## _cr08248 ## Source details **Canonical URL:** [_cr08248](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08248.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08248.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08248.pdf.json) --- ### Executive summary and recent outcomes - Real per capita GDP growth: over 7 percent a year since 2001. - GDP growth: 10.8 percent in 2006; staff estimate about 7 percent in 2007; projected 6 ½ percent in 2008. - Twelve month inflation: about 3½ percent for December 2007–April 2008. - Fiscal and program implementation: - All PSI quantitative assessment criteria for end-December 2007 were met with wide margins. - Domestic public debt fell by 9 percentage points of GDP in 2007. - Ceiling on net domestic borrowing observed by a margin of 1.8 percent of GDP. - International reserves exceeded the PSI floor by about 0.2 months of imports. - Structural reform progress: steady in public financial management, tax system, financial sector, and energy sector regulation. - Missed continuous assessment criterion on fuel price mechanism; remedial measures taken and staff recommends granting a waiver. ### Growth drivers, external developments, and outlook - Transformation highlights: - Unemployment rate fell by more than 10 percentage points between 2001 and 2006 (unemployment remains just under 20 percent). - On track to achieve most MDGs by 2015, including halving the 1990 poverty level. - External recognition: EU special partner (November 2007); WTO invitation (December 2007); UN LDC graduation (January 2008). - External financing composition (1995 vs. 2007): - 1995: Tourism 4%, FDI 12%, Remittances 46%, ODA 38%. - 2007: Tourism 49%, FDI 18%, Remittances 19%, ODA 14%. - Medium-term staff projection and scenario: - Growth projected to average about 6¾ percent through 2013. - Baseline medium-term fiscal scenario: fiscal deficit will average about 5 percent of GDP through 2013; total nominal debt-to-GDP ratio projected to move from 67 percent at end-2007 to 49 percent by 2013. - Alternative scenario: capital expenditures increase by further 2 percent of GDP annually for five years; risk of debt distress remains low and reserve buildup preserved. - Simulation on oil shock: - If oil prices stay just above $100/ barrel for remainder of 2008, growth will be ¼–½ percentage point lower. ### Policy implementation under the PSI and program monitoring - Quantitative outcomes: - All end-December 2007 PSI quantitative assessment criteria met with wide margins. - International reserves and net domestic borrowing ceilings comfortably met. - Key program commitments and reporting: - Government to keep IMF regularly updated; targets reviewed and affirmed for end-June 2008 and set for end-December 2008. - Fifth and sixth PSI reviews scheduled by end-October 2008 and end-April 2009. - Key TMU definitions and reporting requirements (selected): - Net domestic borrowing defined and adjusters specified; ceiling reported in the LOI (values shown in Table 1 of source). - Net international reserves (NIR) defined; weekly NIR table transmitted with maximum two-week delay. - Detailed quarterly and monthly fiscal and monetary reporting requirements specified (including arrears tables, external debt details, and BCV monthly balance sheets). ### Structural reforms, benchmarks, and remedial actions - Energy and utility pricing: - Base utility tariffs mechanism finalized and approved by ARE on March 27, 2008 and posted March 28, 2008. - Fuel pricing implementation difficulties due to complex cost structures of Shell and Enacol; ARE adjusted fuel prices on March 25, 2008. - Specific fuel price changes: gasoil and heavy fuel raised by 12 percent; butane by 7 percent; gasoline by 2.3 percent. - Consultant hired to develop a new fuel pricing formula (structural benchmark for March), expected finalized and published by end June 2008. - New formula: simplified, unified cost structure, regular adjustments, stop accrual of fiscal liabilities, encourage energy-sector investment. - Staff recommends waiver for missed continuous assessment criterion based on remedial measures. - Selected structural benchmarks (timing and status highlights): - Submit the new General Tax Code to the National Assembly: Timing End-Dec. 2007; Status: To be implemented in June 2008. - Submit draft individual and corporate income tax bills: Timing End-Dec. 2007; Status: Postponed to October 2008. - Implement recommendations of the financial sector reform task-force: Timing End-June 2007; Status: Met in November 2007. - Establish Financial Intelligence Unit legislation: Timing End-March 2008; Status: Met. - Instituting November 30 deadline for new spending commitments: Timing End-October 2007; Status: Met. ### Fiscal strategy, reserves, and public investment - Reserve-building objective: - Authorities’ target: increase reserves by about 0.1 month of prospective imports annually, reaching over 4 months by 2013; equivalent to about 6 months expunging FDI-related imports. - Medium-term fiscal framework (MTFF): - Authorities agreed to submit a simplified MTFF to the Council of Ministers with the 2009 budget proposal and publish it on the Ministry of Finance website (Timing: November 2008). - MTFF to indicate total annual revenues, expenditures, domestic financing, and external financing for next three years. - Fiscal projections (baseline): - Fiscal deficit average: about 5 percent of GDP through 2013. - Total nominal debt-to-GDP: from 67 percent at end-2007 to 49 percent by 2013. - Assumption: domestic debt ratio kept below 20 percent of GDP as “policy insurance.” - PSI constraint: - PSI US$35 million ceiling on nonconcessional external borrowing and government guarantees remains unused. ### Financial sector vulnerabilities and policy recommendations - Nonresident deposits (NRD) and banking funding: - NRDs constitute about 40 percent of total bank deposits. - Annual growth rate of NRD stock: about 6 ¼ percent, but slowed in recent years. - Emigrant deposits over total deposits (selected years): 43.0, 41.9, 38.8, 37.1 (2004–2007). - Recommendation: broaden banks’ funding base, reduce reliance on NRDs, improve monitoring of NRDs and external flows. - Banking soundness indicators (selected end-year ratios): - Regulatory capital to risk-weighted assets (2004–2007): 13.3, 12.1, 11.1, 11.4. - Nonperforming loans to total loans (2004–2007): 7.2, 6.3, 3.9, 8.8. - Return on assets (2004–2007): 0.7, 0.5, 0.9, 1.8. - Liquid assets to total assets (2004–2007): 48.1, 46.2, 44.4, 44.6. - Monetary policy stance: - BCV conducts passive monetary management consistent with the peg and an open capital account; official policy rate is interest on the 14-day bill. - Reserve accumulation aided by sterilization, stock exchange investment opportunities, private sector credit growth, and government deposits at BCV. ### Remittances: changing properties and implications (Box 2) - Remittances share of foreign financing fell from 46 percent in 1995 to 18 percent in 2007. - Econometric findings: - A 1 percent increase in real GDP in Cape Verde raises remittances by approximately 2.5 percent. - Detrended correlation (1980–2006) between remittances and GDP: 70 percent. - Evidence suggests remittances becoming more procyclical and more investment-motivated, reducing their role as a shock absorber. - Policy implications: - Monitor sources and direction of NRDs; enhanced macro-prudential surveillance and FSAP follow-up recommended. - Continue BCV’s cautious monetary management consistent with the peg. - Strengthen banking oversight to diversify funding and reduce dependence on NRDs. ### Risks, vulnerabilities, and data/statistics issues - Key risks: - Continued high oil prices and global slowdown tilt risks to the downside. - Narrow export base and tourism specialization expose the economy to external demand shocks. - Infrastructure bottlenecks constrain growth; large transport and energy investments required to support tourism expansion. - Potential indirect effects from difficulties in Portugal’s banks’ home countries (United Kingdom, Ireland, Spain). - Data and statistical shortcomings: - GDP/national accounts: lack of reliable demand-side GDP data; outdated base year. - Labor market statistics: unemployment compiled with long delays; wage data nonexistent. - Tourism statistics: need better arrivals and price data; Tourism Satellite Account planned. - Fiscal data: new chart of public accounts (PNCP) not ready until 2009. - Statistical master plan: estimated US$15 million required through 2010; donors committed substantial part. ### Program review recommendation and authorities’ requests - Staff recommends completion of the fourth review of the PSI program and supports granting a waiver for the missed structural assessment criterion based on remedial measures. - Authorities request Board approval for: - A waiver for nonobservance of a structural assessment criterion. - Support for completion of the fourth review of the PSI program. - Authorities’ commitments: - Continue fiscal prudence, implement MTFF, strengthen debt management capacity, finalize energy pricing formula, pursue financial sector and structural reforms, and request IMF technical assistance where needed. *Source: IMF staff report (2008 Article IV consultation and 4th review of the PSI for Cape Verde).* ### 2007. The previous Article IV consultation for Cape Verde, which is ### 2007. The previous Article IV consultation for Cape Verde, which is ### Executive Summary - Real per capita GDP has increased on average by over 7 percent a year since 2001. - In 2006 real GDP growth reached double digits; staff estimate GDP grew by about 7 percent in 2007. - Twelve month inflation averaged about 3½ percent for December 2007–April 2008, broadly in line with inflation in the euro area. - Policy implementation under the PSI is strong: - All PSI quantitative assessment criteria for end-December 2007 were met with wide margins. - Domestic public debt fell by 9 percentage points of GDP as revenues outperformed targets and expenditures were as budgeted. - Official reserves are building rapidly, strengthening credibility of the exchange rate peg. - Structural reform progress is steady in public financial management, the tax system, the financial sector, and energy sector regulation. - A continuous assessment criterion on full application of the mechanism for setting and adjusting fuel prices was not implemented due to technical difficulties; staff recommends granting a waiver based on remedial measures. - Discussions and understandings from the 2008 Article IV consultation and 4th PSI review focused on: - A medium-term fiscal framework to increase infrastructure and energy investment while keeping debt on an appropriate path. - Financial sector reforms to broaden bank funding and reduce reliance on nonresident deposits, while preparing for further capital account liberalization. - Structural reforms to foster private sector development, diversify the economy, and improve price flexibility in goods (energy) and factor (labor) markets to support the exchange rate peg. ### I. A Success Story in Sub-Saharan Africa - Transformation highlights: - Real per capita GDP growth averaging over 7 percent per year since 2001, faster than most small island economies and the sub-Saharan Africa average. - Unemployment rate fell by more than 10 percentage points