## 1. Impact of Governance Weaknesses on Fiscal Management ## Source details **Canonical URL:** [1. Impact of Governance Weaknesses on Fiscal Management](https://www.imf.org/-/media/files/publications/cr/2020/english/1comea2020003.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2020/english/1comea2020003.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2020/english/1comea2020003.pdf.json) --- ### Overview and macroeconomic significance - Governance defined as “the various institutions, mechanisms, and established practices through which a country exercises governmental authority, discharges its responsibilities, and manages its public resources” (IMF 2017, 2018a). - Corruption defined as “the abuse of public office for private gain” and typically results from weak governance (Fisman and Golden, 2017; IMF 1997 and 2017). - Comoros faces governance weaknesses in administrating the civil service, managing fiscal operations, ensuring the rule of law, and AML/CFT measures; addressing these challenges would likely help spur inclusive growth and lower vulnerability to corruption. - Cross-country research (Hammadi et. al.) suggests that moving the average SSA country governance level to the global average could increase the region’s GDP per capita growth by about 1–2 percentage points. ### Major macro-critical governance weaknesses identified (Fund findings) - Weak rule of law, particularly enforcement of contracts: cases linger and judgments frequently not enforced, undermining private sector activity. - Regulatory framework issues: unclear import and export processes and state monopoly on trade in certain products create drag on private sector activity. - Fiscal management weaknesses: weak public financial management, weak spending controls, and lack of transparency in budget execution. - Weak anti-corruption efforts and AML/CFT measures, which have hurt correspondent banking relationships. - Civil service management weaknesses: hiring and promotion decisions based in part on considerations other than merit, leading to weak results in revenue administration and other public services. ### Governance in managing the civil service Findings: - Hiring and promotion decisions appear to be based in part on patronage, contributing to skills mismatch, high turnover, and weak morale and accountability. - Personnel issues lead to weak results in revenue mobilization, public financial management, and education services. Recommended reforms: - Base civil service hiring and promotion decisions on merit: institute an entry exam (as already used at the Central Bank) and strengthen civil servant training. - Set ambitious but realistic expectations and hold civil servants accountable: assess performance, reward good performance, and sanction weak performance such as absenteeism. - Improve civil service payroll management: continue efforts to weed out any remaining “ghost workers”, including by fully applying the IT tool that links personnel and payroll data. ### Governance issues in managing fiscal operations — Revenue mobilization Key findings and statistics: - Fiscal revenue in Comoros was 8.3 percent of GDP in 2018 versus a Sub-Saharan Africa (SSA) average of 17.7 percent of GDP in 2018. (Text: “Comoros’ fiscal revenue is less than half of the SSA average (8.3 percent vs 17.7 percent of GDP in 2018).”) - Number of active taxpayers in the Medium-Taxpayers’ Office is 256 (almost all in Moroni); fragile country norms suggest 1,500–2,000 taxpayers would be more appropriate. - Research suggests GDP per capita rises sharply once tax revenue rises above 12–13 percent of GDP (Gaspar, Jaramillo, and Wingender, 2016). - IMF research: improvement in Kaufmann, Kraay and Mastruzzi’s Control of Corruption Indicator by one-third of a standard deviation associated with a 1.2 percentage point increase in the government revenue-to-GDP ratio. Transmission channels of weak governance to revenue: - Weakened tax compliance culture and high rates of tax evasion. - Granting of tax exemptions in acts of favoritism and outright corruption of tax officials. - Complexity in business registration and tax system (numerous exemptions) limits transparency, creates room for arbitrary decisions, and discourages business registration and tax compliance. - Weak enforcement of tax payment obligations. Specific vulnerabilities cited: - Lack of transparency in SOE fiscal contributions: fees and charges often set below cost recovery, weak supervision of SOEs, cross-arrears between SOEs and government, and SOE financial strains obscure SOE contributions to fiscal revenue. - Risk to potential oil and gas revenue: “Recent news stories have highlighted the dearth of official information about oil exploration and production sharing commitments.” Recommended reforms for revenue mobilization: - Simplify (including by removing exemptions) and better enforce tax laws and simplify business registration requirements. - Simplify customs laws (including by further reducing exemptions) and sign and implement the new Customs Code to limit discretion in Customs administration. - Strengthen SOE oversight (see Public Financial Management section). - Foster transparency in the nascent petroleum industry; the Fund can provide hands-on support for key elements of the management of natural resources, including the design of petroleum fiscal regimes. ### Public Financial Management (PFM) — findings and vulnerabilities Findings: - Governance weaknesses hamper PFM by allowing extra-budgetary spending, circumventing procurement rules and expenditure controls, and enabling wasteful spending. - Overly-ambitious budgeting through 2018 created large deviations between budget forecasts and realized revenue and spending, undermining transparency and credibility. - Some government accounts remain outside the Treasury Single Account (TSA); exceptional payment procedures are used frequently. - Authorities have for several years informed neither parliament nor the public about budget execution. - Government has accrued a possibly substantial stock of domestic arrears. - Low scores in the 2017 Open Budget survey and successive PEFA assessments document the lack of transparency. Table 1: Key PFM transmission channels and applications to Comoros (selected) - Revenue Administration: Tax revenue stood at only 8.3 percent of GDP in 2018 due to excessive exemptions, complexity in the tax system, a large informal sector, and weak administration. - Natural Resource Wealth: Recent news coverage of heightened public concerns about a lack of transparency about possible oil exploration and production sharing agreements. - Budget Credibility: Overly-optimistic revenue and investment spending forecasts, absence of a medium-term budget framework, and