## _cr08365

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### Executive Summary: crisis, reform package, and IMF support
- Seychelles is in an acute balance of payments and public debt crisis jeopardizing high living standards and development.
- Causes cited: longstanding unsustainable macroeconomic policies, recent external shocks, near-exhaustion of foreign reserves, missed public debt payments, a pegged exchange rate incompatible with fundamentals, complex exchange restrictions and controls, a parallel exchange market, and pervasive dollarization.
- Authorities’ reform package includes:
  - Elimination of all exchange restrictions and a float of the rupee.
  - Significant and sustained fiscal tightening, including reduction in public employment and replacement of indirect subsidies by a targeted social safety net.
  - Reform of the monetary policy framework focusing on liquidity management using indirect instruments.
  - Reduction in the role of the state through further privatization, enhanced fiscal governance, and tax regime review to boost private sector development.
- Debt-sustainability conclusion: reform effort must be complemented by comprehensive public debt restructuring involving a substantial reduction in the debt service burden consistent with long-term ability to pay.
- Program support requested: two-year SBA in the amount of SDR 17.6 million (200 percent of quota); staff recommendation to approve.

### Background and recent developments
- Growth and inflation:
  - Real GDP growth expected to fall to 3.1 percent in 2008 from an average of about 7.5 percent of GDP in 2005-07.
  - CPI up to 37.5 percent (year-on-year) at end-August 2008, compared to 5.2 percent in August 2007.
- External position and reserves:
  - External current account deficit projected to widen from 23 percent of GDP in 2007 to almost 29 percent in 2008.
  - Official reserves as of mid-October had fallen to about US$14 million; official reserves had fallen to about US$15 million as of end September 2008.
  - Balance of payments increasingly financed by external arrears accumulation.
- Public debt and arrears:
  - Total public debt about 151 percent of GDP.
  - External public debt about 98 percent of GDP (US$808 million), of which US$313 million is arrears (mostly Paris Club creditors and privately placed amortizing notes stopped in July 2008).
  - Small multilateral arrears: US$2.2 million.
  - Eurobond coupon payment on US$230 million missed in October 2008; S&P downgraded Seychelles to SD (selective default).
- Financial sector snapshot:
  - Banking industry assets about SR 8.8 billion (113 percent of GDP) as of end-June 2008.
  - Asset allocation: domestic lending about 25 percent of assets; investments abroad 34 percent; domestic government securities 24 percent.
  - Regulatory capital (capital net of provisions and intangibles) at 5.6 percent of net assets—40 basis points short of “well capitalized.”

### Policy discussions — overview and program design
- Political economy: strong political consensus in mid-2008 enabled coherent reform effort under President Michel.
- Program objectives:
  - Restore internal and external stability, resolve macro imbalances, correct overvalued exchange rate, and put public debt on a sustainable path.
- Key program elements (ownership emphasized):
  - Full convertibility of the Seychelles rupee and a floating exchange rate; removal of all exchange restrictions.
  - Sustained fiscal tightening to support competitiveness and debt sustainability.
  - Reform monetary policy to focus on liquidity management with market-based instruments.
  - Reduce the role of the state: privatization, better monitoring of public entities, enhanced transparency.
- Debt restructuring needs:
  - Paris Club creditors indicated willingness to consider treatment under the Evian approach.
  - Authorities developing debt restructuring consistent with Fund’s lending into arrears policy; emphasis on transparency and intercreditor equity.
  - Large cash flow relief on external public debt service needed in 2009-11.
  - Domestic debt largely held by domestic banks and CBS—limited margin for nominal haircut.

### Macroeconomic framework and projections (program assumptions and targets)
- Growth and inflation:
  - Real GDP: contraction in 2009 by about -0.5 percent; recovery thereafter with average real GDP growth of about 5 percent from 2011.
  - Inflation: rupee depreciation expected to raise inflation short-run, peaking in Q2 2009 and declining to 22 percent at end-2009.
    - CPI (Annual average) projections: 2008: 32.2; 2009: 33.8; 2010: 12.6; 2011: 5.8; 2012: 3.2; 2013: 3.0.
    - CPI (End-of-period) projections: 2008: 38.8; 2009: 21.6; 2010: 11.5; 2011: 3.0; 2012: 3.0; 2013: 3.0.
- Current account and reserves:
  - Non-interest current account deficit projected to improve from 26.6 percent in 2008 to 16.4 percent in 2009.
  - Gross official reserves projected (weeks of imports): 2008: 0.1; 2009: 0.2; 2010: 0.8; 2011: 9.2; 2012: 12.1; 2013: 14.1.
- Public debt trajectory (without restructuring):
  - Total public debt incl. arrears: 2007: 146.0; 2008: 151.3; 2009: 161.3; 2010: 149.5; 2011: 138.4; 2012: 126.6; 2013: 121.0.
- Fiscal balances:
  - Overall fiscal balance including grants (percent of GDP): 2007: -9.8; 2008: -1.8; 2009: -6.1; 2010: -1.1; 2011: 0.9; 2012: 3.5; 2013: 3.0.
  - Primary fiscal balance (percent of GDP): 2007: -2.3; 2008: 7.1; 2009: 6.2; 2010: 6.6; 2011: 6.8; 2012: 5.8; 2013: 5.5.
- Risks identified:
  - Downside risks risen; global slowdown could reduce tourism and FDI, widening current account.
  - Monetary policy transmission uncertainty; weak instruments could hamper CBS control of inflation.
  - FDI assumptions conservative: high import content of FDI (85 percent) and profit repatriation imply modest BOP impact.

### Exchange rate liberalization: assessment, implementation, and risks
- Assessment:
  - REER remained significantly overvalued as of mid-2008 despite 2006-07 devaluations.
  - Parallel market premium around 55 percent recently; rising dollarization.
  - REER overvaluation estimates mid-2008:
    - SSA panel ERER: about 26 percent overvalued.
    - Islands panel ERER: about 11 percent overvalued.
    - External sustainability approach: commensurate overvaluation of 12-33 percent for plausible NFAP ranges.
  - Benchmark NFAP plausible range: -200 to -100 percent of GDP.
- Policy choice and implementation:
  - Staff view: a managed float of the rupee was the only short-term alternative given lack of peg credibility and near-exhaustion of reserves.
  - Authorities repealed surrender and pay-in-foreign-exchange requirements effective November 3.
  - FX market interventions limited to smoothing volatility, preserving orderly conditions, and supporting reserve accumulation.
  - CBS established an interbank FX trading platform initially supported by a manual book-entry system with plan to move to RTGS over the coming year.
  - Supervision of banks’ FX risk management to be strengthened; new foreign exchange bureaus to be licensed.
- Initial pressures and risks:
  - Overhang of unrepatriated profits/dividends may put initial pressure on exchange rate.
  - Low official reserves leave vulnerabilities to unfavorable external developments.

### Fiscal measures and restoring public debt sustainability
- Fiscal strategy and targets:
  - Sustained fiscal tightening critical to anchor float and debt sustainability.
  - After large 2008 adjustment, primary surpluses of 6.5 percent of GDP on average programmed in 2009-11.
  - Fiscal strategy rests on expenditure restraint, revenue enhancement, strengthened public financial management, and public sector reform including privatization.
- Frontloaded measures:
  - Bulk of fiscal adjustment and key measures implemented in Q4 2008.
  - Turnaround in primary fiscal balance from 2007 about 8 percent of GDP in 2008; sustained primary surpluses of about 6½ percent through 2011.
- Specific measures and budgetary impacts (Text Table 2, percent of GDP):
  - Revenue Measures total: 0.4 (2008), 3.1 (2009).
    - Eliminate tax exemptions: 0.0 (2008), 0.6 (2009).
    - Raise taxes: 0.3 (2008), 1.6 (2009).
    - Adjust fees, fines, charges and rents and royalties for inflation: 0.0 (2008), 0.5 (2009).
    - New taxes: 0.1 (2008), 0.4 (2009).
  - Expenditure Measures total: -0.1 (2008), 2.0 (2009).
    - Eliminate subsidies: 0.1 (2008), 1.5 (2009).
    - Introduce a targeted social safety net by enacting Agency on Welfare Act: -0.2 (2008), -1.0 (2009).
    - Reduction in the public sector wage bill: 0.0 (2008), 1.5 (2009).
  - Net Budgetary Impact: 0.3 (2008), 5.0 (2009).
- Subsidy and employment reforms:
  - Replace indirect subsidies with targeted social safety net; Welfare Agency Act operational by November 1, 2008.
  - Public sector employees reduction target: 12.5 percent by end-2008 (voluntary and involuntary scheme); separation package and retraining support.
- Debt management commitments:
  - New Public Debt Law to define legal framework; Public Debt Management Committee to monitor parastatal borrowing.
  - IMF TA to strengthen debt operations, recording systems, and contingent-liability management.

### Toward a comprehensive debt restructuring strategy (DSA findings and scenarios)
- DSA findings and conclusions:
  - Public debt is unsustainable.
  - Baseline scenario with new borrowing on commercial terms to refinance arrears: external debt reaches 165 percent of GDP by 2018.
  - Bounds tests show high vulnerability to standard shocks.
  - Comprehensive restructuring with substantial reduction in debt service burden needed to restore sustainability.
  - Even with sharp present value reduction, Seychelles likely to remain highly vulnerable to shocks for an extended period.
  - Staff believes reasonable expectations exist that a restructuring consistent with payments capacity is possible.
- Debt composition and recent developments (end-August 2008):
  - PPG debt stock estimated at 151 percent of GDP.
  - Debt holders (percent of total): Multilateral 4%; Paris Club bilateral 12%; Other official bilateral 7%; External commercial 39%; CBS 10%; Domestic banks 21%; Other domestic 7%.
  - External arrears composition (percent of total external arrears): Multilateral 1%; Paris Club 40%; Other official bilateral 12%; External commercial 47%.
- Non-restructuring (new borrowing) scenario outcomes:
  - Under optimistic refinancing (LIBOR plus 800 bps, 10-year maturity, 1-year grace), public debt projected to rise to over 183 percent of GDP over the next ten years.
  - External debt projected to reach 165 percent of GDP by 2018 in some tables; alternative projections show external debt rising to 128 percent of GDP in 2009 and 165 percent by 2018.
- Domestic debt considerations:
  - Domestic banks’ exposure to government securities almost 45 percent of assets; banks could not take a significant haircut without risking stability.
  - DSA assumes no restructuring of domestic public debt due to banking system risks; negative real interest rates in 2008-10 erode domestic debt.

### Reforming monetary policy and the monetary policy framework
- Objectives:
  - Secure price stability and support floating regime through liquidity management and market instruments.
- Market instruments and auction results (selected exact auction rates):
  - 91-day Treasury Bills tender rates: 23-Sep: 5.9; 3-Oct: 8.7; 10-Oct: 10.2; 17-Oct: 10.2; 24-Oct: 10.5; 31-Oct: 13.6; 5-Nov: 17.2; 7-Nov: 15.1.
  - Deposit Auction Arrangement (7-day weighted average DAA rate): 22-Sep: 5.3; 1-Oct: 5.7; 8-Oct: 7.4; 15-Oct: 8.2; 22-Oct: 8.6; 29-Oct: 9.4; 5-Nov: 9.5; 12-Nov: 9.9.
- Monetary program design:
  - Based on a quarterly reserve money target; monetary aggregate target considered most viable nominal anchor.
  - Program envisages initial rise in velocity and money multiplier, requiring very tight control of reserve money around the float.
  - Close cooperation between Treasury and CBS essential for liquidity management.
- Technical assistance and governance:
  - Continued substantial IMF TA to CBS, including a requested long-term monetary advisor.
  - TA priorities: automate interbank market, introduce reserve money framework, strengthen bank supervision, reinforce CBS governance and transparency.
  - Governance conditions: new external auditors for 2008 accounts; memorandum of understanding between Ministry of Finance and CBS by end-December 2008; revision of CBS act with Fund TA as condition for first program review.

### Financial sector stability, stress tests, and contingencies
- Main vulnerabilities:
  - Major risk: expected increases in default rates on bank loans from higher interest rates and exchange rate movements.
  - Banks have long net open positions in foreign currencies—first-round depreciation effects expected to be positive for capital.
  - Industry capital coverage of government securities about 22 percent; three banks had coverage of only 11-14 percent as of June 30, 2008.
- Stress-test illustrative outcomes (end-June 2008):
  - For a 50 percent devaluation:
    - Current Capitalization: 5.6
    - New Net Capitalization: 5.4
    - New Net Capitalization with stronger bad loan provisioning: 6.6
    - Capital Coverage of Net Loans (2nd round effects): 26.5
  - For a 125 percent devaluation:
    - Current Capitalization: 5.6
    - New Net Capitalization: 5.4
    - New Net Capitalization with stronger bad loan provisioning: 8.3
    - Capital Coverage of Net Loans (2nd round effects): 33.9
- Fiscal cost estimates under stress:
  - If loan losses grow to 20 percent of June 2008 loan balances, only one government-owned institution may require recapitalization; fiscal cost about SR 82 million (1 percent of GDP).
  - If loan losses rose to 40 percent, all four government-owned institutions would require recapitalization or resolution; total cost could reach about SR 333 million (4 percent of GDP).
- Contingencies in program:
  - CBS liquidity support and a 2009 budget contingency for recapitalization of government-owned financial institutions.
  - Need for MCM TA on supervisory intervention and failed bank resolution.

### Structural reforms, governance, and privatization
- Fiscal governance improvements:
  - Implement IMF public financial management review recommendations: medium-term macro framework, inclusion of social security/pension funds in fiscal analysis, single treasury account, cash management system, detailed expenditure ceilings.
- Tax policy and revenue administration:
  - Fundamental tax review to eliminate distortions and broaden base; IMF FAD TA requested.
  - Immediate actions: tax audits of 20 largest enterprises to be completed by end-June 2009; strengthen revenue administration.
- Regulatory, legal, and transparency reforms:
  - Revamp FDI framework; centralize project approval in Ministry of Finance; remove discretionary exemption powers.
  - Public Officers Ethics Act adopted August 2008; financial disclosure required by November 2008.
  - Public Procurement Act to be passed by December 2008.
  - Amendments to AML Act in July 2008 establishing Financial Intelligence Unit.
- Privatization program:
  - Planned divestitures: Seychelles Savings Bank, Agro Industries, Animal Feed Factory, Coetivy Prawn Farm.
  - Avoid retaining minority stakes in privatized firms.
  - SSI created March 2008 to monitor firms with significant government stakes.

### Data issues, reporting, and program monitoring
- Data weaknesses:
  - Key macro statistics needing improvement: deflators and foreign trade statistics.
  - National accounts revised up by some 20–25 percent due to improved coverage; further revisions planned.
- Reporting requirements (selected):
  - CBS weekly reporting within one week: Net international reserves, CBS balance sheet, contracts of new external loans, daily average exchange rate, foreign exchange cash flow, auction results.
  - CBS monthly reporting within 4 weeks: monthly balance sheet, monetary survey, financial soundness indicators, interest rate structure, stock of government securities by holder/maturity.
  - Ministry of Finance weekly: notification of external payments due and not made.
  - Ministry of Finance monthly within 4 weeks: consolidated government operations, detailed revenues/expenditures, monthly treasury report, stock and flow of external debt by creditor, arrears statements.
- Monitoring and performance criteria:
  - Quarterly quantitative performance criteria on net international reserves (NIR), reserve money, and fiscal primary balance.
  - Symmetric adjustor on NIR for deviations from projected financing.
  - Continuous performance criteria: non-accumulation of external and domestic arrears.
  - Structural conditionality focused on macro-critical fiscal and CBS governance measures.

