## 1mdgea2020002

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### Tax Revenue — need, potential, and policy recommendations
- Current position:
  - Tax-to-GDP ratio is currently 10.4 percent of GDP.
  - Comparators: 15.5 percent of GDP in non-resource rich low-income and developing countries (LICDs) and 15 percent in all SSA countries.
- Recent trend and volatility:
  - Tax-to-GDP ratio expected to increase for the seventh year in a row in 2019.
  - Over the 2012-2019 period, the average yearly increase was about 0.4 percentage point of GDP.
  - Historical episodes of volatility: increased by 3 percentage points of GDP during 1995-2000 then returned below initial level in 2002; improved by 4 percentage points of GDP in 2002-2008 then lost half that gain in a single year.
- Authorities’ objective and feasibility:
  - Target: increase the net tax-to-GDP ratio to 15 percent of GDP by 2023.
  - Implied annual increases: more than 1 percentage point of GDP per year (noted as observed only once in Madagascar in the last twenty years).
- Tax potential estimates:
  - October 2017 REO chapter: tax potential about 6.5 percent of GDP.
  - Updated estimation to 2018: tax potential about 7 percent of GDP.
  - Madagascar’s potential larger than SSA average (about 4.8 to 5.5 percent of GDP) and fragile states (about 3.9 to 5.0 percent of GDP).
  - Sectoral potential: large potential from taxes on goods and services (VAT and excise).
  - Caveats: estimates sensitive to modeling assumptions; potential reflects policy choices and preferences; frontier can be raised by improving macroeconomic and institutional conditions.
- Lessons from successful SSA episodes:
  - Sustained revenue mobilization episodes defined as total increase of 2 percentage points of non-resource GDP over three years without substantial declines; only six such episodes in 2000-2016.
  - Common features: broad tax policy and administration reforms, comprehensive multiyear strategies, strong sustained political commitment, and building consensus/social contract.
- Policy recommendations and priorities for Madagascar:
  - Realistic target: credible annual increases of about 0.5 percentage point of GDP per year over the medium-term considered a success.
  - VAT:
    - Improve yield by rationalization of tax expenditures.
    - Tax policy unit undertook impact analyses of tax expenditures for 2016, 2017 and 2018 and started evaluating exemptions.
    - Some measures on taxation of wheat and corn introduced in the 2020 budget law.
  - Excise taxes:
    - Remain relatively untapped compared to peers; low price elasticity for tobacco, alcohol, luxury goods.
    - Some increases introduced in the 2020 budget law (tobacco and beer).
    - Room to modernize management and control of existing excises and consider excises on new goods.
  - Strengthen Tax General Department reforms (initiated 2015) — FAD TA (November 2019) priorities:
    - Revive tax control operations; measure audit performance based on proportion of active taxpayers controlled.
    - Optimize human and budgetary resource management; assign new agents, establish individual performance evaluation, apply disciplinary measures.
    - Improve collection of outstanding tax payments (“Restes à Recouvrer”), stock estimated at about 1 percent of GDP.
    - Strengthen taxpayer identification and address anomalies in Tax Identification Number (NIF) use.
    - Define appropriate VAT threshold: current threshold MGA 200 million (about US$ 50,000); suggested threshold MGA 500 million could eliminate less than 100 companies from Large Enterprise Directorate portfolio, representing barely 0.01% of total VAT revenues.
  - Modernize customs administration (customs reform plan for 2020-2023 under finalization; FAD TA):
    - Target organized fraud and reduce irregularities: up to 70 percent of import declarations non-compliant but only 3 percent notified by customs offices.
    - Intensify control of companies with free zone/exemption agreements: they account for 40 percent of total imports yet no customs infringement officially recorded in 2018 and 2019 regarding exemptions and free enterprises.
    - Fight corruption by improving internal ethics and implementing disciplinary measures.
  - Improve coordination and information-sharing between tax administrations: notify each other in cases of fraud; grant domestic tax administration access to customs import/export data.
  - Build stakeholder buy-in and simplify procedures: social dialogue to explain tax rationality and use; expand on-line declaration and payment procedures for taxpayers.
- Attribution:
  - Prepared by Gabriel Léost. Source: IMF staff.

### Plan Emergence Madagascar (PEM) and public investment scale-up overview
- PEM 2019–2023:
  - Emphasizes infrastructure.
  - Estimates investment financing needs of about USD 12 bn over 2020-2023.
  - Financing expected from domestic resources (about 13 percent of GDP) and private and international investors (about 19 percent of GDP).
- Rationale:
  - Infrastructure shortfalls: access to treated water, schools, hospitals lower than averages for low-income countries and sub-Saharan Africa.
  - World Economic Forum infrastructure quality score: 2.7 out of 7 for Madagascar versus 3.0 and 3.2 for low-income countries and sub-Saharan Africa, respectively.
  - Historical investment performance: general government investment peaked at 12 percent of GDP in 2004, fell below 3 percent in 2013, and about 5 percent in 2017; private investment almost 22 percent of GDP in 2008, 14 percent in 2013, and low since.

### Major challenges to the scale-up and PIM weaknesses
- Financing gap and absorptive capacity:
  - Public investment needs about 41 per-cent of GDP in 2020-21 while total investment projected about 23 percent, leaving a significant financing gap.
  - PPP portfolio small; two upcoming hydroelectric PPP projects estimated to provide about 1.3 percent of GDP each year for the next five years.
  - Draft PEM expects public investment in 2020 and 2021 to be more than double the level of public investment execution during 2016-2019.
- Poor execution, especially externally-financed investment:
  - Budget allocation for public investment (2017 and 2018): about 8 percent of GDP.
  - Executed public investment: 5.4 and 6 percent of GDP in 2017 and 2018.
  - Externally-financed allocation (2017 and 2018): 6.1 and 5.7 percent of GDP; externally-financed execution: 3.5 and 3.7 percent of GDP in 2017 and 2018.
  - Execution of domestically-financed investment generally in line with budget allocation.
- Institutional and efficiency constraints:
  - Weak planning, prioritization, selection, ex ante evaluation, allocation linkage to results, and project management systems.
  - Weak coordination among stakeholders and perceived high corruption.
  - Madagascar’s public investment spending delivers about 30 percent of potential infrastructure benefits versus about 60 percent for sub-Saharan Africa.
  - Construction sector constraints: rising costs of imported raw materials and equipment, low access to finance, operational difficulties.
- PIM reforms and status:
  - Adoption of Public Investment Management Reform Strategy and action plan in 2017.
  - Institutional measures: action plan to implement commitment authorization and appropriations; creation of OCSIF; development of project database; IMF TA preparing manual on selection of projects.
  - Expected implementation of improvements in the next years to increase public investment efficiency.