high volume of in-year spending reallocations. - Wages and Pensions Transparency: Ghost workers and pensioners remain a concern; civil service paybill crowding out priority spending. - Public Procurement/Expenditure Controls: Weak expenditure controls, extra-budgetary commitments, and a buildup of arrears. - Public Investment Management: Little is known about transparency of investment spending and rates of return of envisaged projects. - Treasury Financial Management: Continued use of an “investment account” in parallel with the TSA facilitates off-budget expenditures and limits transparency. - Extra-budgetary Funds and Public Enterprises: Fees and charges below cost recovery levels, insufficient accountability, and cross arrears between the State and SOEs. - Debt and Aid/Other Foreign Inflows: Diversion of funds and the large Comorian citizenship/passport scandal reinforcing AML/CFT concerns and reportedly leading to large-scale misappropriation of funds. PFM reform actions recommended: - Make the return to budget realism permanent: base revenue forecasts on robust macroeconomic forecasts and revenue elasticities in line with historical experience while taking account of structural changes and transitory factors; align investment spending forecasts with capacity limitations. - Strengthen implementation of the TSA: transfer government accounts remaining at commercial banks to the TSA and ensure emergency spending procedures are used only rarely. - Strengthen fiscal reporting: ensure that audited or final annual financial statements are published within 6, 9, or 12 months after the end of the financial year pertaining to a “basic”, “good” or “advanced” practice level. - Audit public-sector arrears and develop an arrears clearance strategy; strengthen internal control framework (control environment, authorization and approval procedures such as mandating payment vouchers for all procurement transactions), risk assessment, monitoring, and adopt/enforce sanctions for extra-budgetary spending. - Strengthen SOE oversight: - Define performance goals and conclude performance contracts (already started). - Mandate preparation of audited annual financial reporting and more frequent reporting to government. - Clear cross-arrears and avoid new ones. - Move towards setting prices at cost recovery after putting in place compensating transfers to the poor. - Review SOE staffing and salary levels. ### Governance issues in ensuring the rule of law - Rule of law (contract enforcement and property rights) remains fragile: cases often linger in courts for years and enforcement of rulings is unreliable. - Causes of judicial sector weakness likely include insufficient funding and political interference. ### Business environment: findings and indicators - Limitations in the business environment curb banks’ ability to move against delinquent creditors and likely significantly constrain investment. - 2020 World Bank Doing Business indicators suggest that Comoros lags the SSA average (and other comparators) in all but two dimensions of its business environment. - Comoros’ weakest scores relate to the judiciary system—enforcing contracts, protecting minority investors, resolving insolvency, and accessing credit. - Comoros is presently ranked 160th (out of 190 countries). - Authorities have established a 2021 DBI ranking target of 150th (out of 190 countries). Recommended policy actions (business environment): - Strengthen the effectiveness of the judiciary in protecting property rights and enforcing contracts: - Refrain from exerting political influence. - Seek a judicial system diagnosis by a credible outside partner. - Enhance funding of the judicial system. - Strengthen staffing in a low-cost manner by complementing the corps of professional judges with laymen judges. - Strengthen arbitration options. - Create an enabling environment for private investment through regulatory reform: - Authorities may ask the World Bank to identify opportunities for quick wins. ### Anti-Corruption: current situation and recommendations Findings: - Implementation of anti-corruption measures is generally weak. - National Commission for Preventing and Fighting Corruption has been recently dismantled, leaving a gap in the architecture. - Obligation for senior public officials to declare their assets: unclear whether interim arrangement (transfer to the Accounts Section of the Supreme Court) has been effective, given lack of transparency and capacity gaps. - Transposition of the UN Convention against Corruption, ratified in 2012, has not yet been evaluated through peer-review. - Although some corruption offenses have been criminalized, not all are fully covered in line with the UNCAC. Recommended policy actions (anti-corruption): - Enhance rules for asset declarations: - Adjust the range of officials subject to asset disclosure requirements. - Broaden the coverage of the declarations. - Verify the accuracy of the declarations and sanction failure or false reporting. - Publish the declarations of senior officials. - Strengthen administrative arrangements for the agency handling processing, verification and enforcement of asset declarations, including efforts to establish an institution to replace the former National Commission for Preventing and Fighting Corruption. ### AML/CFT: findings, legal deficiencies and recommendations Findings: - GIABA identified important shortcomings in Comoros’ fight against money laundering and the financing of terrorism. - Weak laws and weak implementation by public administration and financial institutions; majority of financial institutions have weak AML/CFT systems. - No investigations or convictions for money laundering or terrorism financing to date; correspondent banking relationships have suffered. GIABA legal recommendations include: - Amend the Penal Code to adequately criminalize money laundering (current law fails to adequately criminalize and identify sanctions against kidnapping and trafficking of human beings, smuggling of migrants, smuggling of stolen goods, piracy, insider trading, environmental crimes, manipulation of markets, and fraud; law also fails to incriminate accessory offenses). - Amend the Penal Code to adequately criminalize the financing of terrorism (definition does not cover intended use by an individual terrorist or terrorist organization; Comoros does not formally incriminate the attempt to commit the crime of financing terrorism). - Amend the AML/CFT Law to strengthen customer due diligence, beneficial ownership identification, specify record-keeping obligations and thresholds for transfers requiring heightened diligence. Additional legal and implementation recommendations: - Legal framework should expressly require financial