### Program financing, access, and review schedule
- SBA access and disbursement:
  - Two-year SBA access: SDR 17.6 million (200 percent of quota); 70 percent of quota (SDR 6.16 million) disbursed upon approval.
  - Disbursement schedule (SDR and percent of quota):
    - November 17, 2008 — 6.16 (70 percent of quota) — Board approval.
    - April 5, 2009 — 0.88 (10 percent of quota) — first review.
    - July 5, 2009 — 0.88 (10 percent of quota) — second review.
    - October 5, 2009 — 0.88 (10 percent of quota) — third review.
    - January 5, 2010 — 2.22 (25 percent of quota) — fourth review.
    - April 5, 2010 — 2.22 (25 percent of quota) — fifth review.
    - July 5, 2010 — 2.22 (25 percent of quota) — sixth review.
    - October 10, 2010 — 2.22 (25 percent of quota) — seventh review.
- Financing assurances and partners:
  - 2009 external nonproject financing expected from: Fund under SBA (SDR 2.64 million, 30 percent of quota), other multilaterals (World Bank and AfDB US$15 million), and public debt relief (US$85 million).
  - Staff approached Paris Club creditors seeking financing assurances under Evian approach.
  - Financing assurances reviews to be completed at program reviews.
- Program review cadence:
  - Quarterly program and financing assurance reviews proposed given risks.
  - First program and financing assurances review scheduled for early April 2009; second for early July 2009.
- Consistency with Fund arrears policy:
  - Seychelles has no outstanding liabilities to the Fund.
  - Under proposed SBA, outstanding Fund credit would peak in 2010 at 2.5 percent of exports or about 18 percent of projected official reserves.
  - Prospective obligations to Fund peak in 2013 at 0.8 percent of exports or 3.3 percent of projected reserves.

### Main risks to program success
- Identified risks:
  - Worse-than-anticipated global slowdown affecting tourism and growth.
  - Banking sector vulnerabilities requiring larger recapitalization.
  - External financing availability proving harder to mobilize than anticipated.
  - Global financial turbulence prolonging negotiations with private creditors.
  - Heavy administrative burden on CBS from move to float and market development.
  - Waning social and political consensus for reform and implementation capacity constraints.
- Mitigants and staff view:
  - Authorities demonstrated strong commitment via upfront measures; staff recommends quarterly reviews and close monitoring.

### Staff appraisal — overall assessment and key policy recommendations
- Staff welcomes decisive reform implementation, particularly early liberalization and float of the rupee.
- Main pillars supported: significant and sustained fiscal tightening; monetary framework reform; reduction of state role.
- Debt restructuring: comprehensive restructuring required to restore sustainability; staff supports negotiations with external creditors consistent with payments capacity.
- Monetary and financial recommendations:
  - Maintain tight liquidity control and raise interest rates to positive real levels.
  - Allow domestic interest rates to be market-determined to contain nominal exchange rate overshooting.
  - Strengthen CBS–Ministry of Finance cooperation on liquidity forecasting/management.
  - Bolster banking supervision and provide fiscal contingency for potential recapitalization of state-owned financial institutions.
- Structural and governance recommendations:
  - Implement public financial management reforms, strengthen tax administration, publish program documents, and address safeguards issues at the CBS.

*Italic source: Executive Summary, _cr08365 - Executive Summary*

### Executive Summary ......................................................................................................

### _cr08365 - Executive Summary

### Executive Summary: crisis, reform package, and IMF support
- Seychelles is in the midst of an acute balance of payments and public debt crisis that jeopardizes its high living standards and economic development.
- Causes: longstanding unsustainable macroeconomic policies, recent external shocks, near-exhaustion of foreign reserves, missed payments on public debt obligations, a pegged exchange rate incompatible with fundamentals, complex exchange restrictions and controls, a parallel exchange market, and pervasive dollarization.
- Authorities’ reform package includes:
  - Fundamental liberalization of the exchange regime: elimination of all exchange restrictions and a float of the rupee.
  - Significant and sustained tightening of fiscal policy: reduction in public employment and the replacement of indirect subsidies by a targeted social safety net.
  - Reform of the monetary policy framework: focus on liquidity management based on indirect instruments.
  - Reduction in the role of the state: further privatization, enhanced fiscal governance, and a review of the tax regime to boost private sector development.
- Debt sustainability: the reform effort, however strong, must be complemented by a comprehensive public debt restructuring involving a substantial reduction in the debt service burden consistent with the long-term ability to pay.
- Frontloaded measures:
  - Bulk of fiscal adjustment and other key measures implemented in Q4 2008.
  - Turnaround in the primary fiscal balance from 2007 is about 8 percent of GDP in 2008, with sustained primary surpluses of about 6½ percent through 2011.
  - Fiscal reforms also include removal of tax exemptions, strengthening of tax administration, and strengthening public financial management.
- Medium-term structural reform agenda to be elaborated in 2009 with World Bank and partners; potential successor EFF arrangement for later support.
- Staff recommendation: approve the authorities’ request for Fund support through a two-year SBA in the amount of SDR 17.6 million (200 percent of quota).

### Background and recent developments
- Macroeconomic deterioration and external shocks:
  - Growth decline: real GDP growth expected to fall to 3.1 percent in 2008 from an average of about 7.5 percent of GDP in 2005-07.
  - Inflation surge: CPI up to 37.5 percent (year-on-year) at end-August 2008, compared to 5.2 percent in August 2007, and virtually zero in 2005-06.
  - External current account deficit: projected to widen in 2008 from 23 percent of GDP in 2007 to almost 29 percent.
  - Official reserves: as of mid-October official reserves had fallen to about US$14 million.
  - Balance of payments increasingly financed by external arrears accumulation.
- Recent policy moves in 2008:
  - Fiscal: 2008 budget implemented broadly as approved and further tightened in October implying a substantial correction. Compared to a 2.3 percent deficit in 2007, the primary surplus is now projected at 5.6 percent of GDP in 2008 (excluding a 1.5 percent of GDP transfer of valuation gains from the central bank).
  - Monetary: in June 2008, Central Bank of Seychelles (CBS) raised reserve requirements significantly; local asset ratio (LAR) was reduced, offsetting part of the increase. Broad money growth remained high at end-September 2008 (20.4 percent, year-on-year).
- Public debt and arrears:
  - Total public debt about 151 percent of GDP (unsustainable).
  - External public debt about 98 percent of GDP (US$808 million), of which US$313 million is arrears (mostly to Paris Club creditors and on privately placed amortizing notes stopped in July 2008).
  - Small amount of arrears to multilateral creditors: US$2.2 million.
  - In October 2008 authorities announced inability to make a coupon payment on US$230 million of Eurobond and indicated intention to approach creditors for comprehensive debt restructuring.
  - Standard and Poor’s downgraded Seychelles to SD (selective default).
- Financial sector position and vulnerabilities:
  - Banking industry assets about SR 8.8 billion (113 percent of GDP) as of end-June 2008.
  - Asset allocation: domestic lending about 25 percent of assets; investments abroad 34 percent; domestic government securities 24 percent.
  - Regulatory capital (most stringent measure—capital net of all provisions for loan loss and intangibles) stood at 5.6 percent of net assets—40 basis points short of being considered well capitalized.
  - Vulnerability: large exposure to government securities; industry capital as of June 30, 2008, covered about 22 percent of holdings of government securities; three banks had coverage of only 11-14 percent.

### Policy discussions — overview and program design
- Political economy: strong political consensus in mid-2008 enabled a coherent reform effort; President Michel’s mandate and ruling party support facilitated break with past gradualism.
- Program objectives: restore internal and external stability, resolve macroeconomic imbalances, address overvalued exchange rate, and place public debt on a sustainable path.
- Key program elements (strong ownership by authorities):
  - Achieve full convertibility of the Seychelles rupee and introduce a floating exchange rate regime; removal of all exchange restrictions and market-based float expected to improve external competitiveness and reduce imbalances.
  - Sustain significant fiscal tightening to underpin competitiveness gains and debt sustainability.
  - Reform monetary policy to focus on liquidity management with market-based instruments; floating exchange rate places increased emphasis on monetary policy for price stability and requires enhanced bank supervision to maintain financial stability.
  - Reduce the role of the state and improve business environment: privatization, strengthened monitoring/oversight of public entities, enhanced transparency and governance.
- Debt restructuring needs:
  - Fundamental policy reforms alone are insufficient to restore debt sustainability.
  - Paris Club creditors have informally indicated willingness to consider treatment under the Evian approach.
  - Authorities are developing a debt restructuring strategy consistent with Fund’s lending into arrears policy, emphasizing information transparency, intercreditor equity, and dialogue with all creditor groups.
  - Large cash flow relief on external public debt service is needed in 2009-11.
  - Domestic debt largely held by domestic banking system and CBS—limited margin to absorb a nominal haircut.

### Macroeconomic framework and projections (main assumptions and targets)
- Overview of projections under full implementation of program:
  - Real GDP: contraction in 2009 by about -0.5 percent; recovery thereafter with average real GDP growth of about 5 percent from 2011 driven by rising foreign investment in tourism after lifting exchange restrictions.
  - Inflation: rupee depreciation after the float expected to raise inflation in short run, peaking in Q2 2009 and gradually declining to 22 percent at end-2009. (Text Table 1 projections: CPI (Annual average) 2008: 32.2; 2009: 33.8; 2010: 12.6; 2011: 5.8; 2012: 3.2; 2013: 3.0. CPI (End-of-period) 2008: 38.8; 2009: 21.6; 2010: 11.5; 2011: 3.0; 2012: 3.0; 2013: 3.0.)
  - Current account and reserves: non-interest current account deficit projected to improve in 2009 to 16.4 percent (from 26.6 percent in 2008) due to rupee depreciation and temporary decline in FDI-related imports; gross official reserves to rise from 0.1 weeks of imports in 2008 to 9.2 weeks in 2010 and 12.1 weeks in 2011 (Text Table 1: Gross official reserves (weeks of imports) 2008: 0.1; 2009: 0.2; 2010: 0.8; 2011: 9.2; 2012: 12.1; 2013: 14.1; 2013 projection 15.9 appears in table).
  - Public debt without restructuring: would increase to 161 percent of GDP in 2009 and remain at unsustainably high levels over medium term (Text Table 1 shows Total public debt incl. arrears: 2007: 146.0; 2008: 151.3; 2009: 161.3; 2010: 149.5; 2011: 138.4; 2012: 126.6; 2013: 121.0).
  - Fiscal balances: overall fiscal balance including grants: 2007: -9.8; 2008: -1.8; 2009: -6.1; 2010: -1.1; 2011: 0.9; 2012: 3.5; 2013: 3.0. Primary fiscal balance (percent of GDP): 2007: -2.3; 2008: 7.1; 2009: 6.2; 2010: 6.6; 2011: 6.8; 2012: 5.8; 2013: 5.5.
- Risks:
  - Downside risks have risen. Upside: faster declines in world food and fuel prices could lower inflation and the current account deficit.
  - Monetary policy risks: uncertainty about transmission mechanism and weak instruments could hamper CBS’ control of inflation.
  - External demand risk: global slowdown may dampen growth and widen the current account through lower tourism receipts and FDI.
  - FDI assumptions conservative: pipeline mainly hotels; tight credit conditions could delay implementation; high import content of FDI (85 percent) and profit repatriation assumptions imply modest balance of payments impact.

*Italic source: Executive Summary, _cr08365 - Executive Summary*

### 11.      Staff and the authorities agreed that a fundamental liberalization of the

### Staff and the authorities agreed that a fundamental liberalization of the exchange regime and the rate-determination mechanism are critical to restore credibility in the rupee and eliminate the parallel market

### Exchange rate liberalization: assessment and policy choice
- Staff’s analysis suggests that, as of mid-2008, the exchange rate remained significantly overvalued, notwithstanding the 2006-07 step devaluations (Box 1 and Figure 3).
- The parallel exchange rate has remained fairly stable at a premium above the official rate (about 55 percent lately).
- Dollarization has been rising rapidly in recent years (Figure 2).
- Given:
  - the lack of credibility in the peg,
  - the near-exhaustion of external reserves,
  - a significant parallel market,
  staff view was that a managed float of the rupee was the only alternative, at least in the short-term.
- This short-term choice does not prejudge the appropriate long-run exchange rate regime; options to be carefully assessed once the economy stabilizes include:
  - full dollarization or euroization,
  - a currency board.
- A large step devaluation did not appear feasible because of:
  - difficulty assessing the magnitude of adjustment needed,
  - the CBS’ very limited ability to defend the new rate.

### Removal of exchange restrictions and market infrastructure
- Authorities repealed requirements to surrender foreign exchange earnings and to pay for certain transactions and taxes in foreign exchange on October 31, effective November 3.
- With elimination of these measures, the exchange system is free of restrictions on both current and capital transactions; remaining restrictions subject to Fund jurisdiction under Article VIII have disappeared.
- Authorities committed to limit FX market interventions to:
  - smoothing excessive volatility,
  - preserving orderly market conditions,
  - supporting the reserve accumulation objective.
- With Fund technical assistance, a platform at the CBS for interbank foreign exchange trading has been established:
  - Initially supported by a manual book-entry system,
  - Plan to move to a real-time gross settlement system over the coming year.
- Measures to strengthen market functioning and supervision:
  - Supervision of commercial banks’ risk management and FX trading practices will be strengthened to ensure internal rules based on international best practices.
  - New foreign exchange bureaus will be licensed to stimulate competition.

### Risks, required macro policy stance, and initial pressures
- Authorities aware of risks associated with a large exchange rate depreciation and ready to take supporting measures.
- Maintaining an appropriately tight monetary and, particularly, fiscal policy will be key to anchor the move to a floating regime.
- A remaining overhang of unrepatriated profits and dividends by foreign firms, subsequent to the late-2007 clearing, may put pressure on the exchange rate initially.
- Given the initial low level of official reserves, vulnerabilities to further unfavorable external developments would remain high for some time.

### External stability and exchange rate assessment (Box 1 and Figures)
- Despite 2006-07 step devaluations, most indicators point to a significant overvaluation of the real effective exchange rate (REER) in mid-2008.
- By end-June 2008, the REER had depreciated by about 38 percent since its peak in January 2003.
- The 2008 underlying current account deficit was 21.1 percent of GDP (excluding the net impact of the peak in food and fuel prices).
- Formal assessments indicate REER overvaluation in mid-2008 as follows:
  - Equilibrium real exchange rate (ERER) estimation based on panel of 28 sub-Saharan African (SSA) countries: about 26 percent overvalued.
  - ERER estimation using a smaller panel of Indian Ocean islands (Islands): about 11 percent overvalued.
  - External sustainability approach suggests a commensurate overvaluation of 12-33 percent for plausible ranges of the benchmark net foreign asset position (NFAP).
- Benchmark NFAP assumptions:
  - Plausible range for the benchmark NFAP is -200 to -100 percent of GDP, depending on private sector net foreign position assumptions.
  - BIS data include offshore transactions which, at 159 percent of GDP in March 2008, overstate the private sector’s NFAP.
- Competitiveness indicators imply a combination of exchange rate adjustment and structural improvements in the business environment is needed.

### Fiscal measures and restoring public debt sustainability
- A sustained fiscal tightening is critical to anchor a floating exchange rate and place public debt on a sustainable path.
- After a large adjustment in 2008, primary surpluses of 6.5 percent of GDP on average are programmed in 2009-11.
- Fiscal strategy rests on:
  - Expenditure restraint,
  - Revenue enhancement,
  - Strengthened public financial management,
  - Public sector reform, including further privatization of public enterprises.
- World Bank conducting a Public Expenditure Review to help raise efficiency of health and education spending and prepare agenda for civil service, social security, and public enterprise reforms.
- Staff welcomed revenue and expenditure measures implemented in October and November 2008 and those to be introduced with the 2009 budget (Text Table 2).
- 2009 budget aims at a primary surplus achieved through:
  - Savings on transfers and subsidies,
  - Decline in the wage bill,
  - Rise in tax revenues.
- Fiscal adjustment somewhat backloaded in 2009 due to:
  - Frontloading contingency for potential recapitalization needs for public financial institutions,
  - Seasonality of revenue collections,
  - Staffing redundancy payments in the first quarter.
- Specific measures highlighted:
  - Replace indirect product subsidies with a targeted, modernized social safety net (expected to produce net budgetary savings in 2009).
  - Implement voluntary and involuntary departure scheme to reduce public sector employees by 12.5 percent by end 2008; together with moderate wage increases, expected to significantly reduce the wage bill.
  - Move toward a simplified and harmonized tax system while strengthening revenue administration.
  - Some tax exemptions removed and discretionary powers to grant exemptions eliminated.
  - Non-tax revenue projected to decline in 2009 and 2010 because of lower dividend payments from public enterprises and a decline in the statutory transfer from the central bank.
  - Unrealized valuation gains from foreign currency fluctuations will no longer be transferred from the CBS to the government.