between 2001 and 2006 (note: unemployment remains just under 20 percent). - On track to achieve most MDGs by 2015, including halving the 1990 poverty level. - External recognition: - Accepted as a special partner of the European Union in November 2007. - Invited to join the WTO in December 2007. - Graduated from UN least-developed country (LDC) status in January 2008. - Comparison with PSI peers: - Growth 2001–07 was about the PSI-entry-country average; inflation was the lowest among peers. - Net present value of external central government debt reduced by 16 percent of GDP since 2001. - Reserve accumulation since 2001 exceeded PSI group average. - Drivers of progress: - Lower domestic debt through tax reforms (introduction of VAT in 2004) and recurrent spending restraint. - Strong tourism-related FDI improving external position and reserve rebuilding. - Structural reforms and privatizations (state-owned enterprises, TACV preparation, ENAPOR privatization process) and lower external tariffs ahead of WTO accession. - Revitalized Cape Verde Stock Exchange with market capitalization now 25 percent of GDP. ### II. Recent Performance and Outlook #### A. What Is Happening in the Economy Now - Growth and inflation: - Real GDP growth peaked at 10.8 percent in 2006. - Staff estimate GDP growth about 7 percent in 2007. - Growth expected to moderate to 6 ½ percent in 2008 factoring in global slowdown. - Twelve-month inflation averaged about 3½ percent for December 2007–April 2008. - Fiscal developments: - Prudent 2008 budget expected to reduce domestic debt to 16 percent of GDP by end-2008. - Tax revenues exceed budget forecasts due to growth and improved tax administration; asset sales surpassed expectations. - Authorities’ target for domestic debt, 20 percent of GDP, was reached in 2007 two years ahead of schedule. - Monetary and external sector: - Bank of Cape Verde (BCV) conducts passive monetary management consistent with the peg and open capital account, smoothing and sterilizing short-term capital flows. - Reserves continue to accumulate; FDI-related imports have financed a higher current account deficit without signs of general import surge endangering reserves. - Excess liquidity contained via sterilization, new equity market opportunities, and private sector credit growth; government deposits at the BCV aid sterilization. Key statistics and indicators (preserved as stated) - Real per capita GDP growth: over 7 percent a year since 2001. - GDP growth: 10.8 percent in 2006; about 7 percent in 2007; projected 6 ½ percent in 2008. - Twelve month inflation: about 3½ percent for December 2007–April 2008. - Domestic public debt reduction: 9 percentage points of GDP. - Domestic debt target reached: 20 percent of GDP in 2007; expected 16 percent of GDP by end-2008. - All PSI quantitative assessment criteria for end-December 2007 met; ceiling on net domestic borrowing observed by a margin of 1.8 percent of GDP. - International reserves exceeded the PSI floor by about 0.2 months of imports. #### B. Policy Implementation Under the PSI - Quantitative performance: - All end-December 2007 PSI quantitative assessment criteria met with wide margins. - Ceiling on net domestic borrowing observed by margin of 1.8 percent of GDP. - International reserves exceeded PSI floor by about 0.2 months of imports despite FDI slowdown in late 2007. - Public financial management improvements prevented accumulation of arrears and supported fiscal consolidation (including hiring freeze, decentralizing budget execution, and introducing a November 30 deadline to grant new spending commitments). ### III. Policy Discussions: Sustaining the Strong Performance - Policy priorities agreed during consultations: - Maintain fiscal prudence within a medium-term fiscal framework accommodating infrastructure and energy investment while keeping debt on an appropriate path. - Preserve financial stability by broadening bank funding sources and reducing reliance on nonresident deposits; prepare for capital account liberalization. - Maintain competitiveness and foster private sector development through structural reforms, economic diversification, and improved price flexibility in goods (energy) and factor (labor) markets. - Structural reform focus areas: - Public financial management reforms. - Tax system improvements. - Financial sector reform and regulation. - Energy sector regulation and price-setting mechanisms (with remedial measures addressing implementation issues). *Source: IMF staff report (2008 Article IV consultation and 4th review of the PSI for Cape Verde).* ### 9. Despite capacity constraints, steady progress was made on implementing the ### _cr08248 - 9. Despite capacity constraints, steady progress was made on implementing the ### Structural assessment criteria: progress and remedial actions - Base utility tariffs mechanism: finalized and approved by the Economic Regulatory Agency (ARE) on March 27, 2008 and posted on ARE’s website on March 28, 2008 (LOI, ¶ 5). - Objective of the structural assessment criterion: achieve full cost recovery to stop accumulation of tariff deficits (a contingent liability). - Adjustment of final electricity price for consumers: will take into account the impact of the global food and oil price inflation on the poor and vulnerable segments of the population. - Fuel pricing implementation difficulties: - Complex cost structures of Shell and Enacol prevented implementation of the continuous assessment criterion on full application of the mechanism for setting and adjusting fuel prices. - ARE corrective actions: - Adjusted fuel prices on March 25, 2008, clearing implicit subsidies owed to oil suppliers accrued since the previous adjustment in October 2007. - Hired a consultant (after some delay due to lack of funding) to develop a new fuel pricing formula (structural benchmark for March), expected to be finalized and published by end June 2008. - New formula features and expected outcomes: - Simplified and more transparent formula based on a unified cost structure of the upcoming joint venture between the oil companies. - Will ensure regular fuel price adjustments, stop accrual of fiscal liabilities, and encourage investment in the energy sector. - Staff recommendation: grant a waiver for the missed structural assessment criterion on the basis of these remedial measures. - Specific fuel price changes referenced: - Prices of gasoil and heavy fuel were raised by 12 percent, butane by 7 percent, and gasoline by 2.3 percent. ### Structural benchmarks (selected, 2007–08) - Tax Reforms: - Submit the new General Tax Code to the National Assembly (LOI ¶5). Timing: End-Dec. 2007. Status: To be implemented in June 2008. - Submit the new Code on Judicial Process to the National Assembly (LOI ¶5). Timing: End-Dec. 2007. Status: To be implemented in June 2008. - Submit the draft individual and corporate income tax bills to the National Assembly (LOI ¶5). Timing: End-Dec. 2007. Status: Postponed to October 2008 (LOI ¶5). - Financial Sector: - Implement the recommendations of the task-force on financial sector reform. Timing: End-June 2007. Status: Met in November 2007. - Submit to the National Assembly legislation to establish a Financial Intelligence Unit (LOI ¶5). Timing: End-March 2008. Status: Met. - Submit to the National Assembly legislation to criminalize financing of terrorism and facilitate combating of financing of terrorism (LOI ¶5). Timing: End-March 2008. Status: To be implemented in June 2008. - Submit to the National Assembly legislation to strengthen the framework for combating money laundering (LOI ¶5). Timing: End-March 2008. Status: To be implemented in June 2008. - Public Financial Management: - Instituting November 30 as deadline for granting new spending commitments to reduce end year payment pressure. Timing: End-October 2007. Status: Met. - Finalize reform strategy for General Tax Directorate (DGCI). Timing: End-Dec. 2007. Status: Met. ### Outlook, risks, and challenges - Near-term outlook: broadly favorable but risks tilted to the downside due to continued high oil prices and the global slowdown. - Factors moderating oil price impact: - Economy predominantly service-based. - Depreciation of the US dollar is containing oil prices in escudos; oil price impact likely manageable. - Exposure and downside channels: - Cape Verde relatively unexposed to international capital markets; non-emigrant cross-border flows are relatively small. - Global slowdown could reduce external demand (including tourism) and FDI flows. - Potential indirect effects from difficulties in Portugal’s banks’ home countries (United Kingdom, Ireland, Spain) that are important sources of FDI, remittances and tourism flows. - Simulation note: Staff simulations suggest that if oil prices were to stay just above $100/ barrel for the remainder of 2008, growth will be ¼–½ percentage point lower. - Medium-term staff projection: - Growth projected to average about 6¾ percent through 2013, underpinned by tourism, FDI, and public investment. - Current account deficit likely to widen and be financed increasingly by strong FDI flows (non-debt creating). - Emigrant remittances expected to taper off as income in Cape Verde grows faster than in emigrant host countries and emigration declines. - Staff’s empirical analysis: remittances are becoming more procyclical and thus less reliable as a shock absorber. - Donors: Most donors confirmed that graduation from LDC status will not lead to an abrupt end to concessional aid. - Continued fiscal restraint envisaged; revenue losses from WTO accession and EU economic partnership agreement expected to be limited and gradual. - Historical balance of payments financing shares (1995 vs. 2007, Source: National authorities): - 1995: Tourism 4%, FDI 12%, Remittances 46%, ODA 38%. - 2007: Tourism 49%, FDI 18%, Remittances 19%, ODA 14%. - Identified vulnerabilities and challenges: - Infrastructure bottlenecks constrain growth; tourism expansion requires large-scale transport and energy investments. - Fiscal challenge: use fiscal space to increase capital expenditures while maintaining debt sustainability. - Financial sector reliance on nonresident deposits (NRD): - NRDs constitute about 40 percent of total bank deposits. - Annual growth rate of NRD stock is about 6 ¼ percent, but has slowed in recent years. - Uncertainty about interest-sensitivity of these deposits; banks pressured to launch new savings products; average interest rates across all maturities continue to decline. - Home bias and historical resilience of remittance-based inflows mitigate reversal risk, but NRD exposure warrants close monitoring. - Narrow export base and vulnerability to weakening tourism demand; limited price and wage flexibility; need to diversify growth sources and broaden structural reforms. ### Policy discussions: sustaining strong performance - Policy package to preserve macro stability and respond to changing balance of payments: - Use a medium-term fiscal framework to accommodate increased infrastructure and energy investment while keeping debt on an appropriate path. - Financial sector reforms to broaden banks’ funding base, reduce reliance on non-resident deposits, and further liberalize the capital account. - Structural reforms to diversify the economy and increase price flexibility in goods and factor markets to enhance resilience to shocks. - Authorities’ stance: - Concurred on changing balance of payments and welcomed cross-country analysis. - Noted capacity constraints may hamper policy implementation and reiterated need for continued technical assistance from the Fund. - Government affirms commitment to policy goals in its Letter of Intent and updates plans to meet those goals. ### Box 1 (summary): The Tourism Boom - Cape Verde is the fastest-growing tourism market among the highly-tourism-based economies (HTBEs); travel exports have grown by more than 30 percent annually on average for more than a decade. - Comparative advantages: convenient location, ability to harness overflow of Mediterranean tourism, favorable sociopolitical situation, macroeconomic stability, and good governance. - Risks of tourism specialization: - High volatility and dependence on single export expose the economy to demand shocks. - Tourism sector integration with the rest of the economy makes external shocks more pervasive; business cycle synchronization with originator countries increases volatility. - Cross-country analysis: output volatility tends to increase as economies become more HTBE; HTBEs have business cycles with higher amplitude and longer duration, requiring large buffers. - Policy implication: Cape Verde needs buffers through higher reserves and fiscal space because countercyclical policies are constrained by a pegged monetary policy and small fiscal multipliers with high import leakage. ### Maintaining fiscal prudence: medium-term fiscal strategy and MTFF - Agreed need: articulate a medium-term fiscal strategy to provide room for increased infrastructure spending and ensure upcoming tax reforms are broadly revenue-neutral. - Reserves and peg credibility: - Staff noted reserves target should anchor medium-term fiscal policy; building foreign reserves contributes to peg credibility and keeps public debt on an appropriate path. - Cape Verde’s public debt-to-GDP ratio is one of the highest among HTBEs, and its reserves are below average; need larger buffers (higher international reserves and fiscal space). - Authorities’ target for reserves: increase reserves by about 0.1 month of prospective imports annually, reaching over 4 months by 2013; this is equivalent to about 6 months expunging FDI-related imports, and 172 percent of short-term debt, supported by continued fiscal restraint. - Operational MTFF decisions: - Authorities agreed to submit a simplified medium-term fiscal framework (MTFF) to the Council of Ministers with the 2009 budget proposal and publish it on the Ministry of Finance website (LOI, ¶8). - A simplified MTFF indicates total annual revenues, expenditures, domestic financing, and external financing for the next three years. - Implementing the MTFF requires accelerating public financial management (PFM) reforms to enhance implementation capacity and public investment quality. - Fiscal projections and scenarios: - Baseline medium-term baseline scenario: fiscal deficit will average about 5 percent of GDP through 2013; total nominal debt-to-GDP ratio projected to move from 67 percent at end-2007 to 49 percent by 2013. - Assumption: authorities keep domestic debt ratio below 20 percent of GDP over the medium term as “policy insurance.” - Alternative scenario: capital expenditures on infrastructure increase by further 2 percent of GDP annually for five years; results show the risk of debt distress remains low and reserve buildup is preserved. - PSI program’s US$35 million ceiling on nonconcessional external borrowing and government guarantees remains unused due partly to capacity constraints on debt management (LOI, ¶ 9) and partly to continued availability of concessional financing, including from IDA and Portugal. - Energy sector reforms: steps to improve energy pricing mechanism and broader energy sector reform plan (LOI, ¶ 12) will help reduce fiscal risks over the medium term and potentially contribute fiscal space toward infrastructure development. - MTFF role: tool to ensure upcoming tax reforms and rationalization of tax exemptions are implemented in a broadly revenue-neutral fashion and to enhance implementation of the new Poverty Reduction Strategy (PRSP-2), finalized in May 2008. * _cr08248 - 9. Despite capacity constraints, steady progress was made on implementing the* ### Box 2. Remittances: A Less Reliable Hedge against Macroeconomic Shocks ### Box 2. Remittances: A Less Reliable Hedge against Macroeconomic Shocks ### Overview - Remittances from the Cape Verdean diaspora have historically constituted a large share of external financing. - Staff’s previous analysis (WP/06/132) found remittances from Europe were largely driven by altruistic motives and acted countercyclically in smoothing consumption, while flows from the United States may have partly been motivated by investment in Cape Verde. ### Volatility and recent trends - Remittances have been less volatile than foreign direct investment (FDI) and exports, and only slightly more volatile than official development assistance (ODA). - Remittances as a share of total foreign financing fell from 46 percent in 1995 to 18 percent in 2007. - Compared to other inflows, remittances remain an important source of foreign currency even as they decline in importance. ### Econometric findings on cyclical behavior - More recent econometric evidence suggests remittances are becoming increasingly procyclical, reducing their role as a shock absorber. - Disaggregated data from Portugal, France, and the USA indicate remittances are positively associated with business cycles in Cape Verde: - A 1 percent increase in real GDP growth in Cape Verde raises remittances by approximately 2.5 percent. - Detrended by the Hodrick-Prescott filter, remittances and GDP show a relatively high correlation of 70 percent from 1980 through 2006. - Overall empirical analysis suggests remittances have been increasingly motivated by investment considerations rather than altruistic considerations or for consumption smoothing. ### Implications for financial stability and the banking system - The changing financing structure of the balance of payments and the deceleration of nonresident (emigrant) deposits pose liquidity risk for banks and a potential capital account-based source of vulnerability. - Banks reported the slowdown in non-resident deposit flows was due in part to new investment opportunities in the Cape Verde Stock Exchange, with some nonresidents diversifying away from bank deposits in search of higher yields in equities. - Better monitoring of the sources and direction of nonresident deposits is important for promptly detecting potentially destabilizing capital flows and gauging the appropriateness of the official policy interest rate. - The BCV will closely monitor external flows (including nonresident flows); this action will be supported under the PSI as a structural benchmark (LOI, ¶ 11). - Evidence on the interest sensitivity of non-resident deposits is mixed based on extensive econometric analysis by staff (WP/06/132); more recent data analysis did not radically alter that paper’s conclusions. ### Policy recommendations and authorities’ actions - Continue BCV’s cautious approach of conducting monetary management consistent with the peg, carefully setting its short-run official policy interest rate consistent with its endogenous equilibrium level to smooth inflows or outflows of short-term capital. - Strengthen the banking system through strong oversight of banking system soundness to attract more diverse sources of financing and reduce dependence on nonresident deposits; recent measures (LOI ¶ 5) contribute to this goal. - Follow up on recommendations of the recent MCM technical assistance for an enhanced macro-prudential surveillance framework built around an expanded set of financial soundness indicators. - Monitor external flows and nonresident deposits closely (structural benchmark under the PSI, LOI ¶ 11) and pursue liberalization of financial flows in ways that validate de facto conditions while managing near-term risks. - Use forthcoming FSAP to strengthen assessment of liquidity and credit risks arising from shifts in funding sources and the interaction between tourism-driven real estate demand and banking sector exposures. *Source: Box 2. Remittances: A Less Reliable Hedge against Macroeconomic Shocks, _cr08248.* ### 24. The authorities noted that they are moving ahead with their strategy for ### _cr08248 - 24. The authorities noted that they are moving ahead with their strategy for ### Export diversification and sector development - Authorities are developing several sectors: - Offshore financial center, to be enhanced by the new prudential regulation and the new AML/CFT law. - Fishing and fish-processing industry, marine and transshipment services. - Information technology (IT): a recent agreement between NOSi and Microsoft to facilitate government e-commerce and data processing across Cape Verde has already begun. - Tourism: authorities noted that even within tourism there is room for diversification. - The DTIS will examine, among other issues, how Cape Verde can enter into the enormous and expanding offshore services, information technology, and business process outsourcing market. ### Labor market, energy pricing, and human capital - Authorities recognize the need to make the labor market more flexible and agreed that the recent new labor code will not do much to accomplish that. - Planned measures: - Upgrade human capital. - Retrain labor. - Attract skilled workers. - Improve the mechanism for addressing arbitration and labor disputes. - Energy pricing: - Recent steps taken on energy pricing mean a rapid pass-through of energy prices will facilitate faster adjustment to terms of trade swings. - Staff emphasizes regular application of the new utilities base tariffs and fuel pricing formula to ensure fast adjustment to terms of trade changes and to reduce fiscal risk. - Staff urges accelerating implementation of broader energy sector reforms to further reduce fiscal risk and support growth and poverty reduction. ### Statistics issues and data constraints - Macroeconomic data are broadly adequate for surveillance and program monitoring; mission welcomed recent improvements in data release. - INE recently released a new CPI index and a new web portal, strengthening data collection and improving disclosure. - Authorities now publish most of their data on the Internet.23 - In line with STA’s recommendation, the mission stressed the importance of unambiguously indicating data links on official websites and regularly updating metadata for General Data Dissemination Standards (GDDS). - Specific data shortcomings and planned improvements: - GDP/national accounts: Lack of reliable demand-side GDP data constrains policy formulation, although the BCV does project demand-side GDP. - Labor market statistics: Data on unemployment are compiled with long delays, and wage data are nonexistent. - Tourism statistics: Better data on tourism arrivals and prices are needed; INE plans to compile Tourism Satellite Account statistics. - Fiscal data: The new chart of public accounts (PNCP) will not be ready until 2009. ### Staff appraisal — macroeconomic assessment and risks - Overall assessment: - Cape Verde’s recent economic performance is described as impressive and attributed to a sound homegrown economic reform program and prudent