institutions to report: - (i) transactions that may be related to money laundering and proceeds of corruption, or - (ii) suspected financing of terrorism. - (Current framework requires reporting only of transactions of funds of unlawful origin.) - Adjust laws to: - Prevent the misuse of legal persons and arrangements for money laundering and corruption. - Ensure information on beneficial owners of legal persons and trusts is available to competent authorities. - Strengthen implementation: - Enhance the capacity of the Financial Research Service (SRF); the service’s capacity building needs are extensive. - Strengthen the central bank’s supervision of financial institutions to ensure adequate identification and reporting of transactions that may relate to money laundering and proceeds of corruption, with particular attention to transactions involving politically exposed persons. ### Economic Citizenship Program: recommendations - Authorities should clarify the status of Comoros’ Economic Citizenship Program, including: - The legal status of the program. - The number of citizenships granted. - The revenue that should have accrued to the government budget and the revenue that did in fact accrue. - The recovery of misappropriated funds. - If the program continues, ensure that foreigners purchasing passports are fit and proper and their source of funds is legitimate. ### Implementation timeline and urgency (AML/CFT) - Authorities have formulated and begun implementing an action plan for addressing AML/CFT deficiencies, but effectiveness remains weak and stronger efforts are needed. - Authorities’ objective: National Assembly to promulgate a revised Penal Code by end-April 2020, in light of the next GIABA plenary in May 2020. - Authorities should promptly implement GIABA’s outstanding recommendations and ensure effectiveness of the national AML/CFT regime. Selected institutional and legislative architecture items: - National Anti-Corruption and Prevention Strategy adopted in 2012. - Anti-Corruption Law: Law 08-013 / AU (passed July 25, 2008; promulgated June 21, 2011); Decree No 12-183 / PR, September 15, 2012 reinforces asset declaration requirements. Law has not been operational since 2016 due to dissolution of NCPFC. - Public-Private Partnership law: Law 17-019 / AU (adopted December 25, 2017; promulgated January 24, 2018). - Anti-Money Laundering/Fighting Terrorism law: Law 12-008 / AU (adopted June 28, 2012; promulgated August 2, 2012); defines offenses and preventative measures and spells out terms of reference of the Financial Intelligence Service (FIS). - Institutional entities: NCPFC (dissolved 2016), National Committee to Fight against Money Laundering and Terrorism Financing (Decree No. 12-041 / PR of 18 February 2012), Financial Research Service (SRF), National Directorate for Controlling Public Contracts and Public Service Delegation (NDCPCPSD), Public Procurement Regulatory Authority (PPRA), Public Private Partnership Support Unit (PPPSU), Ad hoc Tender Committee. Status of implementation of selected GIABA recommendations (selected entries): - Recommendation 1: New Penal Code adapted unsigned by the former President is being updated to incorporate international organization recommendations; targeted outcome: New revised Penal Code adopted once again by the National Assembly and promulgated by end of April 2020 at the latest. Responsible party: Ministry of Justice. - Recommendation 2: Bill on terrorism developed; provisions to be integrated into the new code under update. Targeted outcome: Provisions integrated in the code under revision. Responsible parties: Ministry of Homeland Security; Ministry of Justice. - Recommendation 3 and 4: Bill on payment services and providers to be elaborated; targeted outcome: Law adopted and promulgated end of April 2020 at the latest. Responsible parties: Ministry of Finance, Budget and Banking sector; Ministry of Public service and Public Administration. - Recommendation 5: SRF premises to be equipped and competent permanent staff assigned. Responsible party: Ministry of Finance, Budget and Banking sector. - Recommendation 6: Palermo protocol ratification: Law authorizing ratification adopted and communication to President prepared end of 2019 at the latest; targeted outcome: Palermo protocol ratified by the Union of Comoros end of April 2020 at the latest. - Recommendation 7: Bills to revise organic law on judicial organization and establish judicial, economic and financial pole developed; targeted outcome: Organic law revised and law on judicial pole adopted and promulgated end of April 2020 at the latest; judicial pole made operational November 2020 at the latest. Responsible parties: Ministry of Homeland Security; Ministry of Justice. - Recommendation 8: Provisions on registers for declarations of origin/use of transported foreign currencies to be integrated in new code under revision; targeted outcome: Existing legal framework adopted and enforced. Responsible parties: Ministry of Finance, Budget and Banking sector; Ministry of Homeland Security; Ministry of Justice. ### Banking sector — overview and key metrics - Financial system composition: twelve financial institutions — four banks, four micro-finance institutions, and four other financial intermediaries (including one large deposit taking institution, SNPSF). - For the study, all deposit-taking institutions are treated as “banks.” - Banking penetration: 22 percent of the population reports having an account at a financial institution (including SNPSF) or using a mobile money service in the past 12 months, compared to an average of 43 percent in Sub-Saharan Africa (SSA). - Financial system assets: 27 percent of GDP. Asset quality and provisioning: - NPLs at end-March 2019: 21 percent of total loans, with a median provisioning ratio of 55.7 percent. - NPLs increased to 24 percent of system-wide loans at end-October 2019. - A small number of clients account for the lion’s share of NPLs. - Median provisioning coverage assumed in tests: 55.7 percent (as of March 2019). Capital adequacy and vulnerabilities: - System capital adequacy ratio (CAR) at end-March 2019: 24.7 percent of risk-weighted assets (RWA). - Regulatory minimum CAR: 10 percent. - Several banks have low capital buffers above the minimum. - Capital needs of undercapitalized banks: 0.9 percent of GDP. ### Stress test design and scenarios - Eight financial institutions tested: the four banks, three micro-finance institutions, and SNPSF. - Ordinary stress test shocks (increase in NPLs): - Moderate shock: increase in NPLs in each bank by 20 percent (average NPL increase seen during 2011–16). - Severe shock: 35 percent increase in NPLs (largest annual increase during 2011–16). - Extreme