- Text Table 2: Budgetary Impact of Fiscal Measures (in percent of GDP)
  - Revenue Measures: 0.4 (2008), 3.1 (2009)
    - Eliminate tax exemptions: 0.0 (2008), 0.6 (2009)
    - Raise taxes: 0.3 (2008), 1.6 (2009)
    - Adjust fees, fines, charges and rents and royalties for inflation: 0.0 (2008), 0.5 (2009)
    - New taxes: 0.1 (2008), 0.4 (2009)
  - Expenditure Measures: -0.1 (2008), 2.0 (2009)
    - Eliminate subsidies: 0.1 (2008), 1.5 (2009)
    - Introduce a targeted social safety net by enacting Agency on Welfare Act: -0.2 (2008), -1.0 (2009)
    - Reduction in the public sector wage bill: 0.0 (2008), 1.5 (2009)
  - Net Budgetary Impact: 0.3 (2008), 5.0 (2009)

### Toward a comprehensive debt restructuring strategy
- Authorities, assisted by financial and legal advisors, are elaborating a comprehensive debt restructuring strategy to put public debt back on a sustainable path.
- Key considerations agreed with staff:
  - Fiscal effort aims for a significant reduction in the stock of domestic debt, whose value is being eroded by negative real interest rates in 2008, especially on long-term maturities with fixed coupons.
  - Domestic banks’ exposure to government securities is almost 45 percent of assets; banks would not be in a position to take a further significant haircut on government securities.
  - Public debt projected to remain unsustainable over the medium-term in absence of debt restructuring, even assuming full implementation of all program reforms.
  - Seychelles’ debt is among the highest in the world and far higher than in other small states.
- Restructuring strategy objectives:
  - Secure significant cash flow relief in the short to medium-term.
  - Achieve a debt burden consistent with long-term payments capacity.
- Creditor engagement and process:
  - Authorities have engaged in preliminary consultations with Paris Club creditors, who indicated willingness to consider Seychelles’ debt under the Evian approach.
  - Debt reconciliation efforts are underway; debt stock data may be revised.
  - A census of commercial debt holders has been launched; wide dispersion of holdings and current financial market turmoil may lengthen identification and negotiations with commercial creditors.
  - Discussions with commercial and other official creditors planned to begin in November 2008.
- Staff’s preliminary Debt Sustainability Analysis (DSA) findings:
  - Public debt is unsustainable.
  - Under a baseline scenario assuming new borrowing on commercial terms to refinance arrears and close financing gaps, external debt reaches 165 percent of GDP by 2018.
  - Bounds tests show high vulnerability to all standard shocks.
  - A comprehensive debt restructuring involving a substantial reduction in the debt service burden consistent with Seychelles' long-term ability to pay will be needed to restore debt sustainability.
  - Even with a sharp present value reduction of the public debt burden, Seychelles is likely to remain highly vulnerable to a wide variety of shocks for an extended period.
  - Staff believes reasonable expectations exist that a restructuring consistent with Seychelles’ payments capacity is possible.
  - Staff expects to present a more comprehensive sustainability analysis based on an updated medium-term outlook at the time of the first program and financing review.

*Source: IMF staff and Seychelles authorities (excerpts from the provided content).*

### 21.      The authorities are committed to strengthening public debt management (MEFP

### _cr08365 - 21.      The authorities are committed to strengthening public debt management (MEFP

### Public debt management
- A new Public Debt Law will define a legal framework for debt management.
- IMF technical assistance will strengthen debt operations.
- Requirements and priorities:
  - Enhance debt and recording systems and the public financial management framework to ensure that no new external or domestic arrears are accumulated.
  - The Public Debt Management Committee will closely monitor parastatal borrowing.
  - Priority areas for technical assistance include:
    - Communication and coordination between various bodies responsible for public debt, reporting and auditing.
    - Improving operational risk procedures (data records and audits, operational manuals).
    - Managing contingent liabilities (such as guarantees on parastatal debt).

### Reforming monetary policy and the monetary policy framework
- Objectives and context:
  - Reforming monetary policy is a priority to secure price stability and support a successful move to a floating regime.
  - The ability of the central bank to contain monetary expansion has been limited by the pegged exchange rate regime, fiscal dominance, and until recently the absence of indirect instruments of monetary control.
- Market instruments and developments:
  - In preparation for the float of the rupee, the authorities established weekly auctions for short-term commercial bank deposits at the CBS and for 91-day Treasury bills.
  - Banks are actively participating and the beginnings of a yield curve are emerging.
- Treasury bill and deposit auction results (Text Table 3: Seychelles: Auction Results, September-October 2008)
  - Treasury Bills (weekly auction results; average tender rate in percent) — 91 days:
    - 23-Sep: 5.9
    - 3-Oct: 8.7
    - 10-Oct: 10.2
    - 17-Oct: 10.2
    - 24-Oct: 10.5
  - Deposit Auction Arrangement (weighted average DAA rate in percent)
    - 7 days:
      - 22-Sep: 5.3
      - 1-Oct: 5.7
      - 8-Oct: 7.4
      - 15-Oct: 8.2
      - 22-Oct: 8.6
    - 14 days:
      - 22-Sep: 5.1
      - 1-Oct: 6.8
      - 8-Oct: 7.1
      - 15-Oct: 8.6
      - 22-Oct: 9.6
    - 28 days:
      - 22-Sep: 5.3
      - 1-Oct: 7.7
      - 8-Oct: 7.8
      - 15-Oct: n.a.
      - 22-Oct: 10.4
  - Source: Central Bank of Seychelles.
- Monetary program design:
  - The monetary program is based on a quarterly reserve money target.
  - Staff considers a monetary aggregate target the most viable nominal anchor for Seychelles given low financial market development and recent liberalization of interest rates.
  - The stability of money multipliers is likely to be affected by the exchange regime switch, as indicated by the 2006-07 devaluation episode.
  - The program envisages an initial rise in velocity of circulation and the money multiplier, implying the need to maintain very tight reign on reserve money around the float.
  - With confidence in the new regime, tight fiscal policy, and likely much higher market-based interest rates, there will be room for some recovery in liquidity growth and credit.
  - A key challenge is uncertainty about the monetary transmission mechanism; significant “learning by doing” will be needed.
  - Close cooperation between Treasury and the CBS is essential for improving liquidity management.
- Technical assistance and governance:
  - Continuation of substantial IMF technical assistance to the CBS is necessary to support the reform effort.
  - The authorities requested a long-term monetary advisor to assist the transition from a fixed to floating exchange rate regime.
  - Fund TA is needed to support:
    - Establishing and automating the interbank market for securities, bank deposits and foreign exchange.
    - Introducing a reserve money monetary framework.
    - Strengthening bank supervision.
    - Reinforcing CBS governance and transparency in light of the September 2008 safeguards assessment mission.
  - Governance actions and conditions:
    - The authorities have issued a tender for new external auditors to begin with the 2008 accounts in compliance with international audit standards.
    - The Ministry of Finance and CBS will sign by end-December 2008 a memorandum of understanding strengthening and formalizing CBS transactions on behalf of government.
    - A revision of the CBS act to strengthen governance and accountability will be implemented with Fund technical assistance and is a condition for completion of the first program review (MEFP ¶30).

### Financial sector stability
- Adjustment challenge:
  - Large changes to monetary and exchange policies pose significant short-term adjustment challenges for the financial system.
- Main risks and stress-testing results:
  - Major risk confronting banks: expected increases in default rates on bank loans.
  - Banks are well positioned for first-round effects of changes in interest rates (loans are effectively variable rate) and exchange rate depreciation (due to large net open positions).
  - Both higher interest rates and exchange rate depreciation will impact some borrowers’ ability to service loans and lead to higher default rates.
  - After adjusting bank capital for credit risk and possible consequences of higher interest rates and exchange rate movements, banks are left with capital coverage of 27 to 34 percent of their loan portfolio.
  - Banks have some interest rate risk from holdings of government bonds; one third of these are due to mature within one year.
- Contingencies and capacity:
  - Program includes contingencies to cushion impact of increased default risk on bank capitalization.
  - In addition to CBS liquidity support, the 2009 budget includes a specific contingency for potential recapitalization needs of government-owned financial institutions.
  - The CBS lacks experience handling bank failure; MCM TA on supervisory intervention and failed bank resolution has not yet been delivered.
  - Global financial turbulence may affect five foreign-owned banks in Seychelles through impacts on parent institutions; staff encouraged CBS to closely coordinate analysis of potential recapitalization costs with the Ministry of Finance.
- Selected financial soundness and sector characteristics (Figure 6 highlights)
  - Banks are profitable and well capitalized (returns and capital ratios shown in Figure 6).
  - Banking sector is concentrated; share of top 3 banks in total banking system is high.
  - Private sector credit is relatively low (private credit shown as percent of GDP).
  - Commercial banks have increased foreign asset holdings.
  - Banks are not directly vulnerable to exchange rate depreciation, but are significantly exposed to default on private sector loans and government securities.
- Box 2: Financial sector vulnerabilities and stress-testing results (selected outcomes)
  - First-round effects from a depreciation are expected to be positive because banks have long net open positions in foreign currencies.
  - Illustrative scenarios: Impact of Exchange Rate Devaluation on Banking System Capitalization (in percent, as of end-June, 2008)
    - For a 50 percent devaluation:
      - Current Capitalization: 5.6
      - New Net Capitalization: 5.4
      - New Net Capitalization with stronger bad loan provisioning: 6.6
      - Capital Coverage of Net Loans (2nd round effects): 26.5
    - For a 125 percent devaluation:
      - Current Capitalization: 5.6
      - New Net Capitalization: 5.4
      - New Net Capitalization with stronger bad loan provisioning: 8.3
      - Capital Coverage of Net Loans (2nd round effects): 33.9
  - Interest rate risks:
    - Banks can re-price domestic loans quickly, so first-round direct effects on net interest margins are assumed limited.
    - Some domestic investments cannot be re-priced (treasury bonds with fixed coupons; state-owned savings bank term loans with fixed rates).
    - Stress tests show one bank would become under-capitalized if treasury bonds were marked-to-market.
    - Five banks would suffer income losses during a high interest rate period until bonds mature; 28 percent of aggregate bond portfolio was to mature within one year as of June 30, 2008.
  - Second-round effects and fiscal cost estimates:
    - With a 50 percent depreciation, bank industry capital (unadjusted for interest rate first round shocks) can absorb a 27 percent loss to their loan portfolio before industry capital is exhausted—34 percent with a 125 percent depreciation.
    - If loan losses grow to 20 percent of June 2008 loan balances, only one government-owned institution is projected to require recapitalization, with fiscal cost amounting to about SR 82 million (1 percent of GDP).
    - If loan losses rose to 40 percent, all four government-owned institutions would require recapitalization or resolution, and total cost could reach about SR 333 million (4 percent of GDP).

### Structural reforms
- Program focus:
  - Structural reforms under the SBA-supported program focus on key areas to support macroeconomic stabilization.
  - Authorities will work with staff and development partners to develop a more comprehensive medium-term structural reform program and intend to request longer-term engagement under the Extended Fund Facility once finalized.
- Enhancing fiscal governance and transparency:
  - Strengthening public financial management is a key priority to support fiscal consolidation.
  - Authorities committed to implementing key recommendations from an IMF technical assistance review, including strengthening budget preparation, execution, accounting and reporting.
  - Key measures include:
    - Preparing a medium-term macroeconomic framework aimed at achieving fiscal sustainability to help frame annual budgets.
    - Including the social security fund and the pension fund in all fiscal analysis and in presentations, and integrating the current and capital budget process.
    - Setting detailed expenditure ceilings for each ministry and authority and distinguishing between base-line and new expenditures in budget submissions.
    - Establishing a cash management system and a single treasury account.
    - Strengthening financial management, reporting and auditing in line ministries.
- Tax policy and revenue administration:
  - A fundamental review of tax policy and revenue administration is needed to eliminate distortions, discourage evasion, harmonize differentiated and high overall business tax rates, reduce significant exemptions, and broaden the base to enhance fairness and compliance.
  - Authorities requested IMF technical assistance for a comprehensive diagnostic tax policy and revenue administration review and to assist with strengthening tax auditing capacity (MEFP ¶24-25).
- Regulatory framework, governance and accountability:
  - Authorities committed to a clear, rules-based and transparent regulatory framework for domestic and foreign investment, and to improving governance and accountability.
  - FDI framework changes:
    - Revamping the framework for FDI to provide a more transparent and level playing field to new investors.
    - Approval of new projects will require Ministry of Finance vetting and line ministries’ ability to grant tax incentives will be removed.
    - Provisions for granting new discretionary exemptions in the trade and business tax acts have been repealed (MEFP ¶32).
  - Legal framework enhancements:
    - A Public Officers Ethics Act was adopted in August 2008, requiring full financial disclosure by November 2008 and prohibiting conflicts of interest.
    - A Public Procurement Act will be passed by December 2008 to enhance transparency of bidding procedures (MEFP ¶33).
- Reducing the role of the state:
  - Commitment to gradually reduce the size of the public sector through civil service reform and further privatization.
  - Public sector is large (about 40 percent of total employment).
  - As of end-2007, public enterprises represented a net drain on the budget of 2.8 percent of GDP.
  - Government guarantees on parastatal loans amounted to 5.2 percent of GDP as of mid-2008.
  - Authorities committed to privatizing a number of public enterprises in 2009 in the trade sector and to avoid retaining minority stakes in these enterprises (MEFP ¶26).

### Data issues
- Statistics and weaknesses:
  - Seychelles statistics are generally adequate for surveillance, but key macroeconomic statistics need improvement.
  - Weaknesses in deflator estimates and foreign trade statistics limit usefulness for surveillance, analysis, and policy formulation.
  - Country participates in the GDDS and is one of two pilot countries in AFR for the GFSM 2001 framework for compiling fiscal data.
  - Authorities are reviewing national accounts data and have recently revised up nominal GDP by some 20 percent, mainly due to improved coverage.
  - Authorities are encouraged to continue efforts to improve national statistics and will request Fund technical assistance.

### Program design, financing and risks
- Monitoring and quantitative performance criteria:
  - Quarterly quantitative performance criteria set on net international reserves (NIR), reserve money, and the fiscal primary balance (MEFP Table 1).
  - Symmetric adjustor on NIR for deviations from projected program financing.
  - Usual interdiction on accumulation of external and domestic arrears.
  - Program includes a non-zero limit on external borrowing from official creditors for program financing purposes, and zero sub-ceilings on short-term external borrowing and commercial external borrowing.
- Access and financing:
  - Access under the two-year SBA is proposed at SDR 17.6 million (200 percent of quota), with 70 percent of quota disbursed upon approval of the arrangement (Table 9).
  - Frontloading of access reflects front-loaded nature of the reform program and low level of official reserves as the authorities launch liberalization and float the currency.
- Structural conditionality:
  - Focuses on macro-critical measures to strengthen fiscal and CBS governance (MEFP Table 2).
  - Important measures already implemented include:
    - Upfront fiscal adjustment and fiscal reforms to eliminate subsidies and reduce exemptions.
    - Liberalization of the exchange regime.
    - Reform of the monetary policy framework.
  - Structural performance criterion reflects commitment to bolstering tax administration; the measure has been announced in the press.
  - Program includes initial steps to address weaknesses at the CBS identified by the September safeguards assessment.

*Source: _cr08365 - 21.      The authorities are committed to strengthening public debt management (MEFP).*

### 2008. The program also includes a requirement for the CBS’s new external auditor to

### _cr08365 - 2008. The program also includes a requirement for the CBS’s new external auditor to

### Program Financing
- The program is fully financed for 2008.
- For 2009, the external nonproject financing requirement is expected to be closed by:
  - disbursements from the Fund under the prospective SBA (30 percent of quota; SDR 2.64 million),
  - from other multilateral creditors such as the World Bank and the AfDB (US$15 million),
  - and from public debt relief (US$85 million).
- Financing assurances reviews will be completed at the time of program reviews (MEFP ¶37).
- Staff have approached the Paris Club creditors seeking financing assurances aimed at addressing both liquidity and sustainability issues of Seychelles’ debt under the Evian approach.
- The authorities have engaged in discussions with multilateral creditors and plan to clear arrears to those creditors during the program period.
- Authorities are committed to engaging in collaborative discussions with private creditors through an open and transparent dialogue based on the principle of inter-creditor equity.
- A census of external commercial creditors has been launched; the wide dispersion of individual holdings and recent financial market turmoil may lengthen identification and negotiations with commercial creditors.
- Contacts with commercial creditors are planned in November 2008 (MEFP ¶16).