### DIG model baseline: assumptions, macro results, and alternative efficiency scenario
- Model and baseline assumptions:
  - Model: IMF Debt-Investment-Growth (DIG) model.
  - Public investment efficiency set at 31 percent (estimated current efficiency for Madagascar).
  - Initial return on infrastructure investment: 30 percent, gradually declining.
  - Real interest rates on public debt: public domestic commercial debt 9 percent; public external commercial debt 5 percent.
  - Risk-free foreign real interest: 1 percent.
  - Public infrastructure investment, grants, and concessional financing follow DSA levels; additional financing mainly public external commercial debt.
- Baseline macroeconomic results summary:
  - Real GDP per capita growth accelerates from a steady state of 2.7 to 3.5 percent between 2019 and 2023 and stabilizes at 3.4 percent in the long-run.
  - Population growth about 2.5 percent per year implies model-predicted real GDP growth rate of 5.9 percent in 2023, and 5.6 percent in the long-run.
  - Private consumption and investment decrease in the short-run due to higher VAT taxes and higher income tax and interest rate crowding out; infrastructure promotes private investment over time.
  - Tax ratio gradually increases from 20 percent in 2019 to 25 percent in 2023.
  - Fiscal deficit increases to 3.9 percent of GDP in the medium term and stays between 3.4 and 4.9 percent in the long run.
  - Current account deficit increases to 4.8 percent of GDP in the medium-term and gradually decreases to above 4 percent in the long-run.
  - Real exchange rate appreciates in the short and medium term, reverting to pre-investment levels in the long run.
- Alternative scenario — boost public investment efficiency:
  - Assumption: efficiency improves from 31 to 63 percent (sub-Saharan Africa average), holding all else constant.
  - Impacts:
    - Real GDP per capita growth increases by up to 0.7 percent in 2023 and 0.5 percent each year thereafter compared to baseline.
    - Cumulative effect: total increase in real GDP per capita growth of 5 percent over 2019-2028.
    - Private consumption and investment: more pronounced short-run crowding out of private investment but stronger long-run private investment due to better infrastructure; crowding-out reduces contraction of private consumption in short-run; long-run higher wages and consumption via larger formal sector activity.
- Key baseline and scenario figures:
  - USD 12 bn (PEM financing needs over 2020-2023)
  - Domestic resources: about 13 percent of GDP
  - Private and international investors: about 19 percent of GDP
  - Public investment needs: about 41 per-cent of GDP in 2020-21
  - Total investment projected: about 23 percent (in 2020-21)
  - PPP hydro projects: about 1.3 percent of GDP each year for the next five years
  - Public investment efficiency: Madagascar 31 percent; sub-Saharan Africa average 63 percent
  - Initial return on infrastructure investment: 30 percent
  - Real interest rates on public domestic and external commercial debt: 9 and 5 percent, respectively
  - Risk-free foreign real interest: 1 percent
  - Real GDP per capita growth: 2.7 percent (steady state) to 3.5 percent (2019–2023), stabilizing at 3.4 percent in long-run
  - Population growth: about 2.5 percent per year
  - Tax ratio: 20 percent in 2019 to 25 percent in 2023
  - Fiscal deficit: increases to 3.9 percent of GDP in medium term; between 3.4 and 4.9 percent in long run
  - Current account deficit: increases to 4.8 percent of GDP in medium-term; gradually decreases to above 4 percent in long-run
  - Alternative scenario growth gains: up to 0.7 percent increase in real GDP per capita growth in 2023; 0.5 percent each year thereafter; total increase of 5 percent over 2019-2028

### Improving public investment management — recommended practices
- Prioritize and fully finance highest priority projects; present total cost, start year, and estimated completion year in budget documents.
- Present financing progress against total project cost and duration; link projects to PEM engagement and SDG targets.
- Allow sufficient time and resources for project preparation to reduce delays and cost overruns.
- Proactively monitor implementation; establish high-level committees to identify and remove implementation obstacles.
- Ensure enough funding to complete ongoing projects before starting new ones to avoid delays and higher total costs.

### Monetary policy under excess liquidity, operational reforms, and SVAR evidence
- Financial sector context:
  - Banking sector small: total assets representing 27 percent of GDP in 2018.
  - Concentration: four banks (all foreign owned) holding about 80 percent of credit and deposit market shares.
  - Banks hold about 2.5 percent of GDP of sovereign debt: 2/3 in Treasury Bills (BTA) up to one-year maturity; 1/3 in Treasury bonds (BTF).
  - Money markets under-developed; government securities market too shallow for yield curve; fragmented banking system with unequal reserve holdings and limited interbank lending.
  - Foreign exchange interventions guided by an algorithm to smooth exchange rate fluctuations and meet foreign reserve targets.
- Institutional reforms and instruments:
  - BFM pursued multipronged reforms: improve foreign exchange market, build effective interbank market, implement risk-based supervision, transition from reserve money aggregates to targeting interest rates.
  - Since early 2019 BFM expanded toolbox and introduced an interest rate corridor:
    - Initially announced: an overnight policy rate set at 0.9 percent to complement existing 9.5 percent annual policy rate; an overnight deposit facility at zero percent and an overnight lending facility at 4.40 percent.
    - Subsequently adjusted in November to 0.9 percent (deposit?) and 5.3 percent (lending?).
  - Planned operations: fine-tuning at end of reserve maintenance periods; full allotment fixed rate/unlimited volume deposit auctions; outright foreign exchange purchases and swaps; consider issuing central bank bills; better attune reserve requirement ratios in local and foreign currencies.
- Market developments:
  - Interbank interest rates declined from about 7-8 percent in early 2019 to 3.5-4 percent recently.
  - Exchanged volumes and counterparties on interbank market tripled compared to first six months of 2018.
  - Interbank lending duration lengthened with six months to one-year maturities at interest rates in the 7.5-9 percent range.
- Repos introduction and collateral framework:
  - Draft law to introduce repurchase operations based on strengthened collateral framework prepared with Fund TA and awaiting submission to Parliament.
  - Following successful testing in summer 2019, operations could begin as of the first semester of 2020.
  - Expected effects: incentivize longer-horizon interbank lending, support yield curve buildup, secure medium- to long-term interbank operations.
  - Complementary measure: clarify custodian responsibilities on BTF holdings to foster secondary market development.
- SVAR empirical assessment of transmission:
  - Method: structural vector autoregression (SVAR) with monthly data 2000-2018 (with some specified estimation periods).
  - Variables: exports of goods, core CPI, M3, central bank policy rate, nominal effective exchange rate; variables in logs and seasonally adjusted except policy rate (percent).
  - Data properties: variables I(1); cointegration tests indicate at least two linear cointegration vectors (0.05 level*).
  - Identification: activity variable contemporaneously responds only to own shocks; prices respond to own and activity shocks; money responds to own, policy, activity and price shocks; policy rate reacts contemporaneously to money and exchange rate shocks and with lag to activity and price shocks; exchange rate reacts contemporaneously to all shocks.
- SVAR results:
  - Policy rate shock (one-standard deviation unexpected temporary rise) has limited impact:
    - Explains 0.35 percent of goods exports variation.
    - Explains 0.1 percent of consumer price index variation.
    - Estimation period referenced for Figure 8: January 2010-December 2018.
  - Auction deposit (volume) instrument shock has limited impact:
    - Explains 0.07 percent of goods exports variation.
    - Explains 0.02 percent of consumer price index variation.
    - Estimation period referenced for Figure 9: January 2000-December 2018.
- Policy recommendations:
  - Gradual transition to interest rate targeting paced by developments in domestic money market.
  - Continue reforms to improve operational framework and liquidity management capacities.
  - Enhance dialogue with financial market, strengthen market intelligence, increase policy transparency (central bank website), and improve financial literacy in financial press through technical training.
  - Broader reforms: address informality (informal employment exceeds 90 percent of total and nonagricultural employment) and strengthen judicial effectiveness and property rights to support financial deepening and improve transmission.