macroeconomic management. - Good policies have catalyzed investments and export growth, especially in tourism, reducing dependence on aid and remittances. - Economic growth is strong, inflation is moderate, and unemployment and poverty rates have been gradually falling. - Exchange rate and peg: - Staff view the exchange rate as broadly in line with macroeconomic fundamentals, and the peg remains appropriate. - The peg has helped achieve low inflation; staff sees no discernible gains from hardening the peg given entrenched fiscal discipline, enhanced policy credibility, and greater investor confidence. - Key challenges to sustaining performance: - Building tourism will require investments in transportation and energy; the challenge is to use fiscal space to increase capital expenditures while keeping debt sustainable. - Financial sector reliance on nonresident deposits: decelerating growth in nonresident deposits should be monitored as a potential capital account-based source of vulnerability. - Narrow export base with increasing specialization in tourism: need to limit vulnerability from specialization, diversify sources of growth, and increase economic flexibility to enhance resilience to shocks. - Fiscal policy: - Continuing prudence in fiscal policy is essential to buy policy insurance against shocks and support the peg. - A medium-term fiscal strategy is needed to anchor expenditure and tax reform plans. - Given the larger-than-expected domestic debt reduction in 2007, even with plans to increase capital spending to ease infrastructure bottlenecks, the risk of debt distress remains low and the envisaged reserve buildup is preserved. - Staff urges authorities to move ahead with plans toward publishing the MTFF as part of the 2009 budget cycle. - Authorities should pursue plans to enhance the capacity of their debt management office, including through seeking technical assistance. - Financial sector strengthening: - Staff welcomes regulation that broadly aligned prudential requirements for both on- and offshore banks, which should help preserve Cape Verde’s good reputation. - Need to broaden banks’ source of funds to reduce dependence on nonresident deposits. - Staff recommends improving monitoring of nonresident deposits to better gauge the appropriateness of BCV’s policy interest rate by promptly detecting potentially destabilizing capital flows. - Banks’ exposure to the real estate market warrants close monitoring. - Staff welcomes BCV plans to establish enhanced financial sector macro-prudential surveillance to provide a basis for comprehensive assessment of credit risk. - The forthcoming FSAP should help strengthen authorities’ capacity on these issues, including real–financial sector linkages. - Structural reforms: - Necessary to maintain external competitiveness and sustain high growth over the long term. - Staff calls on authorities to implement their strategy for export diversification. - Given the peg, greater flexibility in labor markets and energy prices is needed to facilitate adjustment to shocks. - To remove labor market rigidities, authorities should address the high cost of hiring and firing. - Authorities’ plans to upgrade human capital, retrain labor, and attract skilled workers are important. ### Program review and recommendations - Staff recommends completion of the fourth review of the PSI program. - Based on the strength of the authorities’ policies and corrective measures taken, staff supports granting a waiver for the missed structural assessment criterion. *Source: _cr08248 - 24. The authorities noted that they are moving ahead with their strategy for* ### 34. The next Article IV Consultation will be held in accordance with the decision on ### _cr08248 - 34. The next Article IV Consultation will be held in accordance with the decision on ### Consultation timing - The next Article IV Consultation will be held in accordance with the decision on consultation cycles approved on July 15, 2002. ### National accounts and prices (selected series, annual percentage change / levels where shown) - Real GDP: 10.8, 6.9, 6.5, 6.5, 7.0, 7.1, 6.8, 6.7 - Real GDP per capita: 8.8, 5.0, 4.5, 4.5, 5.0, 5.1, 4.8, 4.6 - Consumer price index (annual average): 5.4, 4.4, 3.6, 2.3, 2.3, 2.3, 2.3, 2.3 - Consumer price index (end of period): 6.2, 3.8, 2.6, 2.3, 2.3, 2.3, 2.3, 2.3 - Nominal GDP (billions of Cape Verde escudos): 105.6, 116.3, 129.4, 144.9, 163.2, 180.2, 205.6, 234.2 ### External sector (selected series) - Exports of goods and services: 35.0, 14.1, 20.9, 16.5, 13.9, 14.5, 13.3, 14.1 - Of which: tourism: 82.5, 40.6, 31.6, 23.8, 17.7, 17.0, 15.1, 15.4 - Imports of goods and services: 23.4, 17.9, 13.9, 13.2, 13.6, 8.2, 15.3, 13.8 - Terms of trade (minus = deterioration): -4.4, -0.9, -4.4, 0.9, 1.2, 1.1, 1.1, 1.1 - External current account (including official current transfers, percent of GDP): -5.0, -9.1, -9.4, -9.9, -10.5, -8.3, -10.0, -10.6 - External current account (excluding official current transfers, percent of GDP): -9.1, -13.5, -12.4, -11.8, -12.2, -9.6, -11.3, -11.7 - External current account (€ millions, including official transfers): -47.7, -96.4, -110.2, -130.0, -155.1, -135.0, -187.0, -224.2 - Gross international reserves (€ millions, end of period): 193.1, 257.7, 307.3, 363.0, 407.6, 481.6, 561.4, 646.9 - Gross international reserves (months of prospective imports of goods and services): 3.1, 3.6, 3.8, 3.9, 4.1, 4.2, 4.3, 4.4 ### Government finance (central government; selected indicators, percent of GDP and levels) - Total revenue (excluding grants) (percent of GDP): 19.6, 17.0, 5.8, 13.2, 13.0, 9.8, 14.7, 14.3 - Total expenditure (percent of GDP): 11.8, -0.7, 22.4, 12.4, 14.7, 3.2, 12.7, 12.0 - Total nominal government debt (percent of GDP): 76.0, 66.9, 60.9, 57.4, 55.2, 54.2, 51.6, 48.9 - External government debt (percent of GDP): 47.2, 47.2, 44.5, 42.4, 40.2, 38.9, 36.7, 34.3 - Domestic government debt, net of deposits (percent of GDP): 28.8, 19.7, 16.4, 15.0, 14.9, 15.3, 14.9, 14.6 - Overall balance (including grants, percent of GDP): -4.9, -0.7, -4.2, -5.0, -5.5, -5.3, -4.9, -4.4 - Overall balance before grants (percent of GDP): -10.4, -5.5, -9.9, -9.7, -10.3, -8.1, -7.6, -7.0 - External grants (percent of GDP): 5.5, 4.8, 5.6, 4.7, 4.7, 2.9, 2.8, 2.7 ### Fiscal operations (central government, selected levels in Millions of Cape Verde escudos) - Revenue, grants, and net lending (2006–2010 sample): 33,437; 31,044; 35,295; 35,131; 38,551; 42,285; 47,759 - Domestic revenue (incl. net lending): 24,604; 25,255; 26,963; 29,559; 31,286; 35,417; 40,030 - Tax revenue: 21,099; 22,828; 24,178; 26,423; 28,059; 31,859; 36,015 - Income and profit taxes: 6,955; 6,952; 7,497; 7,656; 8,462; 9,584; 10,915 - Consumption taxes: 8,351; 9,821; 10,140; 11,565; 13,177; 14,829; 16,812 - International trade taxes: 4,501; 4,889; 5,458; 5,592; 5,583; 6,509; 7,232 - Total expenditure (2006–2010 sample): 40,413; 36,252; 39,943; 35,986; 44,032; 49,504; 56,778 - Capital expenditure (2006–2010 sample): 16,290; 12,415; 16,340; 12,237; 17,581; 19,769; 22,754 - Overall balance, including grants (budget basis): -6,976; -5,208; -4,648; -855; -5,481; -7,219; -9,018 ### Money and credit / Monetary survey (selected aggregates) - Broad money (M2) (levels): 72,643; 85,536; 97,017; 94,605; 105,729; 118,938; 134,608; 149,244 - Reserve money (M0) (levels): 21,136; 21,845; 23,160; 23,957; 27,019; 30,329; 34,272; 38,008 - Net foreign assets (levels): 21,889; 25,138; 30,883; 30,902; 37,176; 43,421; 48,507; 56,851 - Net domestic assets (levels): 50,754; 60,398; 66,134; 63,702; 68,553; 75,517; 86,100; 92,393 - Credit to the economy (levels): 34,496; 44,855; 55,801; 51,804; 59,361; 68,054; 80,039; 88,593 - Income velocity (GDP/M2): 1.317, 1.336, 1.259, 1.291, 1.292, 1.290, 1.288, 1.270 - Emigrant deposits (levels): 28,318; 31,293; 35,494; 33,262; 35,058; 37,060; 39,250; 40,533 - Broad money (M2) growth (change in percent of broad money 12 months earlier): 15.5, 17.7, 13.4, 10.6, 11.8, 12.5, 13.2, 10.9 ### Balance of payments (selected aggregates, Millions of Cape Verde escudos) - Current account balance (including official transfers): -5,259; -10,630; -12,150; -14,339; -17,103; -14,894; -20,631; -24,732 - Trade balance: -40,654; -53,501; -62,113; -71,178; -81,797; -88,282; -102,969; -117,794 - Exports, f.o.b.: 8,429; 6,134; 6,981; 7,242; 7,487; 7,788; 8,132; 8,649 - Imports, f.o.b.: -49,083; -59,635; -69,094; -78,420; -89,285; -96,070; -111,101; -126,443 - Services (net): 13,822; 20,195; 27,689; 34,201; 40,019; 48,137; 54,780; 63,186 - Services credit: 35,523; 44,011; 53,638; 63,351; 72,941; 84,264; 96,124; 110,281 - Of which: tourism credits: 19,097; 26,851; 35,345; 43,764; 51,503; 60,273; 69,368; 80,060 - Capital and financial account (net): 10,871; 19,657; 17,624; 20,480; 22,028; 23,051; 29,427; 34,170 - Direct investment (net): 9,722; 10,378; 10,996; 13,039; 16,080; 18,468; 21,893; 25,413 - Overall balance (percent of GDP): 4.7, 6.1, 4.2, 4.2, 3.0, 4.5, 4.3, 4.0 - Gross international reserves (levels, Millions of Cape Verde escudos): 21,304; 28,424; 33,898; 40,038; 44,964; 53,121; 61,917; 71,355 - Months of current year's imports of goods and services: 3.6, 4.1, 4.3, 4.5, 4.4, 4.8, 4.9, 4.9 ### Banking sector and financial soundness (selected end-year ratios) - Regulatory capital to risk-weighted assets: 13.3, 12.1, 11.1, 11.4 (2004–2007) - Nonperforming loans to total loans: 7.2, 6.3, 3.9, 8.8 (2004–2007) - Return on assets: 0.7, 0.5, 0.9, 1.8 (2004–2007) - Return on equity: 12.3, 9.7, 16.4, 31.5 (2004–2007) - Emigrant deposits over total deposits: 43.0, 41.9, 38.8, 37.1 (2004–2007) - Liquid assets to total assets: 48.1, 46.2, 44.4, 44.6 (2004–2007) *Sources: Cape Verdean authorities; Ministry of Finance and Public Administration; Bank of Cape Verde; IMF staff estimates and projections.