shock: 70 percent increase in NPLs (largest annual system-wide increase in NPLs seen in any fragile state in SSA since the Global Financial Crisis). - Provisioning assumption for ordinary test: constant provisioning coverage ratio of 55.7 percent. - Low recovery rate stress test: assumes recovery rate of NPLs of 2 percent. - Combined ordinary and recovery rate tests: combine NPL shock scenarios with recovery rate of 2 percent. - Reverse stress test: - With provisioning rate of 56 percent, tests the rise in NPLs needed to lower system CAR below regulatory minimum. - With recovery rate of 2 percent, determines lower threshold for NPL increase to breach minimum CAR. - Single name concentration test: simulates default of largest permitted exposure (risk-weighted amount of 25 percent of institution’s capital); uses provisioning rate of 56 percent. ### Stress test key findings and impacts Ordinary stress test (system CAR and impacts): - Current System CAR: 24.7 percent. - Moderate: System CAR 22.6 percent; Impact on CAR -2.1 (percentage points); No. banks failing / percent of system deposits: 2 / 18; Capital shortfall (percent of GDP): 1.0. - Severe: System CAR 21.0 percent; Impact on CAR -3.7 (percentage points); No. banks failing / percent of system deposits: 3 / 26; Capital shortfall (percent of GDP): 1.0. - Extreme: System CAR 16.9 percent; Impact on CAR -7.8 (percentage points); No. banks failing / percent of system deposits: 4 / 39; Capital shortfall (percent of GDP): 1.3. - System CAR after median coverage: Current 24.0; Moderate 21.8; Severe 20.2; Extreme 15.9. - Notes: - In the moderate scenario, no further bank falls below the 10 percent minimum. - In the severe scenario, one additional bank falls below 10 percent (total three banks failing). - In the extreme scenario, one more bank falls below 10 percent (total four banks failing), and the four undercapitalized banks account for 39 percent of system-wide deposits. Low recovery rate stress test and combined results: - Low recovery rate (recovery rate at 2 percent) baseline System CAR: 19.3 percent; Impact on CAR -5.4 (percentage points). - Combined ordinary stress test and recovery rate at 2 percent: - Moderate: System CAR 14.4 percent; Impact on CAR -10.2 (percentage points); No. banks failing / percent of system deposits: 5 / 55; Capital shortfall (percent of GDP): 1.3. - Severe: System CAR 10.4 percent; Impact on CAR -14.3 (percentage points); No. banks failing / percent of system deposits: 5 / 55; Capital shortfall (percent of GDP): 1.6. - Extreme: System CAR -0.8 percent; Impact on CAR -25.4 (percentage points); No. banks failing / percent of system deposits: 6 / 61; Capital shortfall (percent of GDP): 2.4. - Under the low recovery rate test (2 percent recovery), two banks see capital drop below 10 percent to join the two already undercapitalized banks (total four banks failing), accounting for 39 percent of total system deposits; resulting capital shortfall corresponds to 1 percent of GDP, an additional 0.1 percent of GDP compared to current capital needs. Reverse stress test results: - System CAR outcomes and necessary increase in NPL stock: - Unchanged recovery rate: System CAR (percent) 21.4; Impact on CAR -3.3 (percentage points); Necessary increase in NPL stock (percent) 24.0; Capital shortfall (percent of GDP) 1.0. - Recovery rate at 2 percent: System CAR (percent) 14.6; Impact on CAR -10.0 (percentage points); Necessary increase in NPL stock (percent) 80.2; Capital shortfall (percent of GDP) 1.4. - System CAR at 9.9% row: System CAR (percent) 9.9; Impact on CAR -14.7 (percentage points); Necessary increase in NPL stock (percent) 114.0; Capital shortfall (percent of GDP) 1.8. - Recovery rate at 2 percent (alternate): System CAR (percent) 9.9; Impact on CAR -14.7 (percentage points); Necessary increase in NPL stock (percent) 36.5; Capital shortfall (percent of GDP) 1.7. - Interpretation: - With provisioning rate of 56 percent, NPLs would need to more than double to lower the system CAR to less than the regulatory minimum. - If only 2 percent of NPLs can be recovered, NPLs would need to rise by 36.5 percent to lower the system-wide CAR below the regulatory minimum; in both cases capital shortfall about 1.8 percent of GDP (table presents related capital shortfall values across scenarios). Single name concentration stress test: - Current System CAR: 24.7 percent. - Default of largest exposure: System CAR 18.3 percent; Impact on CAR -6.3 (percentage points). - No. banks failing / percent of system deposits: Current 2 / 18; Default of largest exposure 2 / 18. - Capital shortfall (percent of GDP): Current 0.9; Default of largest exposure 0.94. - No additional banks see capital drop below 10 percent under this test. - SNPSF’s capital shortfall would increase marginally under this test. Overall implications: - High aggregate CAR (24.7 percent) masks weaknesses in individual institutions. - NPLs and low recovery rates materially increase numbers of undercapitalized banks and capital shortfalls measured as percent of GDP. - Four to six banks could be undercapitalized under combined adverse scenarios, accounting for up to 61 percent of system deposits in the most severe combined scenario. - Capital shortfalls range across scenarios from 0.9 percent to 2.4 percent of GDP depending on shock severity and recovery assumptions. *Prepared by I. Ahamada, M. Benlamine, L. D’Amico, R. Gupta, R. Randall, Thierry Bayle (MCM), Mokhtar Benlamine (AFR), and Torsten Wezel (MCM). Source: INTERNATIONAL MONETARY FUND.* ### 1. Impact of Governance Weaknesses on Fiscal Management 6 ### 1. Impact of Governance Weaknesses on Fiscal Management 6 ### Overview and macroeconomic significance - Governance is defined as “the various institutions, mechanisms, and established practices through which a country exercises governmental authority, discharges its responsibilities, and manages its public resources” (IMF 2017, 2018a). - Corruption is defined as “the abuse of public office for private gain” and typically results from weak governance (Fisman and Golden, 2017; IMF 1997 and 2017). - Comoros faces governance weaknesses in several macro critical areas including administrating the civil service, managing fiscal operations, ensuring the rule of law, and AML/CFT measures. Addressing these challenges would likely help spur inclusive growth, including by lowering vulnerability to corruption. - Cross-country research (Hammadi et. al.) suggests that moving the average SSA country governance level to the global average could increase the region’s GDP per capita growth by about 1–2 percentage points. ### Major macro-critical governance weaknesses identified (Fund findings) - The rule of law, particularly the enforcement of