### Microfinance, insurance, pensions, postal and savings institutions, mobile banking, and access to credit
- Microfinance institutions (MFIs):
  - Sector size: 5 percent of total financial system assets and less than 2 percent of GDP.
  - Rapid expansion: outstanding deposits and loans augmented exponentially; number of customers increased.
  - Financials: loans covered by deposits; activities profitable but profits modest due to high operating costs.
  - Risks: liquid assets insufficient to cover short-term liabilities (low liquidity ratios); sector well-capitalized; assets good quality; declining NPLs to total loans ratio.
  - Dynamics: stagnation in number of institutions; slow growth in beneficiaries; governance issues affecting some MFIs; new Microfinance law adopted but needs implementation decrees.
- Insurance sector:
  - Size and coverage: sector weighs 7 and 2 percent of total financial assets and GDP, respectively, in 2018.
  - Structure: dominated by two state-owned companies with more than 70 percent market shares; access to insurance services only 3 percent of adult population.
  - Performance: turnover increased 39 percent over past six years; total assets grew almost 57 percent; solvency ratio above minimum; profitability declined from 7.3 percent in 2017 to 6.2 percent in 2018.
  - Investment concentration: more than two thirds of total assets invested in financial assets (including T-Bills and share purchases) — concentration risk.
- Pension systems:
  - Public schemes: CRCM (civil servants and military) and CPR (contractual government employees); private scheme CNAPS (general regime and specific regimes).
  - Coverage: public pension system covers only 3 percent of workforce; private covers 10 percent.
  - Fiscal/funding issues: public pension system in continuous deficit, maintained via government transfers and arrears; reforms to date ineffective due to incorrect evaluation and budgetary treatment; recommendation to better control pension expenditures.
  - Private system: currently collects more than pays but requires review of design, investment choices, and supervision.
- Caisse d’Epargne de Madagascar (CEM):
  - Fully government owned; objective to collect household savings and provide retirement savings plans; active in cash transfers as first Western Union representative.
  - 2018 assets: 3.1 percent of total financial assets or 1 percent of GDP.
  - Almost 1.2 million savings accounts in 2018.
  - Financials: assets and net income increasing though net income remains low; 66 percent of assets concentrated with credit and other financial institutions.
  - Recent licensing as an MFI expected to boost resources and diversify activities.
- Paositra Malagasy (PAOMA):
  - Large national footprint; major player for financial inclusion but facing financial difficulties due to decline in mailing services.
  - 2017 audit aimed to develop action plan; action plan not yet developed.
  - PAOMA started new mobile banking services (Paositra Money) despite audit recommendation to refrain pending completion of action plan.
  - Implemented audit recommendations include taking stock of property assets, preparing full audit of customer accounts, working on procedures manual and audits of financial statements for 2015-2017.
- Mobile banking and digital finance:
  - Three electronic money intermediaries.
  - Accounts grew from less than 140,000 in 2010 to almost 10 million last year.
  - Volume of transactions grew from 2 to about 200 billion of Ariary over same period.
  - Mobile banking expected to become future of financial inclusion due to lower operating costs.
  - Example: BNI Madagascar launched KRED, SME credit product relying on mobile technologies.
  - National strategy for financial inclusion 2018-2022 adopted focusing on financial education, consumer protection, access/use of services, and legal/regulatory framework.
- Access to credit — constraints and allocation:
  - Credit to private sector ratio: 14 percent of GDP at end-2018 (SSA average 25 percent).
  - Doing Business rank 161st out of 190; score regressed from 48.9 to 47.7.
  - Credit concentration by sector in 2018: commerce 22 percent; energy 4 percent; construction 3 percent.
  - Supply-side constraints: absence of credit bureau (operational credit registry in place and first private credit bureau about to be operationalized), weak creditor rights, unfavorable business environment, political instability.
  - Demand-side constraints: only 30 percent of adult population have access to formal financial services; 5 percent have access to credit; informality rate between 30-40 percent of GDP; nominal interest rates around 15 percent on average, up to 60 percent for microfinance banks; collateral and consumer protection issues; SME-specific constraints: only 4 percent of SMEs have a line of credit vs 33 and 30 percent for medium and large enterprises; only 1 percent of SMEs investments financed by banks vs 7 percent for other enterprises; lack of credit culture where 70 percent of adults do not have any credit and only 1 percent use credit for emergencies.
- Conclusions and priority reforms:
  - Financial sector expanding but contribution modest due to low credit access; banking system overall healthy but requires monitoring.
  - MFIs boosted access in rural areas but face liquidity and governance issues; insurance profitable but investment concentration is a vulnerability.
  - PAOMA and CEM can boost financial inclusion but need supervision to protect small depositors.
  - Pension systems need revamping per Fund TA recommendations to avoid budgetary burden.
  - Priority reforms:
    - Adopt and implement new banking and financial stability laws to secure stability and credit expansion (strengthen CSBF independence, improve resolution framework, introduce risk-based supervision, enable outsourcing and service diversification, increase transparency and consumer protection).
    - Improve credit information: operational credit registry and first private credit bureau expected to lower costs and improve lending.
    - Promote digital finance: support national strategy 2018-2022 and leverage mobile banking to reduce costs and geographic constraints.
    - Continue reforms to improve macroeconomic, business, and judicial environment and pursue monetary policy reforms to introduce more predictability in interest rate determination.