### Consistency with Fund arrears policy and Fund credit indicators
- The proposed program is consistent with the Fund’s arrears policy.
- Seychelles has no outstanding liabilities to the Fund.
- Under the proposed two year SBA in an amount of 200 percent of quota:
  - outstanding Fund credit would peak in 2010 at 2.5 percent of exports,
  - or about 18 percent of projected official reserves (Table 11).
- Prospective obligations to the Fund would peak in 2013 at 0.8 percent of exports or 3.3 percent of projected reserves.
- A more difficult global economic and financial environment, and a more protracted negotiation process with commercial creditors are major risks to Seychelles’ capacity to service its prospective obligations to the Fund.

### Risks
- Main risks to the program:
  - a worse-than-anticipated global economic slowdown with adverse effects on tourism and growth,
  - banking sector vulnerabilities that may require greater recapitalization,
  - external financing availability proving harder to mobilize than anticipated,
  - global financial turbulences increasing the risk of protracted discussions with private creditors and compromising program financing,
  - the move to a float imposing a heavy burden on the CBS and its administrative capacity,
  - waning social and political consensus for reform, leading to pressures for fiscal and monetary relaxation,
  - adjustment fatigue and implementation capacity constraints.
- Staff notes the authorities’ strong commitment to implementing the program, demonstrated by upfront measures already taken and willingness to take additional measures.
- In light of these risks, staff proposes quarterly program and financing assurance reviews.

### Staff appraisal — overall assessment and key policy recommendations
- Staff welcomes the authorities’ commitment to a far-reaching reform program to address macroeconomic imbalances built up over past decades.
- The early liberalization of the exchange regime and floating of the rupee is of particular importance and is key to program success.
- Main pillars of the authorities’ program:
  - a significant and sustained fiscal tightening,
  - a reform of the monetary framework,
  - a reduction of the role of the state in the economy.
- The reform effort needs to be supported by a comprehensive restructuring of the public debt, which even with domestic reform efforts would remain unsustainable.

- Exchange rate policy:
  - Staff commends the fundamental liberalization of the exchange regime and allowing the rupee to float.
  - Maintenance of a significantly overvalued exchange rate for several years, aggravated by extensive exchange restrictions and distortionary regulations, severely constrained the economy.
  - The removal of these distortions was urgently needed to restore credibility in the rupee and unify exchange rates.
  - A market-determined exchange rate regime in a small open economy poses challenges, especially as the exit from the peg occurs at a time of crisis and official reserves are virtually exhausted, but the program includes provisions to contain the risks.
  - The frontloading of access under the program is a key component to raise the likelihood of success.

- Fiscal policy:
  - The authorities’ program includes a significant tightening of fiscal policy requiring sustained substantial primary surpluses over the medium term.
  - Key fiscal reforms include public sector employment retrenchment, replacement of indirect product subsidies by a targeted social safety net, and removal of tax exemptions.
  - Strong fiscal policy reforms already adopted or soon to be implemented form a convincing foundation for the proposed fiscal path.

- Monetary policy and financial sector:
  - A major strengthening of the monetary policy framework is underway, notably the CBS’s ability to manage liquidity through indirect market-based monetary intervention.
  - A flexible exchange rate regime places increased emphasis on monetary policy to achieve price stability.
  - Staff encourages authorities to maintain efforts to tighten liquidity significantly and raise interest rates to positive real levels.
  - Allowing domestic interest rates to rise to market determined levels is important to contain potential overshooting in the nominal exchange rate given limited ability to intervene in the foreign exchange market.
  - Need for closer collaboration between the CBS and Ministry of Finance to improve liquidity forecasting and management.
  - Program includes steps to contain risks to the financial system by bolstering banking supervision and a fiscal provision for potential recapitalization needs by state-owned financial institutions.

- Debt sustainability:
  - The debt sustainability analysis clearly indicates that Seychelles’ public debt is unsustainable.
  - Authorities have taken credible first steps in elaborating and implementing a comprehensive public debt restructuring effort.
  - Staff supports negotiations with external creditors on a restructuring aimed at reestablishing public debt sustainability, consistent with Seychelles’ long-term payment capacity.
  - A substantial reduction in the debt service burden consistent with Seychelles' long-term ability to pay is needed.
  - Staff believes the authorities are in compliance with the Fund’s policy on lending into arrears, based on good faith engagement with external creditors and commitment to clear the small amount of arrears to multilateral institutions.

- Structural and governance reforms:
  - A sustained reform effort, including a major structural component, is needed over the medium term.
  - Staff welcomes the authorities’ intention to elaborate, with support, a well-articulated medium-term structural reform agenda.
  - Program includes measures to bolster public sector governance and transparency.
  - Authorities’ decision to publish the program documents and staff report is a first for Seychelles and is welcome.
  - Authorities have initiated actions to address areas identified in the safeguards assessment.
  - Data provided to the Fund are broadly adequate for surveillance and program monitoring; authorities commit to address weaknesses in quality and timeliness of key macroeconomic data with Fund technical assistance.

- Access and frontloading:
  - Staff believes the comprehensive and frontloaded nature of the reform program merits a frontloading of access under the arrangement.
  - Given the low level of reserves at the time major policy changes are implemented, staff considers frontloaded access key to ensure the success of major policy changes.
  - While significant risks exist, early and important policy reforms already undertaken indicate strong ownership of the reform effort.

*Staff report content excerpt.*

### 51.      The staff recommends that the next Article IV consultation be held in accordance

### The staff recommends that the next Article IV consultation be held in accordance with the provisions of the Decision No. 12794 of July 15, 2002 on consultation cycles.

### Recommendation
- The staff recommends that the next Article IV consultation be held in accordance with the provisions of the Decision No. 12794 of July 15, 2002 on consultation cycles.

### National income and prices (selected series, 2005–13)
- Nominal GDP (millions of Seychelles rupees): 4,861; 5,342; 6,113; 7,878; 9,970; 11,580; 12,831; 13,889; 15,006
- Real GDP (annual percentage change): 7.5; 8.3; 7.3; 3.1; -0.5; 3.5; 5.0; 5.0; 5.0
- CPI (annual average): 0.8; -1.4; 5.7; 32.2; 33.8; 12.6; 5.8; 3.2; 3.0
- CPI (end-of-period): -1.1; 0.5; 16.8; 38.8; 21.6; 11.5; 3.0; 3.0; 3.0
- GDP deflator average (annual change): -2.1; 1.5; 6.7; 25.0; 27.2; 12.2; 5.5; 3.1; 2.9

### Money and credit (selected indicators)
- Net claims on private sector (annual change in percent of beginning-of-period broad money): 1.9; 0.4; 9.3; 12.5; 7.4; 14.0; 32.1; ...... (projections not shown)
- Broad money (M2(p)) (annual change): 1.7; 3.0; -14.9; 2.6; 30.4; 21.9; 20.8; ...... 
- Reserve money (percentage change): 3.4; 32.7; -23.1; 3.4; 20.4; 18.8; 15.0; ...... 
- Velocity (GDP/average M2): 1.0; 1.1; 1.5; 1.9; 1.8; 1.8; 1.6; ...... 
- Money multiplier (M2/reserve money): 4.5; 3.5; 3.6; 3.6; 3.9; 4.0; 4.2; ......

### Savings, investment, and external balance (percent of GDP)
- Savings and investment balance: -19.7; -13.9; -23.4; -28.8; -20.9; -21.4; -21.7; -20.2; -20.6
- Gross national savings: 14.6; 14.2; 9.1; 4.9; 9.7; 10.4; 12.0; 15.3; 16.4
- Gross investment: 34.3; 28.1; 32.5; 33.6; 30.6; 31.8; 33.8; 35.6; 37.0
- Current account balance after official transfers: -19.7; -13.9; -23.4; -28.8; -20.9; -21.4; -21.7; -20.2; -20.6
- Total stock of arrears (millions of U.S. dollars): 184.0; 123.5; 160.4; 330.6; ...............

### Government budget and public debt
- Total revenue, excluding grants (percent of GDP): 41.1; 42.0; 35.9; 35.4; 35.5; 35.5; 35.5; 35.5; 35.5
- Identified expenditure and net lending (percent of GDP): 40.4; 49.6; 46.0; 37.6; 41.8; 36.6; 34.6; 32.0; 32.5
- Current expenditure (percent of GDP): 35.1; 41.5; 40.8; 32.2; 35.3; 29.6; 28.6; 25.4; 25.5
- Capital expenditure and net lending (percent of GDP): 5.3; 8.0; 5.1; 5.4; 3.6; 4.8; 6.0; 6.5; 7.0
- Overall balance, including grants (above the line) (percent of GDP): 1.7; -6.2; -9.8; -1.8; -6.1; -1.1; 0.9; 3.5; 3.0
- Primary balance (percent of GDP): 7.3; -0.6; -2.3; 7.1; 6.2; 6.6; 6.8; 5.8; 5.5
- Total public debt (percent of GDP) (including arrears): 147.1; 139.5; 146.0; 151.3; 161.3; 149.5; 138.4; 126.6; 121.0
  - Domestic (percent of GDP): 100.5; 85.8; 74.1; 53.5; 41.5; 34.3; 26.7; 20.0; 20.0
  - External (percent of GDP) (including arrears): 46.6; 53.7; 71.9; 97.8; 119.8; 115.2; 111.7; 106.6; 101.0

### External sector and reserves (millions of U.S. dollars and months of imports)
- Gross official reserves (end of year, millions of U.S. dollars): 56.1; 112.7; 9.8; 18.7; 79.7; 154.7; 214.7; 264.7; 314.7
- In months of imports, c.i.f.: 0.7; 1.3; 0.1; 0.2; 0.8; 1.5; 1.9; 14.1; 15.9
- Exchange rate (Seychelles rupees per US$1, end of period): 5.5; 5.8; 8.0; 8.0; ........
- Total external debt outstanding (millions of U.S. dollars): 55.0; 53.8; 77.9; 97.8; 119.8; 115.2; 111.7; 106.6; 101.0

### Balance of Payments (selected quarterly flow snapshots, 2007–09)
- Current account (millions of U.S. dollars), 2007 Q1–2008 Q4 and 2009 projections: -213; -70; -83; -82; -12; -247; -23; -54; -33; -44; -153
  - Current account (percent of GDP): -23; -7; -8; -8; -2; -29; -3; -8; -4; -6; -21
- Trade balance (millions of U.S. dollars): -175; -68; -70; -78; -0; -216; -13; -27; -24; -21; -85
- Exports of goods (millions of U.S. dollars): 392; 118; 121; 117; 156; 511; 122; 131; 122; 158; 533
  - Of which oil re-exports: 190; 65; 71; 63; 94; 293; 68; 74; 66; 93; 307
  - Of which tuna exports: 184; 50; 45; 49; 54; 198; 50; 51; 51; 51; 202
- Imports of goods (millions of U.S. dollars): -734; -222; -224; -218; -190; -854; -173; -183; -185; -228; -769
  - Oil imports: -236; -74; -106; -85; -71; -337; -65; -98; -72; -91; -327
- Exports of services (millions of U.S. dollars): 481; 144; 129; 113; 118; 505; 143; 118; 126; 130; 517
  - Tourism earnings (millions of U.S. dollars): 284; 82; 71; 72; 77; 303; 86; 73; 79; 93; 318
- Net income (millions of U.S. dollars): -72; -13; -24; -12; -19; -68; -21; -38; -20; -30; -109
- Current transfers, net (millions of U.S. dollars): 331; 110; 97; 37; 121; 110; 84; 1

### Fiscal operations (Consolidated Government, selected 2008 quarterly series, millions of Seychelles rupees)
- Total revenue and grants (2008 Q1–Q4, Act/Est/Proj): 36.2; 9.4; 6.8; 8.9; 10.8; 35.9; 45.3; 8.3; 7.6; 9.3; 10.6; 35.7; 35.5
- Total revenue (percent of GDP quarterly series similar to above): 35.9; 9.4; 6.7; 8.5; 10.7; 35.4; 45.0; 8.2; 7.6; 9.2; 10.5; 35.5; 35.5
- Tax revenue (percent of GDP): 31.0; 6.7; 6.3; 7.8; 9.0; 29.8; 38.9; 7.0; 7.0; 8.5; 8.9; 31.4; 31.6
- Expenditure and net lending (percent of GDP): 46.0; 7.8; 8.6; 7.7; 14.0; 38.1; 44.7; 10.4; 11.8; 9.9; 11.1; 43.2; 37.5
- Current expenditure (percent of GDP): 40.8; 6.3; 7.9; 6.7; 11.7; 32.8; 39.1; 8.6; 10.0; 8.4; 9.5; 36.6; 30.6
- Capital expenditure (percent of GDP): 6.1; 0.3; 0.8; 0.9; 2.1; 4.1; 5.6; 0.7; 0.8; 1.0; 1.1; 3.6; 4.8
- Overall balance, commitment basis (percent of GDP): -9.8; 1.6; -1.8; 1.2; -3.3; -2.3; 0.6; -2.1; -4.2; -0.6; -0.5; -7.4; -2.0
- Primary balance, commitment basis (percent of GDP): -2.3; 2.6; 0.3; 2.4; 1.8; 7.1; 8.5; 0.7; 0.2; 2.1; 3.2; 6.2; 6.6

### Monetary survey and central bank accounts (selected end-period items)
- M3 (Seychelles rupees millions): 5,209.8; 5,290.9; 4,470.9; 4,680.9; 4,716.3; 4,874.0; 5,476.9; 5,432.9; 5,570.4; 5,869.1; 6,482.7; 6,736.6
- M2 (Seychelles rupees millions): 4,802.6; 4,963.1; 3,949.7; 4,041.2; 3,969.8; 4,193.8; 4,757.0; 4,144.9; 4,240.4; 4,539.1; 5,152.7; 5,406.6
- Reserve money (Seychelles rupees millions): 1,688.5; 1,622.7; 1,082.8; 1,113.1; 1,140.8; 1,282.3; 1,271.1; 1,151.4; 1,146.0; 1,260.9; 1,392.6; 1,386.3
- Gross international reserves (millions of U.S. dollars, memorandum): 121.2; 110.9; 66.4; 9.8; 17.7; 14.3; 13.7; 18.7; 19.7; 17.7; 56.8; 79.7
- M2 growth (12–month percent change): 3.7; 4.7; -18.2; -14.9; -17.3; -15.5; 20.4; 2.6; 6.8; 8.2; 8.3; 30.4
- M3 growth (12–month percent change): 6.5; 5.8; -13.1; -7.6; -9.5; -7.9; 22.5; 16.1; 18.1; 20.4; 18.4; 24.0

### Banking sector soundness (selected indicators, 2002–08)
- Regulatory capital to risk-weighted assets: 31.8; 20.9; 21.6; 20.3; 19.6; 15.4; 17.0 (2002–2008 as listed)
- Capital (net worth) to assets: 5.2; 5.4; 5.9; 6.2; 6.6; 6.9; 7.0
- Non-performing loans to gross loans: 2.5; 3.0; 5.1; 3.6; 4.4; 2.3; 2.1
- Tourism share of loans (sectoral distribution): 26.7; 28.3; 27.0; 34.9; 34.2 (annual snapshots)

### Public sector external debt and scheduled debt service
- Public sector external debt (millions of U.S. dollars, 2006–2008 end-Aug): 514.1; 710.2; 793.3; 808.9 (end-June, end-Aug snapshots)
- Arrears outstanding (millions of U.S. dollars): 162.4; 313.7 (memorandum items)
- Scheduled public sector external debt service, annual (millions of U.S. dollars, selected years): 93.8 (2007 Act); 299.6 (2008); 117.0 (2009); subsequent annual schedule provided through 2018 in tabulated form

### Projected macro and balance of payments paths (selected projections, 2008–18)
- Current account (millions of U.S. dollars), 2008–2018 projection path: -247; -153; -172; -187; -185; -202; -224; -244
  - Current account (percent of GDP), 2008–2018 projection path: -29; -21; -21; -22; -20; -21; -20; -17
- Exports of goods (millions of U.S. dollars), projection path (2008–2018): 511; 533; 552; 576; 602; 632; 696; 806
- Imports of goods (millions of U.S. dollars), projection path (2008–2018): -854; -769; -803; -844; -890; -939; -1,045; -1,227
- Gross international reserves (stock, end-of-period, millions of U.S. dollars, projections): 155; 215; 265; 315; 449; 804 (selected years across projection horizon)
- Public external debt (percent of GDP) projection path: 119.8; 115.2; 111.7; 106.6; 101.0; 88.0; 71.4 (multi-year projections)