contracts, suffers from a weak judicial system: cases linger and judgments are frequently not enforced, undermining private sector activity. - The regulatory framework: unclear import and export processes and state monopoly on trade in certain products create drag on private sector activity. - Fiscal management: weak public financial management, including weak spending controls and lack of transparency in budget execution. - Anti-corruption efforts and AML/CFT measures are weak, which has hurt correspondent banking relationships. - Civil service management: hiring and promotion decisions based in part on considerations other than merit, leading to weak results in revenue administration and other public services. ### Governance in managing the civil service Findings: - Hiring and promotion decisions appear to be based in part on patronage, contributing to skills mismatch, high turnover, and weak morale and accountability. - These personnel issues lead to weak results in revenue mobilization, public financial management, and education services. Recommended reforms: - Base civil service hiring and promotion decisions on merit: institute an entry exam (as already used at the Central Bank) and strengthen civil servant training. - Set ambitious but realistic expectations and hold civil servants accountable: assess performance, reward good performance, and sanction weak performance such as absenteeism. - Improve civil service payroll management: continue efforts to weed out any remaining “ghost workers”, including by fully applying the IT tool that links personnel and payroll data. ### Governance issues in managing fiscal operations — Revenue mobilization Key findings and statistics: - Fiscal revenue in Comoros was 8.3 percent of GDP in 2018 versus a Sub-Saharan Africa (SSA) average of 17.7 percent of GDP in 2018. (Text: “Comoros’ fiscal revenue is less than half of the SSA average (8.3 percent vs 17.7 percent of GDP in 2018).”) - The number of active taxpayers in the Medium-Taxpayers’ Office is 256 (almost all in Moroni); fragile country norms suggest 1,500–2,000 taxpayers would be more appropriate. - Research suggests GDP per capita rises sharply once tax revenue rises above 12–13 percent of GDP (Gaspar, Jaramillo, and Wingender, 2016). - IMF research found that an improvement in Kaufmann, Kraay and Mastruzzi’s Control of Corruption Indicator by one-third of a standard deviation was associated with a 1.2 percentage point increase in the government revenue-to-GDP ratio. Transmission channels of weak governance to revenue: - Weakened tax compliance culture and high rates of tax evasion. - Granting of tax exemptions in acts of favoritism and outright corruption of tax officials. - Complexity in business registration and tax system (numerous exemptions) limits transparency, creates room for arbitrary decisions, and discourages business registration and tax compliance. - Weak enforcement of tax payment obligations. Specific vulnerabilities cited: - Lack of transparency in SOE fiscal contributions: fees and charges often set below cost recovery, weak supervision of SOEs, cross-arrears between SOEs and government, and SOE financial strains obscure SOE contributions to fiscal revenue. - Risk to potential oil and gas revenue: “Recent news stories have highlighted the dearth of official information about oil exploration and production sharing commitments.” Recommended reforms for revenue mobilization: - Simplify (including by removing exemptions) and better enforce tax laws and simplify business registration requirements. - Simplify customs laws (including by further reducing exemptions) and sign and implement the new Customs Code to limit discretion in Customs administration. - Strengthen SOE oversight (see Public Financial Management section). - Foster transparency in the nascent petroleum industry; the Fund can provide hands-on support for key elements of the management of natural resources, including the design of petroleum fiscal regimes. ### Public Financial Management (PFM) — findings and vulnerabilities Findings: - Governance weaknesses hamper PFM by allowing extra-budgetary spending, circumventing procurement rules and expenditure controls, and enabling wasteful spending (Table 1 channels). - Overly-ambitious budgeting through 2018 created large deviations between budget forecasts and realized revenue and spending, undermining transparency and credibility. - Some government accounts remain outside the Treasury Single Account (TSA); exceptional payment procedures are used frequently. - The authorities have for several years informed neither parliament nor the public about budget execution. - The government has accrued a possibly substantial stock of domestic arrears. - Low scores in the 2017 Open Budget survey and successive PEFA assessments document the lack of transparency. Table 1: Key PFM transmission channels and applications to Comoros (selected) - Revenue Administration: Tax revenue stood at only 8.3 percent of GDP in 2018 due to excessive exemptions, complexity in the tax system, a large informal sector, and weak administration. - Natural Resource Wealth: Recent news coverage of heightened public concerns about a lack of transparency about possible oil exploration and production sharing agreements. - Budget Credibility: Overly-optimistic revenue and investment spending forecasts, absence of a medium-term budget framework, and high volume of in-year spending reallocations. - Wages and Pensions Transparency: Ghost workers and pensioners remain a concern; civil service paybill crowding out priority spending. - Public Procurement/Expenditure Controls: Weak expenditure controls, extra-budgetary commitments, and a buildup of arrears. - Public Investment Management: Little is known about transparency of investment spending and rates of return of envisaged projects. - Treasury Financial Management: Continued use of an “investment account” in parallel with the TSA facilitates off-budget expenditures and limits transparency. - Extra-budgetary Funds and Public Enterprises: Fees and charges below cost recovery levels, insufficient accountability, and cross arrears between the State and SOEs. - Debt and Aid/Other Foreign Inflows: Diversion of funds and the large Comorian citizenship/passport scandal reinforcing AML/CFT concerns and reportedly leading to large-scale misappropriation of funds. PFM reform actions recommended: - Make the return to budget realism permanent: base revenue forecasts on robust macroeconomic forecasts and revenue elasticities in line with historical experience while taking account of structural changes and transitory factors; align investment spending forecasts with capacity limitations. - Strengthen implementation of the TSA: transfer