*Source: 1mdgea2020002.*

### 1. Tax Revenue _________________________________________________________________________ 5

### 1. Tax Revenue

### A. The Need for Further Revenue Mobilization in Madagascar
- Tax revenue remains low despite recent progress:
  - Tax-to-GDP ratio is currently 10.4 percent of GDP.
  - This compares to 15.5 percent of GDP in non-resource rich low-income and developing countries (LICDs) and 15 percent in all SSA countries.
- Recent trend:
  - Tax-to-GDP ratio expected to increase for the seventh year in a row in 2019.
  - Over the 2012-2019 period, the average yearly increase was about 0.4 percentage point of GDP.
- Volatility and past episodes:
  - Tax revenues increased by 3 percentage points of GDP during 1995-2000 before returning in 2002 at a level below the initial level.
  - During 2002-2008, the tax-to-GDP improved by 4 percentage points of GDP in 6 years before losing half of this gain in a single year.
- Authorities’ objective and feasibility:
  - Authorities aim to increase the net tax-to-GDP ratio to 15 percent of GDP by 2023.
  - This implies increases of more than 1 percentage point of GDP per year over this period.
  - Such an increase in a single year has been observed in Madagascar only once in the last twenty years.
- Importance of revenue mobilization:
  - Essential to finance infrastructure, education, and health and to preserve medium-term fiscal sustainability.
  - Debt-service to revenue ratio is already high, making domestic revenue mobilization important to mitigate liquidity risks.

### B. Estimating Madagascar’s Tax Potential
- Methodology and data:
  - Tax frontier estimated using a panel of 123 countries from 2000-2018 (Annex I).
  - Model covariates include GDP per capita, trade openness, share of agriculture in GDP, income inequality, public spending on education, corruption, and government effectiveness.
- Key estimates:
  - October 2017 REO chapter estimated a tax potential of about 6.5 percent of GDP for Madagascar.
  - An updated estimation using data up to 2018 estimates a tax potential of about 7 percent of GDP.
  - Madagascar’s potential is larger than the average for SSA countries (about 4.8 to 5.5 percent of GDP) and other fragile states (about 3.9 to 5.0 percent of GDP).
- Sectoral potential:
  - Estimations using taxes on goods and services-to-GDP as dependent variable indicate large tax potential from taxes on goods and services (implying possible gains from VAT and excise taxes).
- Caveats:
  - Tax potential estimates are sensitive to modeling assumptions and estimation techniques.
  - The tax potential is not an automatic target: it reflects preferences and policy choices (for example, removal of exemptions on basic consumer staples).
  - The tax frontier can be increased over time by improving macroeconomic and institutional conditions.

### C. Experience from Successful Episodes in Other SSA Countries
- Definition:
  - Sustained revenue mobilization episodes defined as a total increase of 2 percentage points of non-resource GDP over a three-year period with no substantial declines during or immediately after the period.
- Rarity:
  - Only six episodes of sustained revenue mobilization identified in the 2000-2016 period.
- Common characteristics of successful episodes:
  - Broad range of tax policy and revenue administrative reforms prior to and during the mobilization episode.
  - Comprehensive and multiyear reform strategies focusing on basic institutions, broadening the tax base, and modernization of tax administrations.
  - Strong and sustained political commitment; progress often slow or incremental over a prolonged period.
  - Need to build consensus for reform: establish a social contract between the state and citizens, credible commitment to better governance and transparency.

### D. Lessons and Policy Recommendations for Madagascar
- Realistic targets:
  - Based on recent achievements and SSA experiences, ambitious but credible annual increases of about 0.5 percentage point of GDP per year over the medium-term could be considered a success.
- Exploiting taxes on goods and services:
  - VAT:
    - Yield can be improved notably by rationalization of tax expenditures.
    - The tax policy unit at the Ministry of Economy and Finance has undertaken impact analyses of tax expenditures for 2016, 2017 and 2018 (annexed to the budget laws) and started to evaluate existing exemptions, their cost, and effectiveness.
    - Some first measures on taxation of wheat and corn have been introduced in the 2020 budget law.
  - Excise taxes:
    - Excises remain a relatively untapped source of revenue in Madagascar compared to peers.
    - Elasticity of demand relative to price is generally low for some excisable goods (tobacco, alcohol, luxury goods).
    - Some increases introduced in the 2020 budget law (on tobacco and beer).
    - Considerable room to modernize and optimize management and control of existing excise duties on alcohol, tobacco and telecommunications, and to consider excises on new goods.
- Strengthen Tax General Department reforms (initiated in 2015):
  - Priorities from a recent FAD TA mission (November 2019):
    - Revive tax control operations slowed during installation of new government and administrative teams; measure tax audit performance based on proportion of active taxpayers (notably big enterprises) controlled.
    - Optimize management of human and budgetary resources; proceed without delay to assignments of new agents, starting with those for tax control; establish individual performance evaluation systems and apply planned disciplinary measures when necessary.
    - Improve collection of outstanding tax payments (“Restes à Recouvrer”), with the stock estimated at about 1 percent of GDP.
    - Strengthen reliability of taxpayer identification; pursue efforts exploiting anomalies in use of the Tax Identification Number (NIF).
    - Define an appropriate threshold for VAT application: current threshold is low (MGA 200 million, about US$ 50,000) and requires important resources for limited results; a threshold of MGA 500 million could result in elimination of less than 100 companies from the portfolio of the Large Enterprise Directorate, representing barely 0.01% of total VAT revenues, and would allow focus on more important cases.
- Modernize customs administration (customs reform plan for 2020-2023 under finalization; FAD TA recommendations):
  - Target organized fraud and reduce irregularities in customs clearance: up to 70 percent of import declarations remain non-compliant, but only 3 percent are notified by customs offices.
  - Intensify control of companies benefiting from free zone or other exemption agreements: they account for 40 percent of total imports, yet no customs infringement officially recorded in 2018 and 2019 regarding exemptions and free enterprises.
  - Strengthen the fight against corruption by improving internal ethics and implementing disciplinary measures.
- Improve coordination and information-sharing between tax administrations:
  - Tax administrations should notify each other in cases of fraud.
  - Domestic tax administration should have access to customs import/export data: many importers make customs declarations without being identified by domestic tax administration.
- Build stakeholder buy-in and simplify taxpayer procedures:
  - Given weaknesses in public service provision, social dialogue and consultation are important to explain the rationality of the tax system and use of tax revenue.
  - Improve administrative facilitation for taxpayers, including development and expansion of on-line declaration and payment procedures already used by a growing number of large companies.