* ### 1. Population below US$ 1 a day (percent).................. ### _cr08248 - 1. Population below US$ 1 a day (percent).................. ### Millennium Development Goals — Key indicators and exact values - Population below US$ 1 a day (percent): (table header; no single summary value provided) - Poverty gap ratio at US$ 1 a day (percent): (table header; no single summary value provided) - Share of income or consumption held by poorest 20 percent (percent): (table header; no single summary value provided) - 3a. Percentage of poor, 2001–02: 30.0 - 3b. Incidence of absolute poverty (1988 and 2002 comparisons, tabulated values): 49.0 2/ ......37.0...25.0 - Target 2 (hunger): Halve, between 1990 and 2015, the proportion of people suffering hunger. - 4. Prevalence of child malnutrition (percent of children under 5): 13.5.........6.8 - 5. Population below minimum level of dietary energy consumption (percent): (no single summary value provided) - Goal 2 (education) — Target 3: Ensure that, by 2015, children will be able to complete a full course of primary schooling. - 6. Net primary enrollment ratio (percent of relevant age group): 99.2 - 7. Percentage of cohort reaching grade 5: 92.8 - 8. Youth literacy rate (percent age 15–24): 81.5 85.0 88.6 89.1 89.1... - Goal 3 (gender) — Target 4: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education by 2015. - 9. Ratio of girls to boys in primary and secondary education (percent): 96.1......99.9 100.0 - 10. Ratio of young literate females to males (percent ages 15–24): 87.5 90.4 93.3 93.8 93.8 100.0 - 11. Share of women employed in the nonagricultural sector (percent): 39.1 - 12. Proportion of seats held by women in the national parliament (percent): 12.0 11.0 11.0 11.0 11.0... - Goal 4 (child mortality) — Target 5: Reduce by two-thirds between 1990 and 2015, the under 5 mortality rate. - 13. Under 5 mortality rate (per 1,000): 60.0 50.0 38.0 36.0 35.0 20.0 - 14. Infant mortality rate (per 1,000 live births): 45.0 37.0 29.0 30.0 30.0 26.0... - 15. Immunization against measles (percent of children under 12 months): 79.0 66.0 72.0...68.0... - Goal 5 (maternal health) — Target 6: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio. - 16. Maternal mortality ratio (modeled estimate, per 100,000 live births): ...190.0 150.0......... - 17. Proportion of births attended by skilled health personnel: ...54.0 88.5......... - Goal 6 (HIV/AIDS, malaria, other diseases) — Target 7: Halt by 2015, and begin to reverse, the spread of HIV/AIDS. - 18. HIV prevalence among females (percent ages 15–24): (no value listed) - 19. Contraceptive prevalence rate (percent of women ages 15-49): ...52.9......... - 20. Number of children orphaned by HIV/AIDS: (no value listed) - Target 8 (malaria and other diseases): indicators listed but many values not provided. - 23. Incidence of tuberculosis (per 100,000 people): ......182.0 166.3 167.9... - 24. Tuberculosis cases detected under DOTS (percent): ......42.0......... - Goal 7 (environment) — Target 9: Integrate sustainable development; reverse loss of environmental resources. - 25. Forest area (percent of total land area): 8.7...21.1......... - 26. Nationally protected areas (percent of total land area): ...0.0 0.0...... - 27. GDP per unit of energy use (PPP $ per kg oil equivalent): (no value listed) - 28. CO2 emissions (metric tons per capita): 0.2 0.3 0.3......... - Target 10 (water): Halve by 2015 the proportion of people without access to safe drinking water. - 30. Access to improved water source (percent of population): ......74.0...80.0... - Target 11 (slums): Achieve by 2020 significant improvement for at least 100 million slum dwellers - 31. Access to improved sanitation (percent of population): ......71.0...42.0... - 32. Access to secure tenure (percent of population): (no value listed) - Goal 8 (global partnership) — Target 16: Develop and implement strategies for productive work for youth. - 45. Unemployment rate of population ages 15–24 (total): (no value listed) - Target 18 (technology): Make available new technologies, especially information and communications. - 47. Fixed line and mobile telephones (per 1,000 people): ......21.5 171.0 272.6... - 48. Personal computers (per 1,000 people): ...81.7 68.6...79.7... Sources: World Bank, and Fund staff estimates. Notes: - 1: Absolute poverty measures the number of people in 1988 and 2002 whose income is below the 1988 national poverty line, indexed for inflation. - 2: Data for 1988. - 3: Targets 12–15 and indicators 29, 33–44 are excluded because they cannot be measured on a country specific basis. Indicators 21 and 22 are not relevant for Cape Verde. ### Recent economic developments and outlook (selected exact numbers and forecasts) - Real GDP growth rate: peaked at 10.8 percent in 2006; estimated at about 7 percent in 2007. - Real GDP growth for 2008 and 2009: forecast to average about 6 ½ percent. - Consumer price inflation (annual average): declined to 4.4 percent in 2007 from 5.4 in 2006. - Inflation outlook for 2008 and 2009: expected to moderate to trend value of 2 ½ -3 ½ percent. ### Program performance (quantitative and structural outcomes) - Domestic debt reduction: "large reduction in domestic debt (9 percentage points of GDP in 2007)". - Program ceilings: net domestic borrowing ceiling observed by a wide margin for end-December 2007. - International reserves target: met by a large margin though reserve accumulation slowed in final quarter 2007. - Structural benchmarks implementation: - General Tax Code and Judicial Process Code: final drafts submitted to Council of Ministers in May and to Parliament in June 2008 (implementation met with five-month delay). - Income tax code: to be submitted to Parliament in October as part of the 2009 budget (align personal and corporate codes; rationalize tax incentives; introduce loss carry forward and accelerated depreciation). - Energy sector: ARE finalized and posted base utility tariff mechanism by end-March 2008; technical specifications agreed and posted by March 28, 2008; new fuel pricing formula to be finalized and published in June 2008 (structural benchmark for March delayed). - Financial sector: publication of new risk-oriented regulation late 2007; financial intelligence unit established in January 2008; legislative drafting of AML/CFT concluded end-March 2008. ### Economic policies for remainder of 2008 and for 2009 — objectives and commitments - Macroeconomic focus: enhance macroeconomic stability, support exchange rate peg, promote private-sector led growth, continue fiscal consolidation, reduce public debt, build international reserves. - Public debt target: net domestic debt-to-GDP ratio projected to decline below 20 percent by end-2008; original target reached two years ahead of schedule. - Capital expenditure: considering modest increases to ease infrastructure bottlenecks; increases to be in line with strengthened PFM and debt management. - Tax policy: prioritize rationalization of tax incentives and reform of corporate income tax rate; request for IMF technical assistance reiterated. ### Fiscal and public financial management (PFM) measures - New structural measure: submit a simplified medium-term fiscal framework to the Council of Ministers in the 2009 budget cycle and publish it on the Ministry of Finance website in November 2008. - PFM priorities: capacity building for medium-term fiscal policy, implementation of MTEF, program budgeting, and a medium-term investment program (MTIP) in line with PRSP-II for 2008-11. - Debt management: strengthen debt management office; request for IMF technical assistance to enhance asset-liability management and borrowing strategy; donor outreach to secure concessional financing after graduation from Least-Developed-Country status. ### Monetary and financial sector policy actions and targets - Reserve accumulation objective: increase reserves by about 0.1 month of prospective imports annually, reaching over 4 months by 2013. - Monetary policy: BCV will adjust domestic interest rates short run to smooth capital flows; official policy rate is interest on the 14-day bill. - Banking regulation: four onshore banks fully compliant with strengthened prudential requirements; new regulations on capital ratios, provisioning, loan classification, credit risk, and credit concentration published in November 2007 with a 5 year transition for provisioning on non-performing loans. - New structural benchmark: establish a system to enhance monitoring of external flows including non-resident deposits to detect destabilizing capital flows and study interest sensitivity. - Insurance and capital markets: insurance regulation modernization underway; Securities Code and Company’s Act not fully modernized; capital market development required to mobilize emigrant investment beyond emigrant deposits. - Caution on liberalization: further liberalization of financial flows will be preceded by measures to minimize risks to the financial system. ### Energy sector reform — measures, timetable, and financing - Base utility tariff mechanism: approved and posted by ARE; regular tariff adjustments expected to ease Electra’s cash flow and clear arrears. - Fuel pricing formula: current formula complex; new simplified, transparent fuel pricing formula to be finalized and published in June 2008; consideration to base formula on international benchmark prices. - Joint venture and logistics: plan for joint venture of two oil suppliers into a joint logistics company to handle importation, storage and inter-island distribution by July 2008. - Electra reforms: strengthen revenue collection (including prepaid meters); donor-assisted construction of five power plants to be lent to Electra; consideration of management contracts with private sector. - Public-private partnerships (PPP): regulation to be strengthened to ensure risk-sharing prevents government contingent liabilities. - Budget stance on subsidies: commitment not to allow subsidies for energy products in the 2008 budget; ARE adjusted fuel prices by end-March 2008. *Source: IMF staff report content from _cr08248 - selected tables and Letter of Intent (June 9, 2008).* ### 13. Under the PSI, the government will keep the IMF regularly updated on ### _cr08248 - 13. Under the PSI, the government will keep the IMF regularly updated on ### Program monitoring, reviews, and publication - Under the PSI, the government will keep the IMF regularly updated on economic and policy developments and will provide the data needed for adequate monitoring of the program. - This extended LOI provides updates to the MEFP of November 2007: program’s quantitative targets for end-June 2008 were reviewed and affirmed and targets were set for end-December 2008 (Table 1), and two new structural measures on public financial management and the financial sector were included (Table 2). - The fifth and sixth reviews of the PSI are scheduled to be completed by end-October 2008 and end-April 2009, respectively. - Cape Verde will consult with the IMF on the adoption of any measures the government initiates or whenever the Managing Director of the IMF requests such a consultation. - The government authorizes the IMF to publish this letter, the related staff report and selected issues papers. ### Key quantitative assessment criteria and selected target figures (as presented) - Ceiling on net domestic borrowing of the central government (selected cumulative values shown in Table 1): - 0.0; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0 - Ceiling on the outstanding stock of nonconcessional external debt with maturity of less than one year by the central government: - 3; -3.9; -3.7; -5.7; -0.4; -0.8; -1.3; -1.7 - Ceiling on net domestic assets (NDA) of the central bank (BCV): - -3.0; -3.2; -5.1; -3.6; -0.6; -1.3; -2.0; -2.5 - Ceiling on the contracting or guaranteeing of nonconcessional external debt with original maturity of more than one year by the central government: - 35.0; 35.0; 0.1; 5.0; 21.0; 28.0; 35.0 - Floor on net international reserves (NIR) of the Bank of Cape Verde (BCV): - 41.2; 43.0; 53.0; 248.6; 12.6; 25.3; 36.8; 50.6 Memorandum item: Program assumptions (selected quarterly flows) - Nonproject external financial assistance, including credit line (program assumption): - 3.0; 2.9; 0.6; 1.2; 1.8; 2.4 - External debt service: - 2.6; 2.3; 0.7; 1.3; 2.0; 2.6 - Land sales: - 2.0; 1.6; 0.7; 1.4; 2.1; 2.8 - Clearance of end-2006 stock of domestic arrears: - 1.0; 1.3; 0.4; 0.8; 1.1; 1.5 (Note: values above are reported in Table 1 in the original LOI; units indicated in the table are Billions of Cape Verde escudos, Millions of U.S. dollars, and Millions of euros where applicable.) ### Structural assessment criteria and benchmarks (selected items, timing, and status) - Reduce fiscal risks: Fully apply mechanisms for setting and adjusting electricity, water, and fuel prices (LOI ¶12). - Timing: Continuous - Status: Not met (through the period noted) - Reduce fiscal