### Projected financing requirements and sources (2008–18, selected aggregates)
- Gross financing requirements (millions of U.S. dollars): 302.5; 324.4; 328.4; 530.2; 277.4; 296.3; 341.3; 413.3
- External current account deficit (excl. official transfers) (millions of U.S. dollars): 261.4; 171.9; 194.6; 209.7; 207.9; 224.0; 246.3; 266.2
- Amortization of public debt (millions of U.S. dollars): 188.7; 86.0; 58.0; 259.5; 13.2; 12.0; 10.5; 17.1
- Available financing (millions of U.S. dollars): 302.4; 239.6; 271.6; 273.7; 287.1; 305.5; 360.8; 460.9
  - Foreign direct investment (millions of U.S. dollars): 295.9; 208.5; 227.5; 246.4; 274.3; 297.0; 345.8; 441.6
  - IMF (millions of U.S. dollars, projected disbursements): 9.4; 4.1; 13.8; 0.0; 0.0; 0.0; 0.0; 0.0
- External financing gap (millions of U.S. dollars): 0.0; 84.8; 56.8; 256.5; -9.7; -9.2; -19.5; -47.6
- Fiscal financing gap (millions of U.S. dollars): 13.9; 84.8; 36.6; 247.2; -60.3; -59.6; -59.0; -56.4

### IMF prospective Stand-By Arrangement disbursement schedule (millions of SDR and percent of quota)
- November 17, 2008 — Board approval of the SBA arrangement: 6.16 (70 percent of quota)
- April 5, 2009 — Completion of first review (end-December 2008 quantitative and structural performance criteria): 0.88 (10 percent of quota)
- July 5, 2009 — Completion of second review (end-March 2009): 0.88 (10 percent of quota)
- October 5, 2009 — Completion of third review (end-June 2009): 0.88 (10 percent of quota)
- January 5, 2010 — Completion of fourth review (end-September 2009): 2.22 (25 percent of quota)
- April 5, 2010 — Completion of fifth review (end-December 2009): 2.22 (25 percent of quota)
- July 5, 2010 — Completion of sixth review (end-March 2010): 2.22 (25 percent of quota)
- October 10, 2010 — Completion of seventh review (end-June 2010): 2.22 (25 percent of quota)

*Source: IMF staff estimates, Central Bank of Seychelles, Ministry of Finance (figures and projections in the source content).*

### 1.      The government of Seychelles is determined to decisively address Seychelles’

### The government of Seychelles is determined to decisively address Seychelles’ balance of payments and external debt crisis

### Background and crisis drivers
- Achievements in promoting high living standards and social development are in jeopardy due to balance of payments and external debt crisis.
- Global slowdown and sharp food and fuel price increases of 2007-08 exposed long-standing vulnerabilities, including pervasive foreign exchange restrictions and an overvalued pegged exchange rate.
- Consequences observed:
  - Acute foreign exchange shortages and an active parallel market.
  - Sharp rise in inflation to over 30 percent; inflation rose to 38 percent (year-on-year) by August 2008.
  - Depletion of external reserves and accumulation of external arrears.
  - Missed external commercial debt payments in July and October 2008; external rating downgraded to SD (selective default).

### Request for IMF support and program scope
- The Government requests a two-year Stand-by arrangement in an amount of SDR 17.6 million (200 percent of quota).
- Program described in attached MEFP for 2008-09 includes:
  - Removal of foreign exchange restrictions and floating of the rupee.
  - Significant fiscal and monetary tightening.
  - Structural reforms to spur competitiveness and growth.
  - Targeted social safety net to protect vulnerable groups.
  - Preparation for discussions with external creditors to restructure external debt.

### Policy objectives and longer-term engagement
- Broad-based public sector and economic policy reforms are needed and will require several years and sustained partner support. Reforms would include:
  - Comprehensive review of the tax system and strengthening of tax administration.
  - Downsizing of public sector employment.
  - Reducing the role of the state in the economy, including further privatization of public enterprises.
- Intention to work with the IMF to develop a comprehensive structural reform program for the medium term and subsequently request a longer-term engagement under the Extended Fund Facility.

### Recent macroeconomic developments (selected indicators)
- Real GDP growth:
  - 2007: 7.3 percent.
  - 2008: projected about 3.1 percent (down from 7.3 percent in 2007).
- Tourism indicator (visitors nights):
  - Growth about 4.5 percent since early 2008 (year to date), down from 16.6 percent for the same period in 2007.
- 2008 fiscal performance:
  - Primary surplus projected at 5.6 percent of GDP in 2008 (excluding a 1.5 percent of GDP transfer of valuation gains from the Central Bank), compared to a 2.3 percent deficit in 2007.
- Inflation and price adjustments:
  - Inflation accelerated sharply since mid-2007; rose to 38 percent by August 2008.
  - Water and electricity prices adjusted toward cost-recovery; petroleum product prices adjusted monthly.
  - GST elimination on 13 basic food items and LPG offset by increased fuel tax and new import levy on automobiles.
- Central Bank policy and liquidity tools:
  - Reserve requirement on domestic currency deposits increased from 5 to 13 percent as of June 1, 2008.
  - Same reserve requirement introduced on foreign currency deposits in September 2008.
  - Local asset ratio (LAR) reduced from 65 to 50 percent, then from 50 to 45 percent on September 15, 2008 after removing excess reserves from LAR computation.
  - Weekly auctions for 91-day treasury bills and establishment of a weekly auction for a central bank deposit facility (established in mid September).
- Banking sector (as of June 30, 2008):
  - Banking industry assets totaled about SR 8.8 billion (113 percent of GDP).
  - Domestic lending accounted for about 25 percent of assets; most funds invested abroad (34 percent); domestic government securities accounted for 24 percent.
  - Net tangible capitalization stood at 5.6 percent of net assets (40 basis points short of being considered well capitalized).
  - Industry capital covered about 22 percent of bank holdings of government securities; three banks had coverage of only 11-14 percent.
- External and public debt indicators:
  - External current account deficit projected to reach 29 percent of GDP in 2008.
  - Cost of transportation services imports projected to increase by about 37 percent in 2008.
  - Official reserves had fallen to about US$15 million as of end September 2008.
  - Public debt at 151 percent of GDP (2008 figures); external public debt about 97.8 percent of GDP, of which 81 percent of GDP is in arrears.
  - Small amount of arrears to multilateral creditors: US$2.2 million at end-June 2008.
  - Debt servicing capacity extremely limited in 2009-11 and highly dependent on program lending from multilaterals.

### Economic program for 2008–09: objectives and macro framework
- Core objectives:
  - Achieve full convertibility of the Seychelles rupee and introduce a market-determined exchange rate regime.
  - Place public debt on a sustainable path via comprehensive debt restructuring plus fiscal and monetary tightening while preserving financial sector stability.
  - Reduce the role of the state and enhance private sector growth.
- Macroeconomic framework and projections (program period 2008-10 and medium term):
  - Program assumes contraction in GDP in 2009 of about -0.5 percent.
  - Progressive recovery projected in 2010 and beyond with average real GDP growth of about 5 percent.
  - Real effective exchange rate expected to depreciate sharply in late 2008, with small and gradual real appreciation thereafter.
  - Inflation expected to peak in Q2 2009 at about 41 percent and decline to 22 percent at end-2009.
  - Current account balance projected to improve to a deficit of about 21 percent of GDP in 2009 and remain around that level through the medium term.
  - Merchandise imports expected to decline sharply by about 10 percent in US dollar terms in 2009.
  - Growth of goods exports expected to be about 4 percent in 2009.
  - Services exports (largely tourism) expected to grow more strongly over the medium term due to rising direct foreign investment, improved competitiveness, and removal of exchange restrictions.
  - In the absence of external debt restructuring, public sector debt would increase to 169 percent of GDP in 2009 and remain unsustainably high over the medium term.
  - Domestic debt projected to decline through fiscal restraint and negative real interest rates, particularly on long-term bonds.

### Exchange regime and exchange rate policy measures
- Commitment to remove all exchange restrictions and allow the exchange rate of the rupee to be market-determined.
- Preparatory steps completed as of end-October 2008:
  - Amend the Central Bank (CBS) Act to repeal CBS determination of the exchange rate.
  - Repeal Foreign Earnings (Regulations) Act (under which extensive exchange controls were imposed).
  - Remove requirements to pay in foreign exchange.
  - Revoke Exchange Control Act requirements that (i) persons not authorized dealers must conduct foreign currency transactions with authorized dealers; and (ii) persons authorized to buy foreign currency in the course of business must sell such foreign currency to financial institutions.
  - Amend the Financial Institutions Act to authorize a new class of foreign exchange bureaus that may operate in accounts in addition to notes, coins, and travelers’ cheques.
- Further commitments and implementation steps:
  - Prepare and submit to the National Assembly a modernized, simplified and transparent foreign exchange act by end-June 2009.
  - With IMF technical assistance, establish a platform at the Central Bank for interbank foreign exchange (FX) trading; use a manual book-entry system at the CBS in the short term.
  - Reform monetary policy framework to conduct monetary policy based on reserve money targeting.
  - Work with commercial banks to ensure prompt establishment of internal rules for FX trading and risk management based on international best practices.

### Debt restructuring strategy and preparatory actions
- Commitment to develop a comprehensive debt restructuring strategy aimed at closing financing gaps and restoring debt sustainability.
- Hired highly qualified financial and legal advisors to prepare a comprehensive debt strategy and engage in good-faith discussions with creditors.
- Program design assumes debt restructuring will be required to place public debt on a sustainable path.

*Source: Memorandum of Economic and Financial Policies for 2008-09, Government of the Republic of Seychelles (attachments to request for IMF Stand-by arrangement).*

### 16.      The success of our adjustment and reform program requires external financial

### 16.      The success of our adjustment and reform program requires external financial support, including a restructuring of our external debt

### External financing and debt restructuring
- Public announcement on September 30, 2008 to seek to restructure about US$800 million of external debt.
- Commitment to develop a comprehensive debt restructuring strategy with legal and financial advisors consistent with the Fund’s lending into arrears policy, focusing on:
  - information transparency,
  - intercreditor equity,
  - dialogue with all creditor groups.
- Objectives of restructuring:
  - restore public debt sustainability,
  - be consistent with our ability to pay,
  - provide immediate and sizable cash flow relief in the short- to medium-term,
  - sustain reduction of the debt service burden,
  - secure significant balance of payments support from international partners.
- Domestic debt considerations:
  - need to assure the stability of the banking system which has a large portion of its assets in government debt.
- Engagement with multilateral creditors with whom there are arrears to seek agreement on an arrears clearance strategy.

### Strengthening public debt management
- Commitment to submit to the National Assembly a Public Debt Law by end-December 2008 defining a legal framework for public debt management and specifying roles and responsibilities for bodies contracting and managing public debt.
- As agreed with IMF staff, formulate a medium-term public debt strategy aimed at achieving an optimal trade-off between cost and risk of public debt and consistent with long-run debt sustainability.
- Increase transparency by publishing quarterly and annual reports on implementation of the debt strategy.
- Strengthen rules governing provision of government guarantees and start charging guarantee fees.
- Request for technical assistance from the IMF’s Monetary and Capital Markets Department.
- Commitment to refrain from contracting or guaranteeing new loans outside program limits (including project financing) and not to accumulate new arrears to external or domestic creditors.

### Fiscal policy framework and targets
- Further consolidation of public finances is central to the program.
- Commitment to a large and sustained fiscal adjustment to:
  - anchor the move to a floating exchange rate regime,
  - allow for gradual reduction in public debt.
- Target: Primary surpluses of about 6.5 percent of GDP maintained in 2009-10, easing gradually over the medium term.
- Measures to achieve objectives:
  - expenditure restraint including elimination of subsidies and reduction of the wage bill in real terms (from about 9.1 percent of GDP in 2008 to 6.4 percent of GDP in 2010),
  - tax policy measures including removal of exemptions,
  - strengthened tax administration and public financial management,
  - public sector reform,
  - further privatization of public enterprises.

### Fiscal revenue measures (fourth quarter 2008 schedule)
- Raise and harmonize taxes on locally-produced and imported cigarettes to SR500 per 200 cigarettes. — October 1, 2008
- Introduce 10 percent withholding tax on interest income for residents. — October 1, 2008
- Extend GST to all telecom companies. — October 1, 2008
- Announce the introduction of the GST of 15 percent on residential rental income, effective January 1, 2009. — October 10, 2008
- Announce the removal of the exemption on interest income by companies (Tax Act) effective January 1, 2009. — November 1, 2008
- Reintroduce GST on locally produced soft drinks. — November 1, 2008.
- Raise GST on tourism services from 7 percent to 10 percent. — November 1, 2008
- Raise specific taxes/excise tax rates for both locally manufactured and imported alcohol to adjust for inflation. — November 1, 2008

### Fiscal revenue measures (as part of the 2009 budget)
- Raise environmental levy to SR25 from SR10 per month per household. — January 1, 2009
- Adjust fees, fines, charges and rents and royalties for inflation. — January 1, 2009
- Reinstate GST on LPG. — January 1, 2009
- Raise GST on tourism services from 10 percent to 12 percent. — November 1, 2009
- Repeal all provisions for discretionary exemptions in the Trade Tax and Business Tax Acts. — January 1, 2009

### Subsidy reform and social safety net
- Commit to replacing costly and inefficient direct and indirect product subsidies with a well-targeted social safety net.
- Review of the welfare system aims to adopt a multi-dimensional approach to protect the most vulnerable affected by rising inflation and increased food prices.
- Design features of the new safety net:
  - aim to protect the most vulnerable,
  - go beyond monetary transfers to avoid disincentives for employment,
  - provide assistance in a quick and effective way (applicants will receive a response within 3 days),
  - establish a means-testing system,
  - include an explicit exit strategy.
- The agency responsible for implementing the new welfare legislation will be operational by November 1, 2008, and funded out of the budget.
- Specific subsidies to be eliminated and timing:
  - Abolish fishermen fuel subsidy coupons. — October 1, 2008
  - Eliminate indirect universal product subsidies and replace with a targeted social safety net by enacting the Welfare Agency Act. — November 1, 2008
  - Eliminate SR90 per month electricity rebate for households. — January 1, 2009
  - Raise and maintain Seychelles Public Transportation Company (SPTC) bus fare at operating cost-recovery levels. — January 1, 2009
  - Eliminate implicit and explicit subsidies for Agro Industries, Hatcheries, Seychelles Trading Company (STC), and Coevity Prawns. — January 1, 2009
  - Eliminate LPG subsidy by the state oil company (SEPEC) (about SR3 per kg.). — January 1, 2009

### Already implemented expenditure measures
- Implementation in 2008 of a hiring freeze for the public sector.
- Establishment of a public enterprise monitoring unit in the Ministry of Finance to:
  - reinforce parastatal performance monitoring and reporting,
  - better assess quasi-fiscal risks,
  - enforce full cost recovery policy in provision of public utilities.

### Fiscal structural reforms and public sector employment
- Strengthen public financial management framework and budgetary process; implement IMF public financial management review recommendations.
- Review options for expenditure rationalization including outsourcing non-core activities.
- Prepare a consistent medium-term macroeconomic framework to strengthen budget preparation, implementation and monitoring.
- High-level government task force headed by the Minister of Finance to review government services for duplication elimination and outsourcing where efficient.
- Public sector employment rationalization:
  - Intend to reduce government employees by 12.5 percent in 2009 through a voluntary and involuntary departure scheme.
  - Separation package to provide time and means for retraining and employment in the private sector.
  - Voluntary scheme to be conducted in October/November 2008, followed by involuntary redundancies if voluntary scheme does not achieve targets, with departures scheduled to take place by January 1, 2009.

### Tax system reform and administration
- Commitment to a fundamental review of the tax system to create a simple, fair, equitable system with low, harmonized rates and a broader tax base; requested technical assistance from the IMF’s fiscal affairs department.
- Immediate administrative steps:
  - Seychelles Revenue Commission launched tax audits of the 20 largest enterprises (by turnover) in tourism, banking, construction, and fishing sectors to be completed by end-June 2009.
  - Strengthen tax administration and reinforce efforts to recover unpaid taxes.
  - Requested technical assistance on tax administration from the IMF’s fiscal affairs department.