*Prepared by Gabriel Léost. Source: IMF staff.*

### 2.      The Malagasy government has an ambitious development plan that is anchored on a

### 1mdgea2020002 - 2.      The Malagasy government has an ambitious development plan that is anchored on a

### Overview of the PEM scale-up
- The government’s 2019–2023 Plan Emergence Madagascar (PEM) emphasizes infrastructure and estimates investment financing needs of about USD 12 bn over 2020-2023.
- Financing for the USD 12 bn is expected to be mobilized from:
  - domestic resources (about 13 percent of GDP)
  - private and international investors (about 19 percent of GDP)

### Rationale for scaling up public investment
- Infrastructure shortfalls:
  - Access to treated water, schools, and hospitals is lower than the average of low-income countries and sub-Saharan Africa.
  - World Economic Forum infrastructure quality score: 2.7 out of 7 for Madagascar versus 3.0 and 3.2 for low-income countries and sub-Saharan Africa, respectively.
- Historical investment performance:
  - General government investment peaked at 12 percent of GDP in 2004, fell below 3 percent in 2013, and was about 5 percent in 2017.
  - Private investment reached almost 22 percent of GDP in 2008, declined to 14 percent in 2013, and has remained low since then.
- Policy objective: The PEM anchors a significant scale-up of infrastructure investment (general government and private) to achieve inclusive growth and sustainable development outcomes, including progress toward the SDGs.

### Major challenges to the public investment scale-up
- Financing gap and size of needs:
  - Public investment needs are about 41 per-cent of GDP in 2020-21 while total investment is projected to be only about 23 percent in these years, leaving a significant financing gap.
  - PPP portfolio currently small; construction of two upcoming hydroelectric PPP projects is estimated to provide about 1.3 percent of GDP each year for the next five years.
- Ambitious pace relative to absorptive capacity:
  - Draft PEM expects public investment in 2020 and 2021 to be more than double the level of public investment execution during 2016-2019.
- Poor execution, especially of externally-financed investment:
  - Total public investment allocated in the budget laws for 2017 and 2018 was about 8 percent of GDP; executed public investment was 5.4 and 6 percent of GDP in 2017 and 2018, respectively.
  - Externally-financed investment allocated in 2017 and 2018: 6.1 and 5.7 percent of GDP; execution was 3.5 and 3.7 percent of GDP in 2017 and 2018, respectively, and lower than the 4 percent execution in 2016.
  - Execution of domestically-financed investment is generally in line with budget allocation.
- Weak institutional framework and public investment management (PIM):
  - Weaknesses in planning, prioritization, selection, ex ante evaluation, allocation linkage to results, and project management systems for large projects.
  - Weak coordination among key stakeholders, including international development partners and the government.
- Low public investment efficiency and governance issues:
  - Madagascar’s public investment spending delivers only about 30 percent of the potential infrastructure benefits compared to about 60 percent for sub-Saharan Africa.
  - Construction sector constraints include rising costs of imported raw materials and equipment, low access to finance, and operational difficulties.
  - Recurring political volatility has led to changes in priorities and delays; corruption is perceived as high compared to peers.

### Public Investment Management reforms and implementation status
- Follow-up to 2016 PIMA and government actions:
  - Adoption of the Public Investment Management Reform Strategy and an action plan in 2017 to strengthen institutional framework.
  - Institutional measures include adoption of an action plan to implement commitment authorization and appropriations, creation of the Investment and Financing Coordination and Monitoring Unit (Organe de Coordination et de Suivi des investissements et de leur financements, OCSIF), and development of a project database.
  - Government is preparing a manual on selection of projects with IMF technical assistance.
- Expected timing: These improvements are expected to be implemented in the next years and increase public investment efficiency.

### DIG model baseline: assumptions and key parameters
- Model used: IMF Debt-Investment-Growth (DIG) model.
- Key baseline assumptions:
  - Public infrastructure investment, grants, and concessional financing follow levels under the DSA; additional financing covered predominantly by public external commercial debt.
  - Public investment efficiency set at 31 percent (estimated current efficiency for Madagascar).
  - Initial return on infrastructure investment stands at 30 percent, gradually declining over the forecast horizon.
  - Real interest rates on public debt:
    - public domestic commercial debt: 9 percent
    - public external commercial debt: 5 percent
  - Risk-free foreign real interest: 1 percent
  - Other parameters follow either LIDC averages or Madagascar specific values.

### DIG model baseline: macroeconomic results (summary)
- Growth:
  - Real GDP per capita growth accelerates from a steady state of 2.7 to 3.5 percent between 2019 and 2023 and stabilizes at 3.4 percent in the long-run.
  - Population growth about 2.5 percent per year implies a model-predicted real GDP growth rate of 5.9 percent in 2023, and 5.6 percent in the long-run.
- Private sector effects:
  - Private consumption and investment decrease in the short-run due to higher VAT taxes and higher income tax and interest rate crowding out private investment; infrastructure creation helps promote private investment over time.
- Public finances and debt:
  - Tax ratio gradually increases from 20 percent in 2019 to 25 percent in 2023.
  - Fiscal deficit increases to 3.9 percent of GDP in the medium term and stays between 3.4 and 4.9 percent in the long run as public investment scale-up continues.
  - Current expenditures are projected to gradually decrease over time.
- External balance and exchange rate:
  - Current account deficit increases to 4.8 percent of GDP in the medium-term and gradually decreases to above 4 percent in the long-run.
  - Imports increase to supply materials for public investment throughout the period.
  - Real exchange rate appreciates in the short and medium term due to increased external loans and grants and imports for construction; it reverts to pre-investment scale-up levels in the long run.

### Alternative scenario: boosting public investment efficiency
- Assumption:
  - Public investment efficiency improves from 31 to 63 percent (sub-Saharan Africa average), holding all else constant.
- Rationale:
  - In line with PIMA follow-up and the government’s Public Investment Management Reform Strategy and action plan.
- Impacts:
  - Real GDP per capita growth increases by up to 0.7 percent in 2023 and 0.5 percent each year thereafter compared to the baseline.
  - Cumulative effect: total increase in real GDP per capita growth of 5 percent over 2019-2028.
  - Private consumption and investment:
    - More pronounced crowding out of private investment in the short-run but promotion of private investment in the long-run due to more and better infrastructure.
    - Crowding-out reduces the contraction of private consumption in the short-run; long-run effects include higher wages and higher consumption due to larger formal sector activity.