government accounts remaining at commercial banks to the TSA and ensure emergency spending procedures are used only rarely. - Strengthen fiscal reporting: ensure that audited or final annual financial statements are published within 6, 9, or 12 months after the end of the financial year pertaining to a “basic”, “good” or “advanced” practice level. - Audit public-sector arrears and develop an arrears clearance strategy; strengthen internal control framework (control environment, authorization and approval procedures such as mandating payment vouchers for all procurement transactions), risk assessment, monitoring, and adopt/enforce sanctions for extra-budgetary spending. - Strengthen SOE oversight: - Define performance goals and conclude performance contracts (already started). - Mandate preparation of audited annual financial reporting and more frequent reporting to government. - Clear cross-arrears and avoid new ones. - Move towards setting prices at cost recovery after putting in place compensating transfers to the poor. - Review SOE staffing and salary levels. ### Governance issues in ensuring the rule of law - The rule of law (contract enforcement and property rights) remains fragile: cases often linger in courts for years and enforcement of rulings is unreliable. - Causes of judicial sector weakness likely include insufficient funding and political interference. *Prepared by I. Ahamada, M. Benlamine, L. D’Amico, R. Gupta, and R. Randall. Source: INTERNATIONAL MONETARY FUND, “1. Impact of Governance Weaknesses on Fiscal Management.”* ### 17. These limitations have an adverse ### 1comea2020003 - 17. These limitations have an adverse ### Business environment: findings and indicators - Limitations in the business environment curb banks’ ability to move against delinquent creditors and likely significantly constrain investment. - The 2020 World Bank’s Doing Business indicators suggest that Comoros lags the SSA average (and other comparators) in all but two dimensions of its business environment. - Comoros’ weakest scores relate to the judiciary system—namely enforcing contracts, protecting minority investors, and resolving insolvency (as well as accessing credit, Text Figure 6). - Comoros is presently ranked 160th (out of 190 countries). - Authorities have established a 2021 DBI ranking target of 150th (out of 190 countries). ### Recommended policy actions (business environment) - Strengthen the effectiveness of the judiciary in protecting property rights and enforcing contracts: - Refrain from exerting political influence. - Seek a judicial system diagnosis by a credible outside partner. - Enhance funding of the judicial system. - Strengthen staffing in a low-cost manner by complementing the corps of professional judges with laymen judges. - Strengthen arbitration options. - Create an enabling environment for private investment through regulatory reform: - Authorities may ask the World Bank to identify opportunities for quick wins. ### Anti-Corruption: current situation - Comoros’ implementation of anti-corruption measures is generally weak. - The National Commission for Preventing and Fighting Corruption has been recently dismantled, leaving a gap in the architecture. - Obligation for senior public officials to declare their assets: unclear whether interim arrangement (transfer to the Accounts Section of the Supreme Court) has been effective, given lack of transparency and capacity gaps. - The transposition of the UN Convention against Corruption, ratified in 2012, has not yet been evaluated through peer-review. - Although some corruption offenses have been criminalized, not all are fully covered in line with the UNCAC. ### Recommended policy actions (anti-corruption) - Enhance rules for asset declarations: - Adjust the range of officials subject to asset disclosure requirements. - Broaden the coverage of the declarations. - Verify the accuracy of the declarations and sanction failure or false reporting. - Publish the declarations of senior officials. - Strengthen administrative arrangements for the agency handling processing, verification and enforcement of asset declarations, including efforts to establish an institution to replace the former National Commission for Preventing and Fighting Corruption. ### AML/CFT: findings and legal deficiencies - GIABA has identified important shortcomings in Comoros’ fight against money laundering and the financing of terrorism. - Weak laws and weak implementation by public administration and financial institutions; majority of financial institutions have weak AML/CFT systems. - No investigations or convictions for money laundering or terrorism financing to date; correspondent banking relationships have suffered. - GIABA recommendations to amend legal framework include: - Amend the Penal Code to adequately criminalize money laundering (current law fails to adequately criminalize and identify sanctions against kidnapping and trafficking of human beings, smuggling of migrants, smuggling of stolen goods, piracy, insider trading, environmental crimes, manipulation of markets, and fraud; law also fails to incriminate accessory offenses). - Amend the Penal Code to adequately criminalize the financing of terrorism (definition does not cover intended use by an individual terrorist or terrorist organization; Comoros does not formally incriminate the attempt to commit the crime of financing terrorism). - Amend the AML/CFT Law to strengthen customer due diligence, beneficial ownership identification, specify record-keeping obligations and thresholds for transfers requiring heightened diligence. ### Additional AML/CFT legal and implementation recommendations - Legal framework should expressly require financial institutions to report: - (i) transactions that may be related to money laundering and proceeds of corruption, or - (ii) suspected financing of terrorism. - (Current framework requires reporting only of transactions of funds of unlawful origin.) - Adjust laws to: - Prevent the misuse of legal persons and arrangements for money laundering and corruption. - Ensure information on beneficial owners of legal persons and trusts is available to competent authorities. - Strengthen implementation: - Enhance the capacity of the Financial Research Service (SRF); the service’s capacity building needs are extensive. - Strengthen the central bank’s supervision of financial institutions to ensure adequate identification and reporting of transactions that may relate to money laundering and proceeds of corruption, with particular attention to transactions involving politically exposed persons. ### Economic Citizenship Program: recommendations - Authorities should clarify the status of Comoros’ Economic Citizenship Program, including: - The legal status of the program. - The number of citizenships granted. - The revenue that should have accrued to the government budget and the revenue that did in fact accrue. - The recovery of misappropriated funds. - If the program continues, ensure that foreigners purchasing passports are fit and proper and their source of funds is legitimate. ### Implementation timeline and urgency - Authorities have formulated and begun implementing an action plan for addressing AML/CFT deficiencies, but effectiveness remains weak and stronger efforts are needed. - Authorities’ objective: National Assembly to promulgate a revised Penal Code by end-April 2020, in light of the next GIABA plenary in May 2020. - Authorities should promptly implement GIABA’s outstanding recommendations and ensure effectiveness of the national AML/CFT regime. ### Institutional and legislative architecture (selected items) - National Anti-Corruption and Prevention Strategy adopted in 2012; aims to strengthen fiscal controls and public accountability through criminal justice improvements, legislative streamlining, and capacity improvements in Public Procurement Authority and Accounts Section of the Supreme Court. - Anti-Corruption Law: Law 08-013 / AU (passed July 25, 2008; promulgated June 21, 2011); requires asset declarations for senior public officials; Decree No 12-183 / PR, September 15, 2012 reinforces asset declaration requirements. Law has not been operational since 2016 due to dissolution of NCPFC. - Public-Private Partnership law: Law 17-019 / AU (adopted December 25, 2017; promulgated January 24, 2018). - Anti-Money Laundering/Fighting Terrorism law: Law 12-008 / AU (adopted June 28, 2012; promulgated August 2, 2012); defines offenses and preventative measures and spells out terms of reference of the Financial Intelligence Service (FIS). Latest GIABA analysis identifies shortcomings. - Institutional entities described include: NCPFC (dissolved 2016), National Committee to Fight against Money Laundering and Terrorism Financing (Decree No. 12-041 / PR of 18 February 2012), Financial Research Service (SRF), National Directorate for Controlling Public Contracts and Public Service Delegation (NDCPCPSD), Public Procurement Regulatory Authority (PPRA), Public Private Partnership Support Unit (PPPSU), Ad hoc Tender Committee. ### Status of implementation of GIABA recommendations (selected entries) - Recommendation 1: Promulgation of new penal code integrating offenses in UN convention on organized/transnational crime. - Current status: New Penal Code adapted unsigned by the former President is being updated to incorporate international organization recommendations (criminalization of trafficking in stolen property, kidnapping, illicit trafficking, drug trafficking, environment-related offenses). - Targeted outcome: New revised Penal Code adopted once again by the National Assembly and promulgated by end of April 2020 at the latest. - Responsible party: Ministry of Justice. - Recommendation 2: Legal framework incriminating financing of individual terrorism and terrorist organizations. - Current status: Bill on terrorism developed; provisions to be integrated into the new code under update. - Targeted outcome: Provisions of bill integrated in the code under revision. - Responsible parties: Ministry of Homeland Security; Ministry of Justice. - Recommendation 3 and 4: Thresholds for wire transfers and obligation to accompany transfers with originator/beneficiary information. - Current status: Bill on payment services and providers to be elaborated. - Targeted outcome: Law adopted and promulgated end of April 2020 at the latest. - Responsible parties: Ministry of Finance, Budget and Banking sector; Ministry of Public service and Public Administration. - Recommendation 5: SRF human, technical, financial resources. - Current status: Available premises and process underway to equip premises and strengthen SRF in human resources, skills and financial resources. - Targeted outcome: SRF premises equipped and competent permanent staff assigned. - Responsible party: Ministry of Finance, Budget and Banking sector. - Recommendation 6: Ratification of the Palermo protocol. - Current status: Law authorizing ratification adopted and communication to President prepared end of 2019 at the latest. - Targeted outcome: Palermo protocol ratified by the Union of Comoros end of April 2020 at the latest. - Recommendation 7: Legal framework and mechanism for enforcing targeted financial sanctions (UNSC Resolutions 1373 and 1267); creation of judicial, economic and financial pole. - Current status: Bill on terrorism developed; bill revising organic law on judicial organization developed; bill establishing judicial, economic and financial pole developed. - Targeted outcome: Organic law revised and law on judicial pole adopted and promulgated end of April 2020 at the latest; judicial pole made operational November 2020 at the latest. - Responsible parties: Ministry of Homeland Security; Ministry of Justice. - Recommendation 8: Registers for declarations of origin/use of transported foreign currencies and referral to SRF when thresholds exceeded. - Current status: Provisions to be integrated in the new code under revision. - Targeted outcome: Existing legal framework adopted and enforced. - Responsible parties: Ministry of Finance, Budget and Banking sector; Ministry of Homeland Security; Ministry of Justice. ### Banking sector solvency: summary finding - Solvency stress tests find that severe but plausible shocks to asset quality would leave a number of medium- to-large institutions undercapitalized. - Tests that account for a potentially very low recovery rate of non-performing loans (NPLs), as suggested by anecdotal evidence, find substantial impacts. - Findings suggest that the solvency of Comoros’ banking system is fragile. - Capital shortfalls remain limited relative to GDP, reflecting the small size of the banking system. *Source: IMF staff compilation from the provided chapter content.