risks: Finalize and publish the mechanism for setting base utility tariffs (LOI ¶5). - Timing: End-March 2008 - Status: Met - Improve fiscal policy execution: Complete a formal mid-year review of revenue and expenditure developments to allow corrective actions if necessary. - Timing: End-August 2008 - Structural benchmarks completed or scheduled: - Instituting November 30 as deadline for granting new spending commitments to reduce end-year payment pressure. - Timing: End-October 2007 - Status: Met - Finalize reform strategy for the General Tax Directorate (DGCI). - Timing: End-Dec. 2007 - Status: Met - Submit the new General Tax Code to the National Assembly (LOI ¶5). - Timing: End-Dec. 2007 - Status: To be implemented in June 2008 - Submit the new Code on Judicial Process to the National Assembly (LOI ¶5). - Timing: End-Dec. 2007 - Status: To be implemented in June 2008 - Submit draft individual and corporate income tax bills to the National Assembly (LOI ¶5). - Timing: End-Dec. 2007 - Status: Postponed to October 2008 (LOI ¶5) - Finalize and publish a revised mechanism for adjusting petroleum prices (LOI ¶12). - Timing: End-March 2008 - Status: To be implemented in June 2008 - Submit to the National Assembly legislation to establish a Financial Intelligence Unit (LOI ¶5). - Timing: End-March 2008 - Status: Met - Submit to the National Assembly legislation to criminalize financing of terrorism and facilitate combating financing of terrorism (LOI ¶5). - Timing: End-March 2008 - Status: To be implemented in June 2008 - Submit to the National Assembly legislation to strengthen the framework for combating money laundering (LOI ¶5). - Timing: End-March 2008 - Status: To be implemented in June 2008 - New structural benchmarks introduced during the 4th PSI review: - Submit a simplified medium-term fiscal framework (MTFF) to the Council of Ministers in the 2009 budget preparation cycle and publish it on the Ministry of Finance website (LOI ¶8). - Timing: November 2008 - Prepare a quarterly report on developments on balance of payments flows, including an assessment of interest sensitivity of non-resident flows into the banking system (LOI ¶11). - Timing: December 2008 ### Technical Memorandum of Understanding — definitions, adjusters, and reporting requirements - Net domestic borrowing (excluding clearance of arrears and net late payments): - Defined as the cumulative change since start of the calendar year of net credit to the central government from the banking and nonbanking sectors less (1) cumulative clearance during the calendar year of the stock of arrears as of end of previous year and (2) cumulative payments during first three months of the calendar year of expenses authorized by the previous year’s budget, plus expenses accrued during current year that will be paid during first three months of next calendar year as provisioned in the budget law (late payments or atrasados). - The ceiling will be adjusted downward (upward) by cumulative downward (upward) deviations in external debt service, and upward (downward) by cumulative downward (upward) deviations in nonproject external financial assistance and land sales relative to program assumptions. - Net credit to the central government: - Defined as the overall position of main central government institutions vis-à-vis the banking and nonbanking system (stock of outstanding claims on central government, long-term securities held by BCV, commercial banks, nonbank institutions, less government deposits with BCV and commercial banks). The INPS is not included. Excludes claims on the Trust Fund (TCMFs). - Reporting requirements for budget implementation data (quarterly; no later than five weeks after quarter end): - (i) government domestic revenue by category; - (ii) external budget support grants; - (iii) government expenditure, including primary current expenditure, domestic and external interest payments, and capital expenditure (domestically and budget support financed) and estimates of externally project financed capital expenditure; - (iv) gross payment and gross accumulation of domestic accounts payable (atrasados); - (v) gross payment and gross accumulation of domestic payments arrears; - (vi) external loan receipts and principal payments; - (vii) external arrears payments and accumulation; - (viii) bank and nonbank financing; - (ix) privatization and land sale receipts; - (x) any other revenue, expenditure, or financing not included above. - Privatization and land proceeds: - Defined as all monies received by the government from sale or concessioning of a public company, organization, or facility to private parties, and proceeds from sale of government land and liquidation of a public company, less restructuring costs. - Net domestic assets (NDA) of BCV: - NDA defined as reserve money minus net foreign assets of the BCV, evaluated at current end-of-period exchange rates. Reserve money comprises bank reserves and deposits of monetary institutions and private sector with BCV, and cash in circulation. - NDA program ceilings adjusted downward (upward) by cumulative downward (upward) deviations in external debt service and upward (downward) by cumulative downward (upward) deviations in nonproject external financial assistance relative to program assumptions; adjusters valued at current exchange rates. - Reporting: preliminary monthly balance sheets of BCV and consolidated commercial banks transmitted monthly with maximum delay of five weeks; definitive BCV monthly balance sheet provided as soon as available. - Ceilings on nonconcessional external debt: - Nonconcessional external debt defined as debt contracted or guaranteed by central government with grant element < 35 percent, using CIRRs published by OECD DAC. Debt rescheduling and reorganization excluded. Short-term nonconcessional external debt ceiling is continuous; medium- and long-term ceiling is quarterly. Portuguese precautionary credit line, borrowings from the Fund, and rescheduling arrangements are excluded. - Government will consult Fund staff before assuming liabilities when uncertainty exists whether instrument falls under the assessment criterion. - Reporting: details of all new external debt (including government guarantees), indicating terms and creditors, quarterly within five weeks of quarter end. - Net international reserves (NIR) of BCV: - NIR defined as gross international reserves of BCV net of its external reserve liabilities, at current exchange rates. Gross reserves include gold, SDRs, reserve position at IMF, foreign exchange holdings, traveler’s checks, demand and short-term deposits at foreign banks, fixed-term deposits abroad liquidatable without penalty, and investment-grade securities. External liabilities include BCV liabilities to nonresidents with original maturity <1 year, net off-balance-sheet positions, arrears on principal and interest, and purchases from the IMF. - Program floors for NIR adjusted upward (downward) by cumulative downward (upward) deviations in external debt service and downward (upward) by cumulative downward (upward) deviations in nonproject external financial assistance relative to program assumptions; adjusters valued at current exchange rates. - Reporting: NIR table prepared by BCV transmitted on weekly basis, maximum delay of two weeks. - Nonaccumulation of new domestic payments arrears: - Government will not accumulate new domestic payments arrears. A domestic payment obligation is deemed in arrears if not paid within normal grace period of 60 days (30 days for government salaries and debt service) or other period specified by budget law or contractually agreed. - Monitoring: monthly execution of the cash-flow plan and corresponding release of budget appropriations. - Reporting: Ministry of Finance and Public Administration (through D.G.T.) to submit quarterly detailed table of stock of domestic payments arrears, including accumulation, payment, rescheduling and write-off during quarter, within four weeks after quarter end. - Nonaccumulation of external payments arrears: - Government will not accumulate new external payments arrears on a continuous basis; monitored via monthly cash-flow execution. - External arrears defined as total external debt-service obligations not paid by due date, excluding cases with explicit creditor grace periods; exclude arrears pending conclusion of debt-rescheduling agreements. - Reporting: data on (i) debt-service payments; and (ii) external arrears accumulation and payments transmitted quarterly by the Ministry of Finance and Public Administration within five weeks of quarter end. Government will inform Fund staff immediately of any accumulation of external arrears. *Source: Extended Letter of Intent and Technical Memorandum of Understanding (LOI and TMU) as presented in the document.* ### 18. The condition will be deemed met when (i) base utility tariffs are set, and reset with ### _cr08248 - 18. The condition will be deemed met when (i) base utility tariffs are set, and reset with ### Structural assessment criterion for utility and fuel price mechanisms (paragraph 18) - Condition deemed met when: - (i) base utility tariffs are set, and reset with the periodicity, as specified in the agreed base tariff setting mechanism; - (ii) between resetting of base tariffs, utility tariffs are adjusted whenever input costs since the last adjustment have changed cumulatively by more than three percent as specified in the published utility tariff adjustment mechanism; - (iii) within one month of each import shipment of petroleum products, retail petroleum product prices are adjusted and brought in line with the specifications in the retail petroleum price adjustment mechanism. - Applicability: - This structural assessment criterion applies continuously only through end-May 2008, after which the new base utility tariffs and fuel price mechanisms will come into effect. ### Mid-year review of revenue and expenditure (paragraph 19) - Condition deemed met when: - (i) revenue, expenditure, and financing during January–June are assessed and compared with budget forecasts; and - (ii) the necessary corrective actions, if any, are identified. ### Other data requirements for program-monitoring purposes (paragraph 20) - Data transmission requirements: - Data on exports and imports, including volume and prices and compiled by the Director of Customs and the BCV, will be transmitted on a quarterly basis within five weeks after the end of each quarter. - A preliminary quarterly balance of payments, compiled by the BCV, will be forwarded within five weeks after the end of each quarter. ### Fund relations and financial position (selected extracts) - Relations with the Fund: - At end-March 2008, outstanding PRGF loans amounted to SDR 8.5 million (89 percent of the quota). - Membership and accounts (As of March 31, 2008): - Quota: 9.60 SDR Million; %Quota 100.00 - Fund holdings of currency: 9.59 SDR Million; %Quota 99.93 - Reserve position: 0.02 SDR Million; %Quota 0.17 - SDR Department: - Net cumulative allocation: 0.62 SDR Million; %Allocation 100.00 - Holdings: 0.07 SDR Million; %Allocation 11.27 - Outstanding Purchases and Loans: - PRGF arrangements: 8.52 SDR Million; %Quota 88.72 - Latest Financial Arrangements: - PRGF — Date of Expiration: Jul 31, 2005; Amount Approved: 8.64 SDR Million; Amount Drawn: 8.64 SDR Million; Type Arrangement Date: Apr 10, 2002 - Stand-By — Date of Expiration: Mar 15, 2000; Amount Approved: 2.50 SDR Million; Amount Drawn: 0.00 SDR Million; Type Arrangement Date: Feb 20, 1998 - Projected Payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs): - Forthcoming principal and charges/interest and total by year: - 2008: Principal 0.49; Charges/interest 0.05; Total 0.54 - 2009: Principal 0.98; Charges/interest 0.05; Total 1.04 - 2010: Principal 1.48; Charges/interest 0.05; Total 1.53 - 2011: Principal 1.73; Charges/interest 0.04; Total 1.77 - 2012: Principal 1.61; Charges/interest 0.03; Total 1.64 ### Safeguards assessment and exchange arrangements (selected extracts) - Safeguards: - BCV subject to a voluntary safeguards assessment with respect to the Policy Support Instrument (PSI) approved on July 31, 2006; documentation received and assessment underway. - Previous BCV safeguards assessment completed in December 2002 for the PRGF arrangement approved on April 10, 2002; assessment found substantial risks in the bank’s financial reporting framework, internal audit mechanism, and system of internal controls. Most recommendations but one have been confirmed as implemented; further steps needed based on audit opinions on 2005 and 2006 financial statements and the 2004 management letter. - Exchange arrangements: - De facto and de jure exchange rate arrangement: conventional fixed peg. - The escudo has been pegged to the euro at a rate of CVE 110.3 per €1 since January 4, 1999. - Cape Verde accepted the obligations of Article VIII effective July 1, 2004. ### Technical assistance (selected areas and chronology) - Areas of TA and missions (examples): - FAD: June 2004 visit to help move to a VAT, rationalize import tariff, and overhaul domestic indirect tax system; October 2004 mission to review tax administration and VAT implementation; September 2005 mission to assess tax exemptions and incentives. - STA: National accounts (November 2003 and January–February 2006), balance of payments statistics (February 2004), government finance statistics (March 2004, April 2006, February–March 2007), price statistics (June 2004, May–June 2006, October 2007), monetary and reporting (March 2007). - MCM: Accounting, financial sector regulation, monetary operations and liquidity management (April and May 2004); banking supervision, liquidity management, exchange regime and reserves management (November 2005, March–April 2006, June 2006, November 2006, July 2007); Macro-prudential indicators (March 2008). - LEG: Tax legislation (missions October 2006–March 2008); AML/CFT initial assessment (March 2007) and legal drafting (March 2008). ### Joint IMF-World Bank Management Action Plan (selected items) - IMF work program next 12 months (selected): - Article IV consultation — Mission in March 2008; Board meeting May 30, 2008 (expected). - PSI program, 5th review — Mission in September 2008; Board meeting mid-November 2008. - PSI program, 6th review — Mission in February 2009; Board meeting end-April 2009. - Bank work program and joint products (selected): - PRSC-4, PRSC-5, Roads Project-2, GEF (windmill farm), Growth and Competitiveness project (will finance the Master Plan for Tourism); various analytical and advisory activities including Poverty assessment, PPIAF/TA on the energy sector, Growth study/SMEs. ### Statistics issues and planned improvements (paragraphs 21–32) - General assessment: - Quality of economic and financial data generally adequate for surveillance and program monitoring, but substantial improvements needed in some areas. - Weaknesses in fiscal data: large statistical discrepancies, noncompliance with best accounting practices, shortcomings in institutional coverage and sectorization. - Other shortcomings: weaknesses in national accounts, lack of short-term activity indicators besides the confidence barometer, gaps in tracking large external flows (notably FDI, emigrant deposits, and remittances). - Cape Verde has participated in the GDDS since February 2004. Monetary and financial sector metadata updated in August 2007. - Statistical master plan: - Developed under direction of the National Statistical Institute (INE). - Envisages improvements in national accounts (annual and quarterly), business statistics (including a new business census), demographic and social statistics (including a household survey to update the poverty profile), trade statistics (retail and international trade), macroeconomic indicators, labor market and sectoral statistics, and update of the CPI basket every five years. - Development partners have committed a substantial part of the estimated US$15 million required to implement the plan through 2010. - Real sector and national accounts: - Timeliness improved: INE released production and expenditure-based GDP data for 2002–03 in 2005 and provided production-based GDP estimates for 2004–06 to the mission in October 2007. - Base year for constant price estimates is outdated. - INE updating national accounts benchmark and base years from 1980 to 2002 and adopting the 1993 SNA; objective to compile timely GDP by industry and expenditure categories and institutional sector accounts. - Introduction of Tourism Satellite Accounts planned. - 2006 STA mission found a need to improve timeliness and accuracy of national accounts source data, notably the business survey; INE staff capacity overstretched. - Price statistics: - New CPI series released in February 2008 with new weights and updated commodity basket; previous CPI weights dated to 1989. - INE received assistance from the National Statistics Institute of Portugal and STA CPI missions (May–June 2006, October 2006, October 2007). - Labor market statistics: - Weak: unemployment data compiled with long delays and no wage data. - Government finance statistics: - Improvements: GFS compilation system being upgraded; most deposits consolidated at the central bank; SIGOF expanded to cover all semi-autonomous institutes and most municipalities by end of 2007; new chart of government accounts (PNCP) to be implemented in 2009 adopting accrual accounting and double-entry principles. - Quality concerns: large statistical discrepancies, inconsistent flows and stocks, recording of arrears not in line with best practices, donor reporting delays affecting accuracy, weaknesses in external debt data affecting debt sustainability analyses. - Monetary and financial statistics: - Quality adequate inaccuracy and timeliness; SRFs for monetary statistics finalized and SRF-based monetary data published in the IFS Supplement since June 2007; alignment with Monetary and Financial Statistics Manual recommendations. - Gaps remain in tracking source and direction of changes in emigrant deposits, complicating assessment of interest sensitivity and monetary policy stance. *Source: Cape Verde — Staff Report for the 2008 Article IV Consultation and Fourth Review Under the Policy Support Instrument—Informational Annex, Prepared by the African Department, Approved June 9, 2008.* ### 33. With technical assistance from STA, the accuracy, periodicity, and timeliness of ### _cr08248 - 33. With technical assistance from STA, the accuracy, periodicity, and timeliness of ### Balance of Payments statistics - With technical assistance from STA, the accuracy, periodicity, and timeliness of balance of payments statistics compiled by BCV have continued to improve. - Greater use of surveys, combined with the International Transactions Reporting System implemented by the BCV, permitted a significant expansion of data sources and statistical coverage, which to a large extent follow the recommendations of the 5th edition of the Balance of Payments Manual. - Dissemination of quarterly BOP data on the BCV website has been regular. - In 2007 the BCV resumed regular and timely transmission of these data to STA for publication in International Financial Statistics and in the Balance of Payments Statistics Yearbook (BOPSY). - The BCV does not compile an International Investment Position. ### Recent macroeconomic developments and outlook - Real GDP growth rate peaked at 10.8 percent in 2006. - Based on information from the National Statistical Institute (INE), GDP growth is estimated at about 7 percent in 2007. - Growth is projected to moderate to 6 ½ percent in 2008 as tourism and construction continue to expand. - Twelve-month inflation averaged about 3½ percent for December 2007–April 2008. - Food and energy prices have risen, but this has not led to generalized inflation partly due to lack of a strong wage indexation. ### Fiscal policy, debt, and reserves - Prudent implementation of the 2008 budget will ensure that domestic debt will be further reduced to 16 percent of GDP by end-2008. - The authorities’ target for domestic debt, 20 percent of GDP, was reached in 2007, two years ahead of schedule. - Tax revenues are exceeding budget forecasts; expenditures are as budgeted; asset sales have surpassed expectations. - Official reserves are building rapidly. - Sterilization, new investment opportunities on the Stock Exchange, growth in private sector credit, and the buildup of government deposits at the BCV have helped contain excess liquidity. ### Monetary policy and exchange rate peg - The Bank of Cape Verde (BCV) conducts monetary management appropriately given the peg and a largely open capital account. - Passive monetary management by the BCV has been setting the official policy rate consistent with its endogenous equilibrium level, smoothing and sterilizing short-term capital flows. - Reserves continue to accumulate. - FDI-related imports have led to and financed a higher current account deficit, without signs of a more general increase in imports that would jeopardize the targeted increase in reserves. - Monetary management and fiscal prudence are both supporting the exchange rate peg and promoting external stability. ### Structural reforms and private sector development - Several state-owned enterprises were privatized; new management was selected to prepare TACV for privatization; privatization of ports operator (ENAPOR) is underway. - External tariffs were lowered ahead of WTO accession. - The Cape Verde Stock Exchange market capitalization is now 25 percent of GDP (from zero in 2005). - Progress on regulatory framework for the energy sector has been made; authorities are urged to accelerate implementation of the broader energy sector reform plan, especially in adjustment of energy prices. - The second PRSP (PRSP-II) submitted in June 2008 sets out medium-term goals and an integrated strategy; Directors encourage improved costing of PRSP-II expenditure plans and enhanced monitoring and evaluation with reliable poverty indicators. ### Executive Board assessment and recommendations - Directors welcomed Cape Verde's impressive economic performance, graduation from UN LDC status, WTO accession, and EU special partner status. - Directors commended prudent macroeconomic management, commitment to the PSI, faster-than-expected reduction of domestic debt, and buildup of official reserves. - Directors judged external stability to be well secured, noting that the increase in the current account deficit is largely financed by foreign direct investment. - The exchange rate peg has helped achieve low inflation; staff assessment: the real effective exchange rate is broadly in line with fundamentals. - Directors recommended: - Continue prudent fiscal policy