### Key statistics and figures cited
- USD 12 bn (PEM estimated financing needs over 2020-2023)
- Domestic resources: about 13 percent of GDP
- Private and international investors: about 19 percent of GDP
- Public investment needs: about 41 per-cent of GDP in 2020-21
- Total investment projected: about 23 percent (in 2020-21)
- PPP hydro projects: about 1.3 percent of GDP each year for the next five years
- Budget allocation for public investment (2017 and 2018): about 8 percent of GDP
- Executed public investment: 5.4 and 6 percent of GDP in 2017 and 2018
- Externally-financed allocation (2017 and 2018): 6.1 and 5.7 percent of GDP
- Externally-financed execution (2017 and 2018): 3.5 and 3.7 percent of GDP
- Madagascar current public investment efficiency: 31 percent
- Sub-Saharan Africa average public investment efficiency: 63 percent
- Initial return on infrastructure investment: 30 percent
- Real interest rates on public domestic and external commercial debt: 9 and 5 percent, respectively
- Risk-free foreign real interest: 1 percent
- Real GDP per capita growth: 2.7 percent (steady state) to 3.5 percent (2019–2023), stabilizing at 3.4 percent in long-run
- Population growth: about 2.5 percent per year
- Real GDP growth rate implied: 5.9 percent in 2023, 5.6 percent in the long-run
- Tax ratio: 20 percent in 2019 to 25 percent in 2023
- Fiscal deficit: increases to 3.9 percent of GDP in medium term; between 3.4 and 4.9 percent in long run
- Current account deficit: increases to 4.8 percent of GDP in medium-term; gradually decreases to above 4 percent in long-run
- Alternative scenario growth gains: up to 0.7 percent increase in real GDP per capita growth in 2023; 0.5 percent each year thereafter; total increase of 5 percent over 2019-2028

*Prepared by Ha Vu, with inputs from Anja Baum and Luis-Felipe Zanna.*

### 24.      Given the potential of additional increases in growth, Madagascar should focus on

### 24.      Given the potential of additional increases in growth, Madagascar should focus on

### Improving public investment efficiency — recommended public investment management practices
- Identify the highest priority projects among priority projects. Funding availability would need to focus first and foremost on fully financing these projects to ensure their completion. The total cost of these projects would need to be presented in the budget documents together with existing information on the start year and estimated completion year.
- Present financing progress against the total project cost and duration to ensure sufficient resource allocation. For each major project, the budget documents should show the reference to specific engagement and priority in the PEM as well as specific targets in the SDGs. This would allow to better monitor progress in PEM and SDGs.
- Allow enough time and resources to prepare projects to ensure they are ready for implementation. This would help achieve the expected results and reduce inefficiency in the implementation of these projects including delays and cost overruns.
- Proactively monitor the implementation of the major projects to identify projects experiencing delays and take action to expedite them. Experience from other countries suggests that establishing high-level committees to identify and remove implementation obstacles and to ensure projects are completed on schedule and within budget is a good way to ensure the delivery of the expected outputs.
- Ensure enough funding to complete ongoing projects. If projects already started do not receive enough funding to cover expenditures planned in the budget year will result in delays and likely increase total project costs. Such costs can be avoided if budget practices give priority to funding ongoing projects before starting new projects.

### Conclusions and growth projections related to scaling-up public investment
- Scaling-up public investment in Madagascar has the potential to boost economic growth, but the growth impact depends crucially on how the government manages it.
- There is significant scope to strengthen public investment management to maximize the growth impact from the scale up.
- Boosting public investment in infrastructure is crucial to increase economic growth and achieve sustainable development goals in Madagascar. The 2019-2023 PEM is expected to anchor on a significant scale-up of infrastructure investment including general government and private investment to achieve inclusive growth and sustainable development.
- Projected growth impacts from the scale-up and improved efficiency:
  - Scaling up of public investment could increase annual real GDP growth from a steady state of about 5 percent in 2019 to about 6 per-cent in 2023 and 5.6 percent in the longer term.
  - Improving public investment management would significantly increase public investment efficiency which could lead to an additional increase of about 0.5 percent real GDP growth each year and additional 4.5 percent over ten years.
- To realize these additional growth benefits, Madagascar should strengthen public investment management practices by focusing on the highest priority projects, fully financing them, allocating sufficient preparation time and resources, and proactively monitoring and expediting implementation.

### Monetary policy under excess liquidity — constraints and reform direction
- Financial sector context and constraints:
  - The banking sector is small, with total assets representing 27 percent of GDP in 2018, and heavily concentrated, with four banks, all foreign owned, holding about 80 percent of credit and deposit market shares.
  - Banks have been structurally maintaining excess liquidity buffers for years, partly due to volatile economic conditions and price fluctuations in the vanilla sector.
  - Banks hold about 2.5 percent of GDP of sovereign debt, 2/3 in the form of Treasury Bills (Bons du Trésor par Adjudication – BTA) of up to one-year maturity, and 1/3 in the form of Treasury bonds (Bons du Trésor Fihary - BTF).
  - Money markets remain under-developed, the market for government securities is too shallow for a yield curve to emerge, and the banking system is fragmented with unequal reserve holdings and limited interbank lending.
  - Foreign exchange interventions have been guided by an algorithm for intervening in the interbank market to smooth exchange rate fluctuations and meet foreign reserve targets.
- Institutional reforms and policy instruments:
  - The central bank, Banky Foiben’i Madagasikara (BFM), has pursued a multipronged reform strategy to improve the foreign exchange market, build an effective interbank market, and implement a risk-based approach to financial supervision, to allow a gradual transition from reserve money aggregates to directly targeting interest rates.
  - Until 2014 monetary policy was less active and relied on deposit auctions (volume instruments) and the reserve money aggregate as the intermediary target.
  - Since early 2019, BFM began expanding its toolbox and introduced an interest rate corridor:
    - Initially announced: an overnight policy rate set at 0.9 percent to complement the existing 9.5 percent annual policy rate; an overnight deposit facility at zero percent and an overnight lending facility at 4.40 percent.
    - Subsequently adjusted in November to 0.9 percent (deposit?) and 5.3 percent (lending?).
  - BFM plans to conduct fine-tuning operations at the end of reserve maintenance periods, eventually conduct full allotment fixed rate/unlimited volume deposit auctions, expand instruments to include outright foreign exchange purchases and foreign exchange swaps, consider issuing central bank bills, and better attune reserve requirement ratios in local and foreign currencies.
- Recent market developments and outcomes:
  - Improved communication and institutional changes facilitated intensified interbank market activity: interbank interest rates declined from about 7-8 percent in early 2019 to 3.5-4 percent recently.
  - Exchanged volumes and counterparties on the interbank market tripled compared to the first six months of 2018.
  - The duration of interbank lending has lengthened, with transactions for six months to one-year maturities at interest rates in the 7.5-9 percent range.
- Implications:
  - Structural excess bank liquidity, banking sector fragmentation, and absence of a yield curve have undermined the effectiveness of the interest rate channel for both short- and long-term maturities.
  - The priority on foreign reserve accumulation has constrained use of the exchange rate channel for domestic price stabilization, and foreign exchange purchases add liquidity that the central bank must mop up, creating potential tensions between monetary and exchange rate policy objectives.
  - Strengthening liquidity management capacities, enhancing communication with market operators, and addressing low financial inclusion and high informality are needed to support a transition to interest rate targeting.