### Privatization program
- Actively pursue further privatization to encourage private sector activity and reduce fiscal cost of parastatals.
- Planned divestitures over the next year: Seychelles Savings Bank, the Agro Industries, the Animal Feed Factory and the Coetivy Prawn Farm.
- Policy: avoid retaining minority stakes in privatized firms.
- Creation in March 2008 of Societé Seychelloise d’Investissement (SSI) to strengthen monitoring of firms with significant government stakes.
- SSI to commission management audits of firms with large state holdings, including the tuna cannery plant.

### Monetary policy framework and instruments
- Monetary policy to emphasize liquidity management to establish price stability following shift to a flexible exchange rate.
- Exchange rate anchor to be replaced by a reserve money target.
- CBS to rely more actively on market-based monetary policy instruments; domestic interest rates have already increased and are likely to rise further, especially around the floating of the rupee.
- Introduction of facilities for trading T-bills, foreign exchange and deposits at the central bank to promote efficient liquidity management and support inter-bank market development.
- CBS and government committed to providing regular and predictable supply of instruments over a range of maturities to facilitate market development and establishment of a market-based yield curve.

### Phasing out distortions and operational measures
- Phase out burdensome financial regulations and administrative monetary policy instruments over the program period.
- Specific measures:
  - The LAR will be phased out over the program period as conditions permit, in consultation with IMF staff, to promote lending to the private sector; replaced by a supervisory liquidity requirement for prudential purposes and strengthened financial supervision.
  - Statutory commercial bank reserves will be remunerated at 0.25% per annum; excess reserves are no longer remunerated and no longer form part of the LAR.
  - CBS introduced weekly auctions for a liquidity deposit facility on September 22, 2008. Initially, deposits will be auctioned for 7, 14 and 28 days in amounts determined by liquidity sterilization objectives.
  - CBS is providing a facility for the trading of government securities at market rates of discount. Weekly auctions of 91-day T-bills started October 3, 2008.

### Technical assistance and capacity building for the CBS
- Continued need for international support to build capacity for policy monitoring and implementation.
- Benefited from IMF technical assistance in central banking, foreign exchange markets and banking supervision.
- Welcome expert visits from IMF’s Monetary and Capital Market Department to assist in:
  - establishing an interbank market in foreign exchange, government securities, and bank deposits with the CBS;
  - initiating automation of this market;
  - introducing a monetary framework based on reserve money targeting;
  - reinforcing banking supervision.
- Request for a long-term monetary advisor to help transition from a fixed to floating exchange rate regime.

### Safeguards, audits, and governance
- Commitment to address areas identified by the IMF safeguards assessment mission of September 2008.
- Invitation to international audit firms to tender for external audit of the 2008 accounts.
- For 2008 and future audits, commitment to appoint only international audit firms with recognized experience in central bank audits.
- 2008 audit formalization via a Supplementary Statement of Work specifying:
  - an audit partner with recognized experience in central bank audits,
  - full compliance with International Standards on Auditing,
  - quarterly audits of key monetary data, as specified in the TMU, in addition to the financial statements audit.
- Data will be submitted to the IMF in conformity with the program quarterly quantitative performance criteria throughout the program period, beginning with December 2008 data.
- With IMF assistance, intend to strengthen governance and transparency aspects of the CBS Act and CBS operations in 2008-2009.
- Operational step:
  - Approve a memorandum of understanding, under Article 34 of the CBS act, formalizing the operational terms and conditions under which the CBS acts as agent for the government. — End-December 2008

### Financial sector stability considerations
- Anticipation that changes in the exchange rate regime and monetary policy framework, against global financial turbulence, will pose short-run challenges to financial sector stability.
- Assessment of mid-2008 data: strong net open positions in foreign currencies for banks mean a depreciation of the Seychelles rupee would improve the capital position of most banks, but these positions can change quickly and will be closely monitored.
- Concern about the impact of higher interest rates on borrower default rates.
- Government-owned financial institutions face both exchange rate and interest rate risk.

*IMF staff report excerpt (content unit: _cr08365 - 16. The success of our adjustment and reform program requires external financial)*

### 32.      We are committed to carefully monitoring the impact of the exchange rate

### _cr08365 - 32.      We are committed to carefully monitoring the impact of the exchange rate

### Financial-stability measures and contingency planning
- Commitment to carefully monitor the impact of the exchange rate regime change on banks and non-banks’ balance sheets and to take all measures necessary to maintain stability and soundness of the financial system.
- Government actions:
  - Provisioned a contingency in the 2009 budget to cover potential losses and recapitalization needs of state-owned financial institutions.
  - Will reassess the strategic role of public non-bank financial institutions.
  - Seeking technical assistance to create a specialized oversight function at the Ministry of Finance and to advise on options available to the government.

### Transparency and good governance (F)
- Private investment strategy:
  - Private investment is a key component of sustained medium-term growth; steps will be taken to ensure potential investors are treated with equity and with the highest level of transparency.
  - Revamp the process by which new direct investment is attracted to remove discretionary incentives and ensure a level playing field.
  - Authority for approving new projects will be centralized at the Ministry of Finance, with final approval resting with the cabinet.
  - Ensure uniform application of the investment code and removal of discretionary ministerial exemptions.
- Legal and institutional reforms adopted or planned:
  - Public Officers Ethics Act adopted in August 2008: provides a code of conduct and ethics for civil servants, requires financial declarations, and prohibits conflicts of interest.
  - Public Procurement Act (modeled on the COMESA standard) to be passed by December 2008: objective to standardize procurement procedures, modernize and harmonize regulations, enhance transparency, competitiveness, and efficiency; tender procedures to ensure competitive bidding through strict and uniform minimum number of bidders and public disclosure of all bids.
  - Amendment to the Anti-Money Laundering (AML) Act in July 2008: established a Financial Intelligence Unit with powers of investigation and sanction; enabled the Supreme Court to order civil proceedings for the preservation and disposal of proceeds of criminal conduct under the Act.

### Statistical issues (G)
- Acknowledged weaknesses:
  - Deficiencies remain in key macroeconomic data, especially deflator estimates and foreign trade statistics, limiting usefulness for surveillance, economic analysis, and policy formulation.
- Planned actions:
  - Government will strive to improve quality, periodicity, and timeliness of macroeconomic statistics.
  - Government will request technical assistance from the Statistics Department of the Fund.
  - Strive to implement the GFS classification to present fiscal accounts in the IMF format for easier budget monitoring and reporting.

### Program financing (H)
- 2008 financing (after disbursements):
  - US$1.6 million in financial assistance from the European Union.
  - First tranche of the prospective SBA of 70 percent of quota (SDR 6.16 million) from the IMF.
- 2009 expected external nonproject financing coverage:
  - Disbursements from the IMF under the prospective SBA (30 percent of quota; SDR 2.64 million; US$3.85 million).
  - Multilateral creditors: US$15 million.
  - External debt relief: US$85million.

### Program monitoring (IV)
- Monitoring framework:
  - SBA will be monitored by quarterly program and financing assurances reviews.
  - Quarterly quantitative performance criteria and indicative targets for end-2008 and 2009 are set out in Table 1; structural benchmarks and performance criterion for the first review shown in Table 2.
  - Non-zero ceilings on contracting or guaranteeing external debt allow for normal public project finance and program support from multilateral institutions exclusively.
- Focus of the first review (completion based on meeting quantitative performance criteria at end-December 2008):
  - Reform of the exchange regime.
  - Use of market-based monetary policy.
  - Normalizing relations with external creditors.
  - Preparation of a fundamental review of tax policy.
  - Strengthening of tax administration and public expenditure management.
  - Strengthening the CBS act and operations to address areas identified by the safeguards assessment.
  - 2009 budget consistent with program objectives.
- Review schedule:
  - First program and financing assurances review under the Stand-by arrangement scheduled to be completed in early April 2009.
  - Second program and financing assurances review scheduled for early July 2009.
- Policy commitments:
  - Seychelles will avoid introducing new exchange restrictions, multiple currency practices, or bilateral payments agreements in contradiction with Article VIII of the IMF’s Articles of Agreement and avoid imposing any import restrictions for balance of payments reasons.
  - Authorities stand ready to adopt additional measures, in consultation with Fund staff, if necessary to ensure program success.
- Technical Memorandum of Understanding (TMU):
  - Defines the quantitative performance criteria, indicative targets and adjusters under the program.

### Key quantitative definitions and exemplar figures (Technical Memorandum of Understanding)
- Net International Reserves (NIR) of the CBS (program definition):
  - Reserve assets: claims on nonresidents readily available and controlled by the CBS (include holdings of SDRs, foreign exchange, demand and short-term deposits at foreign banks, fixed-term deposits abroad liquidatable without penalty, and any holdings of investment-grade securities). Excludes project balances.
  - Reserve liabilities: liabilities to nonresidents contracted by the CBS, any net off-balance-sheet position (futures, forwards, swaps, or options), including IMF liabilities.
- Snapshot figures (in millions of U.S. dollars) — Net International Reserves of the CBS (as of October 13, 2008):
  - Net foreign assets of the CBS92.7
  - Foreign assets14.6
  - Official reserves (A)14.6
  - Other claims0
  - Foreign liabilities0
  - Liabilities vis-à-vis correspondents (excluding IMF)0
  - Liabilities to the IMF (B)0
  - Other liabilities0
  - Net International Reserves (A-B)14.6
- Calculation and monitoring:
  - Reserve assets and liabilities at each test date must be converted into U.S. dollars using end-of-period exchange rates assumed in the program.
  - Quarterly NIR data submitted by the CBS to the IMF will be audited by the CBS external auditors in accordance with International Standards on Auditing; reports due no later than two months after each test date.
- Adjusters for NIR floor:
  - NIR floor adjusted upward (downward) by the amount by which new external balance of payments financing exceeds (falls short of) amounts assumed in the program (MEFP Table 1).
  - Floors also adjusted upward (downwards) by the amount that external debt service payments fall short (exceed) amounts assumed in the program.
- Reserve money (ceiling) definition and monitoring:
  - Reserve money = currency issued + deposits held by financial institutions at the central bank (bank reserves).
  - Quarterly reserve money data audited by external auditors; reports due no later than two months after each test date.
  - Adjuster formula for changes in reserve requirement coefficients:
    - ∆RM = ∆rD * DD0 + ∆rF * DF0
    - DD0 denotes level of domestic currency deposits and DF0 denotes level of foreign currency deposits to which reserve requirements apply during the period immediately preceding the effective date of new reserve regulation; ∆rD and ∆rF denote change in reserve requirement coefficient for domestic and foreign currency deposits, respectively.
- Primary balance of consolidated government (cumulative floor):
  - Defined as total consolidated government and social security fund revenues (excluding privatization and long-term lease income receipts) less all noninterest (primary) expenditures of government and social security fund, on a commitment basis.
  - Adjuster: floor on primary surplus will be adjusted upwards by cumulative amount of contingency for recapitalizing state-controlled financial institutions not used for that purpose. Any amounts spent for recapitalization in excess of programmed contingency need to be funded within the program limit on the primary balance.
- Public external debt ceiling:
  - Ceiling applies to contracting or guaranteeing of new external liabilities by the public sector (central government, CBS, all public agencies and parastatals for operations not directly linked to commercial activities).
  - Exclusions: use of Fund resources; operations related to external debt restructuring; normal import-related credits; purchases of treasury securities by non-residents; borrowing by parastatals in conduct of normal commercial operations.
  - Zero subceiling on short-term external debt applies continuously to contracting or guaranteeing of short-term external debt with original maturity up to and including one year.
  - Debt definition follows Executive Board’s Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-(00/85)) and includes loans, suppliers credits, leases, and arrears, penalties, and judicially awarded damages arising from failure to make payment under contractual obligations that constitute debt.
- External arrears of public sector:
  - Non-accumulation of arrears to external creditors is a continuous performance criterion.
  - External payments arrears defined as external debt service due and not paid within contractually agreed period, including contractual and late interest.
  - Arrears for which a clearance framework has been agreed or a rescheduling agreement is sought are excluded.
- Budget expenditure arrears:
  - Non-accumulation of budget expenditure arrears is a continuous performance criterion.
  - Defined as sum of: (1) any invoice received by a spending agency for verified goods, services, and capital goods not paid within contractually agreed period or, absent a grace period, within 30 days; (2) unpaid wages, pensions, or transfers pending longer than 30 days to domestic or foreign residents, irrespective of currency denomination.

### Reporting requirements and frequencies (II. Data and Information)
- CBS weekly reporting (within one week from end of period):
  - Net international reserves.
  - The CBS balance sheet.
  - Contracts of any new external loan agreements entered into by the CBS.
  - The daily average exchange rate of the Seychelles rupee for the previous five days (in Seychelles rupees per U.S. dollar) as posted by the CBS and a table on the number and size of daily transactions in the market.
  - The foreign exchange cash flow.
  - Results of liquidity deposit auctions, primary treasury bill auctions, and secondary auctions.
- CBS monthly reporting (within 4 weeks from end of month):
  - Monthly balance sheet of the CBS.
  - The monetary survey.
  - Financial soundness indicators.
  - Structure of interest rates.
  - Stock of government securities in circulation by holder (banks and nonbanks) and by original maturity.
- Ministry of Finance weekly reporting (within one week from end of period):
  - Notification of payments coming due on external debt, which were not made (increase in arrears).
- Ministry of Finance monthly reporting (within 4 weeks from end of month):
  - Consolidated government operations on a commitment basis and cash basis in the IMF-supported program format.
  - Detailed revenues and expenditures of the central government and social security fund.
  - Monthly accounts of the public non-bank financial institutions.
  - Monthly treasury report.
  - Stock and flow of external debt by creditor.
  - Statement on budget expenditure and external debt service arrears; data on clearance of arrears to distinguish between domestic and external obligations and between scheduled interest payments, scheduled principal repayments, and commercial and other current transactions.
  - Contracts of any new external loan agreements entered into by the government and parastatals.

*Source: MEFP and Technical Memorandum of Understanding excerpts from the provided IMF content unit.*

### 16.      The government and CBS will consult with Fund staff on all economic and financial

### 16.      The government and CBS will consult with Fund staff on all economic and financial

### Key findings on debt sustainability
- The debt sustainability analysis (DSA) confirms that Seychelles’ public debt is unsustainable.
- A comprehensive public debt restructuring is critical for restoring debt sustainability.
- Seychelles is likely to remain highly vulnerable to a wide variety of shocks for an extended period of time.
- Engagement in constructive good-faith discussions with all external creditors is critical.

### Structure of public debt and recent developments
- As of end-August 2008, the public and publicly guaranteed (PPG) debt stock is estimated at 151 percent of GDP.
- External public sector debt is 94 percent of GDP (54 percent of total public debt).
- Domestic public debt outstanding accounts for about 57 percent of GDP (38 percent of total public debt).
- Debt holders and shares (Seychelles: PPG Debt, End-August 2008, in percent of total):
  - Multilateral: 4%
  - Paris Club official bilateral: 12%
  - Other official bilateral: 7%
  - External commercial: 39%
  - CBS: 10%
  - Domestic banks: 21%
  - Other domestic: 7%
- Currency composition shifted: share of external debt increased from 38 percent in 2006 to 62 percent of total public debt in August-2008.
- Maturity structure of domestic public debt:
  - More than half of domestic debt is due to mature over the course of the next two years (residual basis), implying significant near-term rollover risks.
- External arrears developments:
  - Since 2006, external arrears nearly tripled, increasing from 13 percent to more than 36 percent of GDP (as of end-August 2008).
  - As of end-August 2008, arrears composition (Seychelles: External Arrears on PPG Debt, End-August 2008, in percent of total external arrears):
    - Multilateral: 1%
    - Paris Club official bilateral: 40%
    - Other official bilateral: 12%
    - External commercial: 47%
  - Arrears to multilateral creditors are relatively small (US$2.2 million, 0.3 percent of GDP), primarily to Arab Bank for Economic Development in Africa and OPEC.
- Credit rating and default events:
  - Following July non-payment and acceleration of a privately-placed external amortizing note, arrears to commercial creditors increased by about 14 percent of GDP.
  - Standard & Poor's downgraded the external credit rating to SD (selected default).
  - On October 1, 2008, Standard & Poor's downgraded the Eurobond (US$230 million, 9.125 percent due 2011) to “D” (default) and assigned a recovery rating of “4”, indicating expectation of an average recovery of 30-50 percent on defaulted debt.

