lending

56.5 39.1 39.6 46.4 31.1

Overall fiscal balance (including grants)

-21.2 -12.0 -15.3 -25.4 -15.5

Public debt

157.6 152.9 156.9 175.2 141.9
           

Money and credit

(Annual percent change)

Net domestic assets1

16.0 7.6 13.7 12.9 11.3

Broad money

10.7 5.7 12.1 15.9 13.7
           

External sector

(Percent of GDP, unless stated otherwise)

Current account balance (including official

transfers)

0.3 -3.6 -6.1 -5.5 -4.8

Current account balance (excluding official

transfers)

-9.0 -7.7 -9.2 -8.3 -7.4

Overall balance of payments

-8.7 -1.8 -2.0 3.0 2.3

External debt

63.9 59.3 58.0 61.9 47.8

External debt-service ratio2

14.6 25.1 27.0 41.5 37.3

Gross international reserves (US$ millions)

27.7 23.6 32.4 56.7 73.1

Gross international reserves (months of imports

of goods and services)

0.7 0.7 1.1 1.8 2.0
 

Sources: Eritrean authorities; and IMF staff estimates and projections.

1Change, percent of beginning-of-period broad money.

2Based on three-year average of exports of goods and services.

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. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.



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