*Source: 1mdgea2020002 - 24.      Given the potential of additional increases in growth, Madagascar should focus on*

### 14.      The introduction of the repurchase operations (repos) regulatory framework is

### 14.      The introduction of the repurchase operations (repos) regulatory framework is

### Introduction of repos and operational reforms
- A draft law to introduce repurchase operations based on a strengthened collateral framework has been prepared with Fund TA and is awaiting submission to Parliament.
- Following successful testing over the summer of 2019, operations could begin as of the first semester of 2020.
- Expected effects:
  - Further incentivize interbank lending at longer horizons.
  - Support the buildup of a yield curve.
  - Secure medium- to long-term interbank operations.
- Complementary measure: clarification of custodian responsibilities on BTF holdings to ensure these securities can be effectively accessed and managed by the central bank, thereby helping to foster development of a secondary market for bonds.

### Empirical approach to assess monetary policy transmission
- Methodology: structural vector autoregression (SVAR) to investigate the relationship between monetary policy instruments and economic activity.
- Estimation sample and frequency:
  - Monthly data over the period 2000-2018 (except for one specified estimation period).
  - Variables expressed in logarithmic form and seasonally adjusted using the Census-X13 methodology, except the policy rate (expressed in percent).
- Variables included:
  - Exports of goods (indicator of economic activity; selected to get around shortcomings of quarterly GDP series)
  - Core consumer price index
  - Broad money aggregate M3
  - Central bank policy rate (main policy variable of interest)
  - Nominal effective exchange rate
- Note: The correlation between inflation and core inflation reaches 92.6 percent between January 2001 and August 2019.

### SVAR structure and identifying assumptions
- Structural ordering and contemporaneous responses encoded in the SVAR imply:
  - The activity variable contemporaneously only responds to its own shocks.
  - The price variable contemporaneously responds to its own shocks and to those affecting the activity variable.
  - The money variable contemporaneously responds to its own shocks, as well as to shocks on the policy rate, on activity and on prices.
  - The policy rate contemporaneously reacts to its own shocks, as well to money and exchange rate shocks, but only with a lag to activity and price shocks.
  - The nominal effective exchange rate reacts contemporaneously to all shocks.

### Data properties, unit roots, and cointegration
- Lag lengths chosen by standard information criteria; unit root tests by Augmented Dickey-Fuller and Phillips-Perron tests.
- All variables found to be integrated of order one in level, implying they are I(0) in first difference.
- Cointegration tests indicate the existence of at least two linear cointegration vectors (selected at the 0.05 level*).

### Estimation choices and caveats
- Given data limitations, prior-discussed results and a short sample, SVAR models are estimated with variables in level, implicitly assuming cointegration relations driving long-run behavior.
- Rationale: focus on long-run relationships rather than short-term relationships which log-differenced variables would emphasize.

### Results: effectiveness of the policy rate
- A monetary policy shock defined as a one-standard deviation of an exogenous, unexpected, temporary rise of the policy rate has limited impacts on main macroeconomic aggregates in Madagascar.
- Variance decomposition following a policy rate shock:
  - Explains 0.35 percent of the goods exports variation.
  - Explains 0.1 percent of the consumer price index variation.
- Estimation period referenced for Figure 8: January 2010-December 2018.

### Results: effectiveness of the auction deposit (liquidity) instrument
- Alternative simulations replace the policy rate by the volume of offered deposit auctions (“appels d’offre négatifs”), the main instrument used in practice by the central bank for liquidity management.
- With unchanged structural restrictions, the impact on macroeconomic aggregates remains limited.
- Variance decomposition following a one-standard-deviation of an exogenous, unexpected, temporary rise of the volume of offered deposit auctions:
  - Explains 0.07 percent of the goods’ exports variation.
  - Explains 0.02 percent of the consumer price index variation.
- Estimation period referenced for Figure 9: January 2000-December 2018.

### Policy recommendations
- Transition path:
  - Gradual transition to an interest rate targeting framework, as currently pursued by BFM, given the limited effectiveness of current transmission.
  - Continue reforms to improve operational framework and liquidity management capacities, paced by observed developments in the domestic money market.
- Transparency and market engagement:
  - Enhance dialogue with the financial market and strengthen market intelligence to anchor expectations.
  - Ensure further transparency of monetary policy operations and decisions, make more intensive use of the central bank’s website, and improve financial literacy in the financial press through dedicated technical training.
- Broader structural and institutional reforms needed to improve transmission:
  - Address informality: Informal employment exceeds 90 percent of total and nonagricultural employment in Madagascar; informality reduces effectiveness of monetary transmission by mitigating shocks on wages and inflationary pressures and weakening the credit cost channel due to low access to finance in the informal sector.
  - Strengthen judicial effectiveness and property rights enforcement to support financial deepening and the development of financial intermediation and financial stability.

*Source: REPUBLIC OF MADAGASCAR / INTERNATIONAL MONETARY FUND*

### 7. Microfinance institutions (MFIs) have boosted access to financial services in rural

### 7. Microfinance institutions (MFIs) have boosted access to financial services in rural areas.

### Microfinance: outreach and scale
- MFIs activities have expanded rapidly even though the sector only counts for 5 percent of the total financial system assets and less than 2 percent of the country’s GDP.
- MFIs outstanding deposits and loans have augmented exponentially in line with the increased numbers of customers.
- Loans are covered by deposits and activities seemed to be profitable even if profits remain modest due to high operating costs.
- MFIs liquid assets are insufficient to cover short-term liabilities as indicated by low liquidity ratios.

### Financial performance and risks in the microfinance sector
- Overall, the sector remains well-capitalized.
- Assets are of good quality and credit risk stays low as illustrated by the declining NPLs to total loans ratio.
- Profitability: activities seemed profitable but profits remain modest because of high operating costs.
- Liquidity risk: the sector is prone to liquidity issues (low liquidity ratios).
- Sector dynamics:
  - Stagnation in the number of institutions.
  - Slow growth in the number of beneficiaries.
  - Low profitability suggesting the current financial model may have reached its limit.
- Governance and supervision:
  - Governance issues affected some MFIs, stressing the need to strengthen sectoral supervision.
  - The recent adoption of the new law on Microfinance was a positive step but should be followed by adoption of implementation decrees.

### Insurance sector: coverage, performance, and risks
- Size and coverage:
  - Insurance sector weighs 7 and 2 percent of the total financial assets and GDP, respectively, in 2018.
  - Dominated by two state-owned companies holding more than 70 percent of market shares.
  - Access to insurance services is as low as 3 percent of the adult population.
- Performance:
  - Turnover increased by 39 percent over the past six years, driven by non-life insurances.
  - Total assets grew by almost 57 percent over the same period.
  - Solvency ratio remains higher than the minimum regulatory requirement; outstanding premium ratio also above minimum.
  - Profitability declined from 7.3 percent in 2017 to 6.2 percent in 2018.
- Investment concentration risk:
  - More than two thirds of total assets in the sector are invested in financial assets, including T-Bills and share purchases, creating potential concentration risk that requires close monitoring.