- Domestic debt by residual maturity and instrument, end-August 2008 (Total SR 4.5 billion):
  - 20-year CBS amortizing bond: 22.9%
  - 3-month t-bills: 24.5%
  - 1-year t-bills: 2.2%
  - 2008 t-bonds: 3.0%
  - 2009 t-bonds: 17.1%
  - 2010 t-bonds: 5.1%
  - 2011-2016 t-bonds: 12.7%
  - CBS short-term advance: 4.2%
  - Treasury deposits: 0.5%
  - Domestic bank loans: 5.2%
  - 2014 t-stocks: 1.6%
  - 2009 t-stocks: 1.1%

### Macroeconomic assumptions used in the DSA
- Near-term growth:
  - Real GDP shrinking by about 0.5 percent in 2009.
  - Annual real GDP growth assumed to be around 5 percent in the long term.
- Inflation:
  - Inflation would peak in 2009 at about 34 percent.
  - Inflation would gradually decline to about 3 percent by 2012.
- Foreign direct investment (FDI):
  - Notwithstanding a US$3.4 billion pipeline of approved foreign-financed projects in tourism, net FDI inflows in the medium-term are projected to decline significantly, with 2009 inflows falling by about 30 percent in absolute terms (a drop of about 4 percent of GDP) relative to its 2008 level.
  - FDI inflows are expected to recover gradually, recouping recent levels by 2012-13.
  - The long-term FDI-to-GDP ratio is assumed to stabilize at about 30 percent of GDP.
  - Note: FDI inflows are relatively neutral for the balance of payments as foreign-financed investments have import content of 85-90 percent and result in outflows in the form of repatriated profits.
- Tourism:
  - Tourism earnings projected to grow by 9 percent per annum in the long run.
  - Some moderation of tourism receipts is expected in the near term due to slower world-wide economic growth.
- External current account (non-interest):
  - Projected to improve from 26.7 percent of GDP in 2008 to 16.4 percent of GDP in 2009, mostly reflecting a significant import compression (a drop of about 10 percent) following liberalization of the exchange rate regime.
  - Over the longer term, projected to widen moderately to an average of about 18.5 percent of GDP.
- Fiscal projections:
  - Primary balance improves by 9.4 percentage points of GDP in 2008.
  - Primary surplus remains over 6 percent of GDP in 2009-11.
  - Primary surplus declines from 5.2 percent of GDP in 2012 to 3.6 percent in 2018.
  - Government revenues projected to average 35.5 percent of GDP in 2009-18.
  - Primary expenditures projected to decline from 37.5 percent of GDP in 2007 to an average of about 32 percent of GDP in 2016-18.
- Domestic debt restructuring:
  - DSA assumes no restructuring of domestic public debt due to risks to Seychelles banking system.
  - A period of negative (or low positive) real interest rates on long term government fixed coupon bond in 2008-10 significantly erodes domestic debt as inflation is high and domestic interest rates are relatively low.
  - Substantial privatization and long-term lease income in 2008-09 reduce domestic debt, though this factor diminishes over time.
- Reserves target:
  - Foreign reserves target of at least three months of prospective imports is assumed to be reached by 2015.

### Non-restructuring (new borrowing) scenario and outcomes
- Scenario assumption:
  - External financing gaps are closed by new external borrowing.
  - All external arrears are assumed to be cleared through refinancing.
  - Assumed borrowing terms: LIBOR plus 800 basis points with 10 year maturity and one year grace period.
- Caveat:
  - The assumed terms are optimistic and should be viewed as a lower (optimistic) bound of the country’s debt sustainability outlook.
- Scenario results:
  - Public debt remains unsustainable under the new borrowing scenario.
  - Over the next ten years, the debt-to-GDP ratio is projected to rise to over 183 percent of GDP.
  - External debt ratios:
    - External debt rises sharply in 2009 to 128 percent of GDP due to exchange rate depreciation and continues growing.
    - External debt-to-GDP ratio projected to reach 165 percent of GDP in 2018.
  - Debt dynamics are extremely sensitive to underlying assumptions; even moderate shocks to current account deficit and nominal interest rate can trigger much worse outcomes.

_Italic: APPENDIX II S EYCHELLES: DEBT SUSTAINABILITY ANALYSIS (excerpt)._

### 9.      Given the magnitude of Seychelles’ public debt burden, a comprehensive debt

### _cr08365 - 9.      Given the magnitude of Seychelles’ public debt burden, a comprehensive debt

### Key conclusion on debt restructuring and vulnerability
- A comprehensive debt restructuring involving creditors accepting significant concessions is required to restore public debt sustainability.
- Even with a sharp reduction in the debt service burden consistent with the long-term ability to pay, Seychelles is likely to remain highly vulnerable to a wide variety of shocks for an extended period of time.

### Public sector debt stocks (selected levels and composition)
- Public sector debt (end-June 2006; end-Aug 2007; 2008; 2008): 138.9, 151.9, 149.8, 151.3 (in percent of GDP)
- Public sector external debt (same sequence): 53.1, 77.9, 92.3, 94.1 (in percent of GDP)
- Multilateral external debt: 4.2, 5.6, 5.6, 6.3 (in percent of GDP)
- Bilateral external debt: 18.5, 22.5, 25.3, 29.0 (in percent of GDP)
- Paris Club: 13.6, 16.4, 18.1, 18.7 (in percent of GDP)
- Commercial external debt: 30.4, 49.8, 61.4, 65.8 (in percent of GDP)
- Eurobond: 20.7, 25.2, 26.8, 26.8 (in percent of GDP)
- Arrears (total): 12.8, 17.6, 20.9, 36.4 (in percent of GDP)
- Public sector domestic debt: 85.8, 74.1, 57.5, 57.3 (in percent of GDP)
- Central Bank of Seychelles domestic debt: 20.8, 18.6, 14.2, 15.6 (in percent of GDP)
- Commercial banks domestic debt: 49.6, 41.4, 31.9, 31.3 (in percent of GDP)
- Memorandum: Nominal GDP (in millions of Seychelles rupees): 5,342; 6,113; 7,878; 7,878
- Memorandum: Nominal GDP (in millions of US dollars): 968; 912; 859; 859

### Public sector debt trajectory and drivers (2005–18 baseline projections, percent of GDP)
- Public sector debt (actual/projections): 2005: 147.1; 2006: 139.5; 2007: 151.9; 2008: 150.5; 2009: 168.6; 2010: 162.8; 2011: 164.1; 2012: 164.8; 2013: 166.7; 2014: 167.6; 2015: 170.1; 2016: 173.8; 2017: 178.1; 2018: 182.7
- Foreign-currency denominated share (percent of GDP): 2005: 46.6; 2006: 53.7; 2007: 77.9; 2008: 97.8; 2009: 128.0; 2010: 129.4; 2011: 138.4; 2012: 144.5; 2013: 150.4; 2014: 155.6; 2015: 159.7; 2016: 162.5; 2017: 164.2; 2018: 164.7
- Change in public sector debt (year-on-year, percent of GDP): 2005: -15.1; 2006: -7.6; 2007: 12.4; 2008: -1.4; 2009: 18.1; 2010: -5.8; 2011: 1.3; 2012: 0.7; 2013: 1.9; 2014: 0.9; 2015: 2.5; 2016: 3.7; 2017: 4.3; 2018: 4.6
- Primary deficit (percent of GDP): 2005: -7.3; 2006: 0.6; 2007: 2.3; 2008: -7.1; 2009: -6.2; 2010: -6.6; 2011: -6.8; 2012: -5.8; 2013: -5.5; 2014: -4.9; 2015: -4.2; 2016: -3.8; 2017: -3.6; 2018: -3.6
- Revenue and grants (percent of GDP): consistently 35.9–35.5 in projection years, with historical 2005: 42.1; 2006: 43.4; 2007: 36.2; 2008: 35.9
- Primary (noninterest) expenditure (percent of GDP): 2005: 34.8; 2006: 43.9; 2007: 38.5; 2008: 28.8; projected 2009 onward ~29.5–31.9

### Automatic debt dynamics and contributions
- Automatic debt dynamics (percent of GDP): 2005: -2.4; 2006: -7.5; 2007: 0.7; 2008: -2.2; 2009: 32.5; 2010: 0.6; 2011: 9.5; 2012: 8.1; 2013: 9.3; 2014: 7.3; 2015: 7.7; 2016: 8.1; 2017: 8.5; 2018: 8.7
- Contribution from interest rate/growth differential (percent of GDP): 2005: -2.4; 2006: -7.6; 2007: -10.2; 2008: -25.2; 2009: -10.9; 2010: -6.5; 2011: 4.6; 2012: 5.6; 2013: 7.0; 2014: 7.3; 2015: 7.7; 2016: 8.1; 2017: 8.5; 2018: 8.7
- Contribution from exchange rate depreciation (percent of GDP): 2005: 0.0; 2006: 0.2; 2007: 10.8; 2008: 23.0; 2009: 43.4; 2010: 7.1; 2011: 4.8; 2012: 2.5; 2013: 2.3; 2014–2018: 0.0

### Debt sustainability: public debt-to-revenue and gross financing need
- Public sector debt-to-revenue ratio (percent): 2005: 349.5; 2006: 321.6; 2007: 419.5; 2008: 419.5; 2009: 471.8; 2010: 458.6; 2011: 462.1; 2012: 464.5; 2013: 468.9; 2014: 472.2; 2015: 479.2; 2016: 489.8; 2017: 502.0; 2018: 514.9
- Gross financing need (percent of GDP): 2005: 61.3; 2006: 55.9; 2007: 44.3; 2008: 47.4; 2009: 49.7; 2010: 34.1; 2011: 66.7; 2012: 31.6; 2013: 34.8; 2014: 34.7; 2015: 33.9; 2016: 35.3; 2017: 38.8; 2018: 42.5
- Gross financing need (in billions of U.S. dollars): 2005: 0.5; 2006: 0.5; 2007: 0.4; 2008: 0.4; 2009: 0.4; 2010: 0.3; 2011: 0.6; 2012: 0.3; 2013: 0.3; 2014: 0.4; 2015: 0.4; 2016: 0.4; 2017: 0.5; 2018: 0.6

### Macroeconomic and fiscal assumptions (key indicators)
- Real GDP growth (percent): 2005: 7.5; 2006: 8.3; 2007: 7.3; 2008: 3.1; 2009: -0.5; 2010: 3.5; 2011–2018 projections: 5.0 each year
- Average nominal interest rate on public debt (percent): 2005: 3.7; 2006: 4.2; 2007: 6.1; 2008: 7.5; 2009: 17.4; 2010: 11.7; 2011: 14.0; 2012: 11.9; 2013: 12.6; 2014: 12.8; 2015: 13.0; 2016: 13.2; 2017: 13.3; 2018: 13.3
- Average nominal interest rate on forex debt (percent): 2005: 1.7; 2006: 2.6; 2007: 7.5; 2008: 3.5; 2009: 16.6; 2010: 12.0; 2011: 15.6; 2012: 13.1; 2013: 13.4; 2014: 13.5; 2015: 13.5; 2016: 13.6; 2017: 13.6; 2018: 13.7
- Average real interest rate (percent): 2005: 5.8; 2006: 2.7; 2007: -0.6; 2008: -17.5; 2009: -9.8; 2010: -0.6; 2011: 8.4; 2012: 8.9; 2013: 9.7; 2014: 9.9; 2015: 10.1; 2016: 10.3; 2017: 10.4; 2018: 10.4
- Nominal depreciation of local currency (LC per dollar, percent): 2005: 0.0; 2006: 0.4; 2007: 21.4; 2008: 36.8; 2009: 48.2; 2010: 5.8; 2011: 3.6; 2012: 1.7; 2013: 1.5; 2014–2018: 0.0
- Inflation rate (GDP deflator, percent): 2005: -2.1; 2006: 1.5; 2007: 6.7; 2008: 25.0; 2009: 27.2; 2010: 12.2; 2011: 5.5; 2012: 3.1; 2013–2018: 2.9 each year

### Alternative scenarios and bound tests (public sector DSA highlights)
- Alternative A1 (key variables at historical averages in 2008–12): public debt trajectory (percent of GDP): 2008: 150.5; 2009: 181.7; 2010: 193.6; 2011: 202.1; 2012: 208.2; 2013: 213.9; 2014: 217.3; 2015: 221.2; 2016: 225.6; 2017: 230.1; 2018: 234.8
- Alternative A2 (No policy change, constant primary balance in 2008–12): 2008: 150.5; 2009: 177.2; 2010: 180.3; 2011: 191.6; 2012: 201.8; 2013: 213.6; 2014: 223.7; 2015: 235.3; 2016: 248.3; 2017: 262.1; 2018: 276.7
- Bound test B1 (real interest rate at baseline plus one-half standard deviation): 2008: 150.5; 2009: 178.4; 2010: 182.6; 2011: 195.6; 2012: 209.3; 2013: 225.9; 2014: 242.4; 2015: 262.3; 2016: 285.6; 2017: 311.9; 2018: 341.0
- Bound test B2 (real GDP growth at baseline minus two standard deviations): 2008: 150.5; 2009: 170.9; 2010: 167.7; 2011: 172.0; 2012: 176.2; 2013: 182.3; 2014: 187.9; 2015: 195.7; 2016: 205.7; 2017: 217.0; 2018: 229.4
- Bound test B5 (one time 15 percent additional real depreciation in 2009): 2008: 150.5; 2009: 206.8; 2010: 201.2; 2011: 204.7; 2012: 207.3; 2013: 211.6; 2014: 214.5; 2015: 219.1; 2016: 225.2; 2017: 232.0; 2018: 239.2
- Bound test B6 (10 percent of GDP increase in other debt-creating flows in 2009): 2008: 150.5; 2009: 178.6; 2010: 172.9; 2011: 174.8; 2012: 175.9; 2013: 178.4; 2014: 179.9; 2015: 182.9; 2016: 187.3; 2017: 192.3; 2018: 197.5

### External debt and balance of payments (selected levels and dynamics)
- External debt (percent of GDP): 2005: 55.0; 2006: 53.8; 2007: 77.9; 2008: 97.8; 2009: 128.0; 2010: 129.4; 2011: 138.4; 2012: 144.5; 2013: 150.4; 2014: 155.6; 2015: 159.7; 2016: 162.5; 2017: 164.2; 2018: 164.7
- Change in external debt (percent of GDP): 2005: 0.2; 2006: -1.2; 2007: 24.0; 2008: 19.9; 2009: 30.3; 2010: 1.4; 2011: 9.0; 2012: 6.1; 2013: 5.9; 2014: 5.2; 2015: 4.1; 2016: 2.8; 2017: 1.7; 2018: 0.5
- Identified external debt-creating flows (percent of GDP): 2005: 5.9; 2006: -5.1; 2007: 2.0; 2008: -0.9; 2009: 17.6; 2010: -8.9; 2011: -0.4; 2012: -2.1; 2013: -1.3; 2014: -2.3; 2015: -3.3; 2016: -3.9; 2017: -4.5; 2018: -5.2
- Current account deficit excluding interest payments (percent of GDP): 2005: 19.0; 2006: 12.7; 2007: 19.9; 2008: 26.7; 2009: 16.4; 2010: 17.5; 2011: 18.3; 2012: 19.4; 2013: 19.9; 2014: 19.6; 2015: 19.1; 2016: 18.5; 2017: 17.8; 2018: 16.9
- Net non-debt creating capital inflows (negative, percent of GDP): 2005: -8.9; 2006: -14.2; 2007: -24.6; 2008: -34.4; 2009: -28.4; 2010: -28.2; 2011: -28.6; 2012: -29.9; 2013: -30.4; 2014: -29.6; 2015: -30.3; 2016: -30.5; 2017: -30.6; 2018: -30.7
- Net foreign direct investment, equity (percent of GDP): 2005: 8.9; 2006: 14.2; 2007: 24.6; 2008: 34.4; 2009: 28.4; 2010: 28.2; 2011: 28.6; 2012: 29.9; 2013: 30.4; 2014: 29.6; 2015: 30.3; 2016: 30.5; 2017: 30.6; 2018: 30.7