to safeguard the peg and reduce vulnerability to shocks. - Publish a medium-term fiscal framework as part of the 2009 budget cycle. - Continue strengthening financial sector regulation and supervision; broaden banks' funding sources to reduce dependence on nonresident deposits. - Move ahead with structural reforms to diversify the economy and improve price flexibility. - Accelerate energy sector reforms, including energy price adjustments. - Improve costing, monitoring, and evaluation of PRSP-II expenditure plans and identify reliable poverty indicators. - The next Article IV consultation is expected within 24 months, subject to Executive Board decision on consultation cycles in program countries. ### Selected economic and financial indicators, 2004–08 (highlights) - Real GDP growth: 2004: 4.3; 2005: 6.5; 2006: 10.8; 2007 Est.: 6.9; 2008 Proj.: 6.5 - Real GDP (per capita): 2004: 2.4; 2005: 4.6; 2006: 8.8; 2007 Est.: 5.0; 2008 Proj.: 4.5 - Consumer prices (annual average): 2004: -1.9; 2005: 0.4; 2006: 5.4; 2007 Est.: 4.4; 2008 Proj.: 3.6 - Gross capital formation (percent of GDP): 2004: 38.9; 2005: 41.0; 2006: 43.0; 2007 Est.: 42.6; 2008 Proj.: 45.0 - Gross national savings (percent of GDP): 2004: 25.3; 2005: 37.6; 2006: 38.0; 2007 Est.: 33.4; 2008 Proj.: 35.6 - Net foreign assets: 2004: 31.9; 2005: 58.8; 2006: 14.8; 2007 Est.: 22.9; 2008 Proj.: 20.3 - Credit to the economy: 2004: 9.3; 2005: 9.0; 2006: 30.0; 2007 Est.: 15.5; 2008 Proj.: 14.6 - Broad money (M2): 2004: 10.5; 2005: 15.5; 2006: 17.7; 2007 Est.: 10.6; 2008 Proj.: 11.8 - Total domestic revenue (percent of GDP): 2004: 23.3; 2005: 23.7; 2006: 23.9; 2007 Est.: 25.4; 2008 Proj.: 24.2 - Total grants (percent of GDP): 2004: 9.0; 2005: 6.3; 2006: 5.5; 2007 Est.: 4.8; 2008 Proj.: 5.6 - Total expenditure (percent of GDP): 2004: 36.1; 2005: 36.3; 2006: 34.3; 2007 Est.: 30.9; 2008 Proj.: 34.0 - Overall balance (including grants, percent of GDP): 2004: -3.8; 2005: -6.3; 2006: -4.9; 2007 Est.: -0.7; 2008 Proj.: -4.2 - External debt (percent of GDP): 2004: 55.0; 2005: 53.7; 2006: 47.2; 2007 Est.: 47.2; 2008 Proj.: 44.5 - Net domestic debt (percent of GDP): 2004: 34.6; 2005: 33.3; 2006: 28.8; 2007 Est.: 19.7; 2008 Proj.: 16.4 - Exports of goods and services (local currency): 2004: 5.3; 2005: 23.9; 2006: 35.0; 2007 Est.: 14.1; 2008 Proj.: 20.9 - Imports of goods and services (local currency): 2004: 6.5; 2005: 0.5; 2006: 23.4; 2007 Est.: 17.9; 2008 Proj.: 13.9 - Real effective exchange rate (annual average): 2004: -3.0; 2005: -2.5; 2006: 2.7; 2007 Est.: 1.3; 2008 Proj.: ... - Overall balance of payments (percent of GDP): 2004: 4.1; 2005: 5.6; 2006: 4.7; 2007 Est.: 6.1; 2008 Proj.: 4.0 - Current account balance (including current grants, percent of GDP): 2004: -14.4; 2005: -3.4; 2006: -5.0; 2007 Est.: -9.1; 2008 Proj.: -9.4 - Gross reserves (months of prospective imports): 2004: 2.4; 2005: 2.8; 2006: 3.1; 2007 Est.: 3.6; 2008 Proj.: 3.8 - External debt service (percent of exports): 2004: 11.2; 2005: 8.6; 2006: 5.7; 2007 Est.: 4.7; 2008 Proj.: 4.1 *Based on IMF staff report, Executive Board discussion, Public Information Notice No. 08/80, and Press Release No. 08/155 (as of June–July 2008).* ### 1. We thank staff for the comprehensive and well-illustrated report and selected issues ### 1. We thank staff for the comprehensive and well-illustrated report and selected issues paper on Cape Verde ### Acknowledgment and overarching assessment - Authorities thank staff for the comprehensive and well-illustrated report and selected issues paper on Cape Verde and for the fruitful policy dialogue. - Authorities appreciate Fund advice supporting efforts to overcome policy challenges. - Authorities have consented to Fund publication of their letter of intent, the staff report, and selected issues paper. ### Recent achievements and socio-economic outcomes - Real GDP growth continued to be strong over recent years. - Macroeconomic and external stability were consolidated, with inflation kept in check, domestic debt significantly reduced and the external position largely improved. - Falling unemployment and a continued decline in the incidence of poverty—pace that, if maintained, should enable the country to significantly reduce extreme poverty, in line with the poverty MDG. - Cape Verde earned graduation from UN least-developed country status and a Special Partnership with the European Union. ### Remaining challenges - Poverty and unemployment remain high despite steeply declining paths in recent years. - Growth performance is hampered by: drought and weather vagaries, weak infrastructure, and high food and energy prices. - Authorities seek continued support from international partners, notably the Fund. ### Recent Performance under the Policy Support Instrument (PSI) - Economic activity in 2007 was strong. - In the face of rising energy and food price increases, real GDP growth remained strong, reaching about 7 percent. - CPI inflation declined and is also expected to continue to follow its downward path this year. - The external current account deficit peaked, due to higher FDI-related imports, but was more than financed by foreign investment flows. - All quantitative assessment criteria were met, some with wide margins; examples include the end-December 2007 criteria on net domestic borrowing and international reserves, which were comfortably met. - Drivers of program overperformance included strict fiscal discipline, strong country ownership of the PSI, improved tax administration, and prudent macroeconomic management. - Structural reform implementation largely proceeded, though some reforms were delayed primarily due to capacity constraints. - Capacity constraints prevented timely implementation of the continuous assessment criterion on the full application of the mechanism for setting and adjusting fuel prices. - Authorities promptly took corrective actions by adjusting fuel prices on March 25, 2008, and working to develop by the end of this month a new fuel pricing formula with the assistance of an international consulting firm. - In light of these corrective actions, authorities request Directors’ support for a waiver for the missed assessment criterion. ### Ongoing and near-term structural actions - Tax policy and administration: - New General Tax Code and Judicial Process Code will be submitted to the National Assembly. - Authorities intend to improve tax system efficiency to make it more conducive to private sector development. - Income tax bills and draft legislation aimed at streamlining tax incentives will be submitted to the National Assembly in the coming months. - Financial sector and AML/CFT: - Anti-money laundering and CFT legislations were submitted to the National Assembly; legislation to establish a financial intelligence unit was also submitted. - Central bank (BCV) published in November 2007 new prudential requirements for capital ratios, provisioning and loan classification, credit risk assessment, and credit concentration. - All resident banks currently comply with the new requirements; authorities will continue to monitor compliance. - Energy and utility reforms: - Authorities elaborated and published in March 2008 a mechanism for setting base utility tariffs, as part of energy sector reforms to help reduce fiscal risks. - The approval of the new base utility tariff mechanism will help reduce fiscal liabilities by allowing full recovery of the costs borne by the electricity and water company, Electra. - Recent adjustment of fuel prices illustrates determination to exclude energy subsidies from the 2008 budget. - Authorities intend to finalize and publish soon a streamlined and transparent fuel pricing formula. - Anticipating increased use of public private partnerships (PPPs) to finance large-scale investments (particularly in the energy sector), authorities envisage strengthening regulatory framework for PPPs and are attractive to greater private sector involvement in the management of the electricity company. - Business environment: - Measures to promote private sector development include reducing time necessary for creating a business and streamlining the tax system. ### Reform and policy agenda and macroeconomic framework - Focus of Article IV discussions: consolidating macroeconomic stability and enhancing resilience to shocks, particularly food and oil price increases. - Evidence indicates food and oil price increases are starting to exert noticeable inflationary pressures in Cape Verde. - Staff simulations confirm that a continuously high level of oil prices would likely have an adverse impact on growth and the country’s external position. - Policy responses undertaken/considered: - Measures to assist vulnerable households, including reduction of import duties and value-added tax exemptions on some cereals. - Considering ways to increase agricultural output, notably through improvements in rural infrastructure. - Expectation of Fund and other international institutions’ assistance to cope with oil and food price shocks. ### Fiscal and public debt developments - In 2007, domestic debt was reduced by 9 percentage points of GDP, reaching the program original target, a net domestic-to-GDP ratio of 20 percent, two years ahead of schedule. - With prudent budget and policies set for 2008, authorities expect to further consolidate this achievement. - Authorities attach high importance to safeguarding debt sustainability while pressing ahead with their investment program; improving debt management will rank high on the agenda and will require addressing capacity constraints. - Authorities would appreciate Fund technical assistance on debt management. ### Monetary policy and external reserves - Monetary policy will continue to be geared at helping further accumulate reserves to support the exchange peg, which remains appropriate. - Targeted pace of reserve accumulation: about 0.1 month of prospective imports per year, setting the stage for reaching over 4 months by 2013. - BCV intends to develop a system to better monitor external flows, including non-resident deposits, and stands ready to change interest rates, if necessary, to prevent destabilizing capital flows. ### Public financial management and medium-term planning - By November 2008, authorities intend to develop and submit for consideration by the Council of Ministers a simplified medium-term fiscal framework which will also be made public. - This is expected to pave the way for adoption of a medium-term framework and investment program to capture authorities’ intention to augment investments in infrastructure and the energy sector. ### Conclusion and requests - Cape Verde’s achievements have helped lift its population out of absolute poverty and strengthened policy credibility. - Authorities are hopeful graduation from least-developed country status will not lead to premature shortage of concessional financing; they welcome reassurances from most partners that concessional assistance will not abruptly end. - Authorities request the Board’s approval for: - A waiver for nonobservance of a structural assessment criterion. - Support for the completion of the fourth review of the PSI program. *Source: Letter of intent and authorities’ statement, “1. We thank staff for the comprehensive and well-illustrated report and selected issues paper on Cape Verde.”* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08248.pdf_