### Pension systems: coverage and sustainability concerns
- Structure:
  - Public schemes: CRCM (civil servants and military) and CPR (contractual government employees).
  - Private scheme: CNAPS (general regime and specific regimes for agriculture and household employees).
- Coverage:
  - Public pension system covers only 3 percent of the workforce.
  - Private pension system covers 10 percent of the workforce.
- Public pension deficits:
  - Public pension system has been in continuous deficit for years; continues to function thanks to regular government transfers and arrears accumulation.
  - Reforms to date have been ineffective due to incorrect evaluation of the system and budgetary treatment of pension payments.
  - Recommendation: strengthen financial viability by better controlling pension expenditures.
- Private pension challenges:
  - Currently collects more than it pays, but design, investment choices, and supervision need to be reconsidered to preserve financial viability.

### Caisse d’Epargne de Madagascar (CEM)
- Role and size:
  - Fully owned by the government; main objective to collect household savings via regular savings books, term accounts, and retirement savings plans.
  - Active in cash transfers as first Western Union representative in the country.
  - In 2018, assets amounted to 3.1 percent of total financial assets or 1 percent of the country’s GDP.
  - Number of savings accounts reached almost 1.2 million in 2018.
- Financial position and vulnerabilities:
  - Assets and net income have been increasing, though net income remains low due to likely increasing costs.
  - Concentration of deposits with credit and other financial institutions (66 percent of assets in 2018) could be a source of concern.
  - Recent licensing of CEM as an MFI will boost its resources and diversify its activities.

### Paositra Malagasy (PAOMA)
- Role and challenges:
  - Large footprint across the country; major player for financial inclusion despite financial difficulties.
  - Activities affected by diminution of mailing services; attempts to diversify services have not halted accumulating financial difficulties.
  - 2017 audit aimed to develop an action plan for development.
- Audit implementation status:
  - Action plan not yet developed; PAOMA started new mobile banking services (Paositra Money) despite audit recommendation to refrain pending completion of the action plan.
  - Implemented recommendations include: taking stock of property assets; preparing a full audit of customer accounts; working on procedures manual and audits of financial statements for 2015-2017.

### Mobile banking and digital finance
- Rapid expansion:
  - System counts three electronic money intermediaries.
  - Number of accounts grew from less than 140,000 in 2010 to almost 10 million last year.
  - Volume of transactions grew from 2 to about 200 billion of Ariary over the same period.
- Implications:
  - Due to lower operating costs, mobile banking is likely to become the future of financial inclusion in Madagascar.
  - Financial institutions increasingly use electronic money intermediaries; example: BNI Madagascar launched KRED, a credit product for SMEs relying on mobile technologies.
- Policy context:
  - Madagascar adopted its national strategy to promote financial inclusion for the period 2018-2022, focusing on financial education and consumer protection, access and use of financial services, and legal and regulatory framework.

### Access to Credit — main obstacles and sectoral allocation
- Low credit intermediation:
  - Credit to the private sector ratio is 14 percent of GDP at end-2018 against an average of 25 percent for SSA countries.
  - Country ranks 132nd out of 190 in terms of access to finance.
- Credit concentration by type and sector:
  - Credit concentrated on short-term segments and non-capacity enhancing sectors.
  - In 2018, commerce received 22 percent of the total credit; energy 4 percent; construction 3 percent.
- Supply-side constraints:
  - Asymmetric information: absence of a credit bureau makes borrower information costly to obtain.
  - Weak protection of creditors’ rights: existing bankruptcy law does not prioritize creditors in liquidation.
  - Unfavorable business environment: Doing Business rank 161st out of 190; score regressed from 48.9 last year to 47.7 this year.
  - Political instability: volatile political situation linked to electoral cycles creates a risky environment and risk-averse banks.
- Demand-side constraints:
  - Low financial inclusion: only 30 percent of the adult population have access to formal financial services; 5 percent have access to credit.
  - High informality: informality rate between 30-40 percent of the GDP.
  - High credit costs: nominal interest rates revolve on average around 15 percent, up to 60 percent for banks providing microfinance services.
  - Collateral constraints: inability to satisfy collateral requirements due to valuation or lack of formal property rights.
  - Weak consumer protection: customers often lack complete information on final credit conditions and have limited recourse and comparison options.
  - SME-specific factors:
    - Only 4 percent of SMEs have a line of credit against 33 and 30 percent for medium and large enterprises, respectively.
    - Only 1 percent of SMEs investments are financed by banks against 7 percent for other types of enterprises.
  - Lack of credit culture: 70 percent of adults do not have any credit from formal or informal sources; only 1 percent of adults use credit to address emergencies.

### Conclusion and policy recommendations
- Summary assessment:
  - The financial sector is expanding but its contribution to the economy remains modest due to low access to credit.
  - The banking system appears overall healthy with limited exposure to risks, but monitoring is required given ambitious development plans.
  - MFIs have boosted access to financial services for traditionally excluded actors and areas.
  - Insurance sector remains profitable but concentration of investments is a vulnerability.
  - PAOMA and CEM have significant room to boost financial inclusion but require careful supervision to preserve small depositors’ savings.
  - Both public and private pension systems need revamping based on Fund TA recommendations to ensure efficient use of public funds and avoid budgetary burden.
- Priority reforms and actions:
  - Adopt and implement the new banking and financial stability laws to secure financial stability and credit expansion; the new banking law:
    - Strengthens independence of the financial supervisor (CSBF).
    - Improves the bank resolution framework.
    - Introduces risk-based supervision and reinforces corrective supervisory measures.
    - Includes measures favoring access to credit: possibility to outsource banking services to selected providers, options to diversify banking services, higher transparency requirements, and reinforced consumer protection.
  - Improve availability of credit information:
    - Operational credit registry in place and first private credit bureau about to be operationalized.
    - Better credit information is expected to lower costs, improve loan review quality, strengthen regulator monitoring, and discipline borrowers.
  - Promote digital finance:
    - Digital finance and mobile banking can bypass brick-and-mortar costs and reduce geographical constraints.
    - Support implementation of the national strategy for financial inclusion 2018-2022.
  - Continue reforms to improve macroeconomic, business, and judicial environment:
    - A sound business and judicial environment will reduce uncertainties and guarantee property rights.
    - Pursue monetary policy reforms to introduce more predictability in interest rate determination.

*Source: 1mdgea2020002 - 7. Microfinance institutions (MFIs) have boosted access to financial services in rural areas (PDF).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1mdgea2020002.pdf_