* ### 1. The Comorian financial system remains underdeveloped. There are twelve financial institutions: ### 1. The Comorian financial system remains underdeveloped. There are twelve financial institutions: ### Overview of the financial system - Twelve financial institutions: four banks, four micro-finance institutions, and four other financial intermediaries (including one large deposit taking institution, SNPSF). - For the study, all deposit-taking institutions are treated as “banks.” - Banking penetration: 22 percent of the population reports having an account at a financial institution (including SNPSF) or using a mobile money service in the past 12 months, compared to an average of 43 percent in Sub-Saharan Africa (SSA). - Financial system assets: 27 percent of GDP. ### Asset quality and provisioning - Non-performing loans (NPLs) at end-March 2019: 21 percent of total loans, with a median provisioning ratio of 55.7 percent. - NPLs increased to 24 percent of system-wide loans at end-October 2019. - A small number of clients account for the lion’s share of NPLs. - Median provisioning coverage assumed in tests: 55.7 percent (as of March 2019). ### Capital adequacy and vulnerabilities - System capital adequacy ratio (CAR) at end-March 2019: 24.7 percent of risk-weighted assets (RWA). - Regulatory minimum CAR: 10 percent. - Several banks have low capital buffers above the minimum. - Capital needs of undercapitalized banks: 0.9 percent of GDP. ### Stress test design and scenarios - Eight financial institutions tested: the four banks, three micro-finance institutions, and SNPSF. - Ordinary stress test shocks (increase in NPLs): - Moderate shock: increase in NPLs in each bank by 20 percent (average NPL increase seen during 2011–16). - Severe shock: 35 percent increase in NPLs (largest annual increase during 2011–16). - Extreme shock: 70 percent increase in NPLs (largest annual system-wide increase in NPLs seen in any fragile state in SSA since the Global Financial Crisis). - Provisioning assumption for ordinary test: constant provisioning coverage ratio of 55.7 percent. - Low recovery rate stress test: assumes recovery rate of NPLs of 2 percent. - Combined ordinary and recovery rate tests: combine NPL shock scenarios with recovery rate of 2 percent. - Reverse stress test: - With provisioning rate of 56 percent, tests the rise in NPLs needed to lower system CAR below regulatory minimum. - With recovery rate of 2 percent, determines lower threshold for NPL increase to breach minimum CAR. - Single name concentration test: simulates default of largest permitted exposure (risk-weighted amount of 25 percent of institution’s capital); uses provisioning rate of 56 percent. ### Stress test key findings and impacts - Ordinary stress test (system CAR and impacts): - Current System CAR: 24.7 percent. - Moderate: System CAR 22.6 percent; Impact on CAR -2.1 (percentage points); No. banks failing / percent of system deposits: 2 / 18; Capital shortfall (percent of GDP): 1.0. - Severe: System CAR 21.0 percent; Impact on CAR -3.7 (percentage points); No. banks failing / percent of system deposits: 3 / 26; Capital shortfall (percent of GDP): 1.0. - Extreme: System CAR 16.9 percent; Impact on CAR -7.8 (percentage points); No. banks failing / percent of system deposits: 4 / 39; Capital shortfall (percent of GDP): 1.3. - System CAR after median coverage: Current 24.0; Moderate 21.8; Severe 20.2; Extreme 15.9. - Notes: - In the moderate scenario, no further bank falls below the 10 percent minimum. - In the severe scenario, one additional bank falls below 10 percent (total three banks failing). - In the extreme scenario, one more bank falls below 10 percent (total four banks failing), and the four undercapitalized banks account for 39 percent of system-wide deposits. - Low recovery rate stress test and combined results: - Low recovery rate (recovery rate at 2 percent) baseline System CAR: 19.3 percent; Impact on CAR -5.4 (percentage points). - Combined ordinary stress test and recovery rate at 2 percent: - Moderate: System CAR 14.4 percent; Impact on CAR -10.2 (percentage points); No. banks failing / percent of system deposits: 5 / 55; Capital shortfall (percent of GDP): 1.3. - Severe: System CAR 10.4 percent; Impact on CAR -14.3 (percentage points); No. banks failing / percent of system deposits: 5 / 55; Capital shortfall (percent of GDP): 1.6. - Extreme: System CAR -0.8 percent; Impact on CAR -25.4 (percentage points); No. banks failing / percent of system deposits: 6 / 61; Capital shortfall (percent of GDP): 2.4. - Under the low recovery rate test (2 percent recovery), two banks see capital drop below 10 percent to join the two already undercapitalized banks (total four banks failing), accounting for 39 percent of total system deposits; resulting capital shortfall corresponds to 1 percent of GDP, an additional 0.1 percent of GDP compared to current capital needs. - Reverse stress test results: - System CAR outcomes and necessary increase in NPL stock: - Unchanged recovery rate: System CAR (percent) 21.4; Impact on CAR -3.3 (percentage points); Necessary increase in NPL stock (percent) 24.0; Capital shortfall (percent of GDP) 1.0. - Recovery rate at 2 percent: System CAR (percent) 14.6; Impact on CAR -10.0 (percentage points); Necessary increase in NPL stock (percent) 80.2; Capital shortfall (percent of GDP) 1.4. - System CAR at 9.9% row: System CAR (percent) 9.9; Impact on CAR -14.7 (percentage points); Necessary increase in NPL stock (percent) 114.0; Capital shortfall (percent of GDP) 1.8. - Recovery rate at 2 percent (alternate): System CAR (percent) 9.9; Impact on CAR -14.7 (percentage points); Necessary increase in NPL stock (percent) 36.5; Capital shortfall (percent of GDP) 1.7. - Interpretation: - With provisioning rate of 56 percent, NPLs would need to more than double to lower the system CAR to less than the regulatory minimum. - If only 2 percent of NPLs can be recovered, NPLs would need to rise by 36.5 percent to lower the system-wide CAR below the regulatory minimum; in both cases capital shortfall about 1.8 percent of GDP (table presents related capital shortfall values across scenarios). - Single name concentration stress test: - Current System CAR: 24.7 percent. - Default of largest exposure: System CAR 18.3 percent; Impact on CAR -6.3 (percentage points). - No. banks failing / percent of system deposits: Current 2 / 18; Default of largest exposure 2 / 18. - Capital shortfall (percent of GDP): Current 0.9; Default of largest exposure 0.94. - No additional banks see capital drop below 10 percent under this test. - SNPSF’s capital shortfall would increase marginally under this test. ### Overall implications - The Comorian banking system shows high aggregate CAR but significant concentration of risks: - High system CAR (24.7 percent) masks weaknesses in individual institutions. - NPLs and low recovery rates materially increase numbers of undercapitalized banks and capital shortfalls measured as percent of GDP. - Four to six banks could be undercapitalized under combined adverse scenarios, accounting for up to 61 percent of system deposits in the most severe combined scenario. - Capital shortfalls range across scenarios from 0.9 percent to 2.4 percent of GDP depending on shock severity and recovery assumptions. *Prepared by Thierry Bayle (MCM), Mokhtar Benlamine (AFR), and Torsten Wezel (MCM).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1comea2020003.pdf_