### External debt sustainability and stress tests (selected outcomes)
- External debt-to-exports ratio (percent): 2005: 67.5; 2006: 60.8; 2007: 81.3; 2008: 82.8; 2009: 89.5; 2010: 94.7; 2011: 102.0; 2012: 106.4; 2013: 110.3; 2014: 115.0; 2015: 118.8; 2016: 121.6; 2017: 123.6; 2018: 124.5
- Gross external financing need (percent of GDP): 2005: 25.6; 2006: 26.4; 2007: 30.7; 2008: 50.7; 2009: 41.0; 2010: 38.0; 2011: 72.9; 2012: 45.3; 2013: 51.6; 2014: 53.2; 2015: 54.3; 2016: 55.7; 2017: 57.2; 2018: 58.1
- Gross external financing need (in billions of US dollars): 2005–2018 sequence shows low absolute values with peaks corresponding to percent of GDP increases (detailed annual values provided in tables)

### Balance of payments and reserves (selected 2007–18 items, US$ millions or percent of GDP where indicated)
- Current account (US$ millions): 2007: -213; 2008: -247; 2009: -215; 2010: -248; 2011: -315; 2012: -332; 2013: -369; 2014: -406; 2015: -441; 2016: -475; 2017: -509; 2018: -542
- Current account (percent of GDP): 2007: -23; 2008: -29; 2009: -29; 2010: -31; 2011: -37; 2012: -36; 2013: -38; 2014: -38; 2015: -39; 2016: -39; 2017: -38; 2018: -38
- Income, net (US$ millions): 2007: -72; 2008: -68; 2009: -170; 2010: -206; 2011: -280; 2012: -301; 2013: -349; 2014: -401; 2015: -456; 2016: -514; 2017: -576; 2018: -641
- Interest payments (US$ millions): 2007: -33; 2008: -33; 2009: -94; 2010: -107; 2011: -158; 2012: -154; 2013: -175; 2014: -199; 2015: -222; 2016: -247; 2017: -273; 2018: -299
- Gross international reserves (stock, e.o.p., US$ millions): 2007: 10; 2008: 19; 2009: 80; 2010: 135; 2011: 185; 2012: 230; 2013: 265; 2014: 311; 2015: 368; 2016: 427; 2017: 485; 2018: 545
- Months of prospective goods & services imports (selected): 2007: 0.1; 2008: 0.2; 2009: 0.8; 2010: 1.3; 2011: 1.7; 2012: 2.0; 2013: 2.2; 2014: 2.4; 2015: 2.7; 2016: 2.9; 2017: 3.1
- Scheduled public external debt service (US$ millions) and percent of G&S exports (selected): scheduled service (US$ millions): 2007: 100; 2008: 222; 2009: 180; 2010: 165; 2011: 470; 2012: 238; 2013: 310; 2014: 355; 2015: 401; 2016: 459; 2017: 525; 2018: 593. Percent of G&S exports: 2007: 11.4; 2008: 21.8; 2009: 17.2; 2010: 15.0; 2011: 40.2; 2012: 19.1; 2013: 23.3; 2014: 24.8; 2015: 26.2; 2016: 27.9; 2017: 29.7; 2018: 31.2

### Stress-test visuals and summary observations (figures)
- Public DSA bound tests (Figure 1a) and External DSA bound tests (Figure 1b) illustrate that under multiple stress scenarios (real interest rate shocks, growth shocks, primary balance shocks, combined shocks, and one-time 15 percent real depreciation in 2009) public and external debt ratios rise sharply and remain elevated well above baseline projections.
- Individual and combined shocks produce materially higher public and external debt paths, with combined shock scenarios showing particularly large increases in debt-to-GDP trajectories.

*Source: INTERNATIONAL MONETARY FUND. Staff Report for the 2008 Article IV Consultation and Request for a Stand-By Arrangement—Informational Annex (October 31, 2008).*

### 1. Article IV consultation and approval of 2-year Stand-By

### 1. Article IV consultation and approval of 2-year Stand-By Arrangement (SBA)

### Program structure, reviews, and timing
- Quarterly program and financing assurances reviews under the SBA:
  - First review: February 2009
  - Second review: May 2009
  - Third review: August 2009
  - Fourth review (if needed): November 2009
  - (preliminary) Fourth review timing noted: August 2009 (preliminary)
  - First quarter 2009 listed as timing for some items; other items noted as Ongoing or 2009
- Provisional timing and expected delivery dates (as presented):
  - Medium-term macro-economic and fiscal framework to inform Public Expenditure Reviews: n.a. — October 2009 (Bank request to Fund)
  - Debt Sustainability Analysis: n.a. — October 2009 (Fund request to Bank)
- Joint products and missions:
  - Joint mission to discuss a medium-term structural reform agenda focusing on: social safety net targeting; civil service reform; parastatal reform; and promoting private sector investment — May 2009 (preliminary) and August 2009 (preliminary)

### Technical assistance and capacity building (missions and timing)
- FAD technical assistance mission on tax policy and revenue administration review.
  - Timing indicated: September 2009
- MCM technical assistance on:
  - Reforming the monetary policy framework (long-term monetary advisor, automation of interbank market, reserve money management)
  - Strengthening bank supervision
  - CBS governance
  - Timing indicated: February 2009; May 2009; August 2009; November 2009
  - (preliminary) October 2009 also listed
- MCM technical assistance on public debt management.
  - Timing indicated: First quarter 2009; Ongoing; 2009; November 2009; October 2009 (preliminary)

### Medium-term structural reform agenda (joint focus)
- Areas of analytical work and policy notes requested:
  - Assessment of the poverty impact of a devaluation; strategy on strengthening the social safety net and enhancing targeting of social assistance. — TBD; February-March 2009
  - Policy note on civil service reform. — TBD; June 2009
  - Policy note on parastatal reform and privatization. — TBD; June 2009
  - Strategy on improving business environment and promoting private sector investment. — TBD; June 2009

### African Development Bank Group (AfDB) relations (summary as of October 2008)
- AfDB operations since 1978: 19 operations (15 projects, 1 study, 3 lines of credit).
- Cumulative approvals as of October 2008: UA 84.87 million.
  - Share by source:
    - ADB: 73 percent
    - Nigeria Trust Fund (NTF): 14 percent
    - African Development Fund (ADF): 13 percent
- Sectoral allocation of operations:
  - Social sector: 46 percent
  - Financial sector: 16 percent
  - Agricultural sector: 15 percent
  - Transportation: 13 percent
  - Water supply and sanitation: 10 percent
  - Industrial sector: 1 percent
- Disbursement history:
  - Before sanctions, about 76.8 percent of total commitments had been disbursed; balance of 23.2 percent cancelled after sanctions.
- Arrears and clearance:
  - Country under sanctions since February 16, 2000 due to arrears.
  - Payment of US$ 40 million on October 6, 2006 as first installment; balance of US$ 6.75 million on November 14, 2006. AfDB lifted sanctions and started reengagement discussions.
  - Progress limited due to intermittent arrears from second half of 2007; Seychelles is now current on obligations and an agreement reached for a joint ADB-World Bank reengagement strategy.
- Grant access and specific AfDB assistance under processing:
  - African Water Facility grant: € 955,000 signed in May 2008 to finance preparation of the Water Development Plan; study expected to be completed by December 2009.
  - MIC Technical Assistance Fund proposals under processing:
    - Grant request UA 600,000 to support human resource development, training and capacity building, and establishment of the Seychelles University Foundation.
    - Grant request US$ 500,000 to finance studies for a Submarine Cable System to link Seychelles to East Africa.
- Exchange rate conversion note: UA 1 = US$ 1.55722 as at October 27, 2008.

### Statistical issues and data quality (as of October 2008)
- General:
  - Data provision has shortcomings but is broadly adequate for surveillance.
  - Seychelles participates in the General Data Dissemination System (GDDS) and government finance statistics modules of the Anglophone Africa project funded by DFID. Participating in GDDS since December 2006.
  - Sustained technical assistance and additional resources likely required over the medium term to significantly improve the quality of economic statistics.
- Real sector statistics:
  - National accounts: calendar-year basis; 1986 base year historically; new provisional national accounts estimates for 2004-2007 with 2006 as base year published in February 2008. Overall level of GDP revised up by 25 percent in current prices due to improved coverage and methodology. Further revisions planned for late 2008 or early 2009.
  - Tourism statistics: compiled weekly and monthly; production indicators compiled quarterly; both reported to the IMF in a timely manner.
  - Average earnings and employment by sector: collected quarterly; no data on unit labor costs. Central bank publishes a monthly estimate of the unemployment rate.
  - CPI: uses expenditure weights from household budget survey of May 2006–July 2007; base period July 2007; prices collected on or around the 15th of every month.
- Government finance statistics:
  - Recorded on a cash basis broadly consistent with the Government Finance Statistics Manual (1986).
  - Authorities participated in a GFS pilot study presenting statistics in the GFSM 2001 analytic framework; currently participating in a DFID-financed technical assistance project to improve cash-based statistics and lay foundations for accrual-based measures and extended institutional coverage.
  - Annual consolidated central government transactions reported for GFSY; recent cash data on central government budgetary operations prepared for IFS publication using GFSM 2001 Statement of Sources and Uses of Cash.
- Monetary and financial statistics:
  - Monetary data reported regularly to STA for IFS; analytical framework generally sound.
  - Integrated monetary database fully operational using standardized report forms (SRF). SRF-based monetary data published in the IFS Supplement since March 2007.
- External sector statistics:
  - Substantial progress in adopting BPM5 methodology.
  - Trade data reported quarterly with some delay; balance of payments data reported generally nine months after the reference period, with provisional estimates provided to missions seven months after the reference period.
  - Quality of balance of payments data impaired by foreign exchange parallel market operations.
  - Considerable progress in collecting and updating public sector external debt and debt-service and external payments arrears since hiring financial advisors.

### Table of common indicators (as of October 30, 2008) — selected entries with exact dates/frequencies
- Exchange Rates: Date of latest observation 10/24/08; Date received 10/24/08; Frequency of Data Daily; Frequency of Reporting Daily; Frequency of Publication Daily.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation 06/30/08; Date received 08/06/08; Frequency of Data Daily; Frequency of Reporting Daily; Frequency of Publication Daily.
- Reserve/Base Money: Aug. 08; Date received 10/24/08; Monthly/Monthly/Monthly.
- Broad Money: Aug. 08; Date received 10/24/08; Monthly/Monthly/Monthly.
- Central Bank Balance Sheet: Aug. 08; Date received 10/24/08; Monthly/Monthly/Monthly.
- Consolidated Balance Sheet of the Banking System: Aug. 08; Date received 10/24/08; Monthly/Monthly/Monthly.
- Interest Rates: Date of latest observation 10/24/08; Date received 10/24/08; Weekly/Weekly/Weekly.
- Consumer Price Index: Date of latest observation 09/31/08; Date received 10/21/08; Monthly/Monthly/Monthly.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: Sept. 08; Date received 10/16/08; Monthly/Monthly/Monthly.
- Stocks of Central Government and Central Government-Guaranteed Domestic Debt: 08/31/08; Date received 09/15/08; Monthly/Monthly/Quarterly.
- External Current Account Balance: 06/30/08; Date received 09/15/08; Quarterly/Quarterly/Quarterly.
- Exports and Imports of Goods and Services: 03/31/08; Date received 09/30/07; Frequency of Data Monthly; Frequency of Reporting Irregular; Frequency of Publication Irregular.
- GDP/GNP: 12/31/07; Date received 03/03/08; Frequency of Data Annual; Frequency of Reporting Annual; Frequency of Publication Irregular.
- Gross External Debt: 08/31/08; Date received 09/15/08; Monthly/Monthly/Irregular.
- International Investment Position: ... / ... / NA / NA / NA.

### Supplementary information (Prepared by African Department staff; Approved November 12, 2008) — program reforms and near-term developments
- Major program reforms became effective on November 1, 2008. President Michel outlined main components on October 31.
- Foreign exchange liberalization and currency developments:
  - National assembly approved laws to remove all controls on foreign exchange and market float of the rupee on October 31.
  - On the first trading day (November 3), the rupee depreciated by about 37 percent against the U.S. dollar.
  - Exchange rates were highly variable during the first week; no major runs on the currency.
  - As of November 11 the rupee had depreciated a further 12 percent.
  - Authorities processing over 20 requests to license foreign exchange bureaus.
  - Fund technical assistance provided for transition and drafting market arrangements.
- Fiscal and social measures:
  - Indirect product subsidies were eliminated.
  - National Assembly approved creation of the agency on welfare to implement a targeted social safety net.
  - President announced a graduated public sector wage increase that is below the rate of inflation and a series of programmed revenue measures.
- Central Bank of Seychelles (CBS) policy and governance:
  - CBS announced domestic price stability will be the policy objective.
  - Nascent interbank market for deposits at the central bank and for treasury bills has begun; interest rates are rising.
  - Interest rates will need to rise further in coming weeks to positive real levels to support the new policy framework.
  - New CBS Governor, a former Fund staff member, appointed on November 1 after incumbent resigned.
  - CBS has tendered for an external audit that meets international audit standards and expects to finalize contract discussions shortly.
- Interest rate developments (Treasury Bills and Deposit Auction Arrangement — presented as exact series):
  - Treasury Bills (weekly auction results; average tender rate in percent) — 91 days:
    - 23-Sep: 5.9
    - 3-Oct: 8.7
    - 10-Oct: 10.2
    - 17-Oct: 10.2
    - 24-Oct: 10.5
    - 31-Oct: 13.6
    - 5-Nov: 17.2
    - 7-Nov: 15.1
  - Deposit Auction Arrangement (weighted average DAA rate in percent):
    - 7 days:
      - 22-Sep: 5.3
      - 1-Oct: 5.7
      - 8-Oct: 7.4
      - 15-Oct: 8.2
      - 22-Oct: 8.6
      - 29-Oct: 9.4
      - 5-Nov: 9.5
      - 12-Nov: 9.9
    - 14 days:
      - 22-Sep: 5.1
      - 1-Oct: 6.8
      - 8-Oct: 7.1
      - 15-Oct: 8.6
      - 22-Oct: 9.6
      - 29-Oct: 11.0
      - 5-Nov: 11.1
      - 12-Nov: n.a.
    - 28 days:
      - 22-Sep: 5.3
      - 1-Oct: 7.7
      - 8-Oct: 7.8
      - 15-Oct: n.a.
      - 22-Oct: 10.4
      - 29-Oct: 11.6
      - 5-Nov: 11.8
      - 12-Nov: n.a.
  - Source: Central Bank of Seychelles (Table. Seychelles: Interest Rates, September-November 2008)
- Program financing and creditor engagement:
  - Program financing assurances have been received from Paris Club creditors for the Stand-By Arrangement.
  - Creditors confirmed commitment to consider a debt stock reduction at some appropriate time in the future in view of Seychelles’ unsustainable debt situation and in accordance with the Evian approach.
  - Authorities and financial advisors to commence meetings with private creditors in Europe and the Middle East in the week of November 17, 2008.
  - Discussions begun with non-Paris Club official creditors.
- Governance and transparency:
  - President and each member of cabinet signed and submitted declarations of their assets to the ethics commission on November 5, as required by the 2008 Public Officers’ Ethics Act.
- Recent economic developments (reported as exact figures):
  - Tourism: tourism spending for the first six months was up 39 percent over the same period in 2007; in the third quarter, it was down by 37 percent compared to 2007.
  - Inflation: eased in September to 34.2 percent as energy prices declined.
  - Fiscal outturn: nine month primary surplus was 5.8 percent of GDP compared to a projected 5.3 percent, largely because tax revenues were higher than expected.
  - Monetary indicators: reserve money growth has been contained, and foreign reserves are above the end-2008 performance criterion floor.

*Prepared by the staff of the African Department; Approved by Mark Plant (AFR) and Philip Gerson (SPR); November 12, 2008.*

### 6.      Staff welcomes the decisive implementation of the bold and difficult reform

### _cr08365 - 6.      Staff welcomes the decisive implementation of the bold and difficult reform

### Background and crisis assessment
- Seychelles is experiencing an acute balance of payments and public debt crisis that jeopardizes high living standards and economic development.
- Exchange rate misalignment, complex exchange controls, foreign exchange shortages, a flourishing parallel market, and rising dollarization preceded the crisis.
- External shocks (oil and food price increases) and the global slowdown exacerbated vulnerabilities, contributing to: rapid inflation, falling reserves, missed debt payments in July and October 2008, and Standard and Poor’s downgrade to SD (selective default).
- Public debt at almost 151 percent of GDP is judged unsustainable. External public debt is some 95 percent of GDP (US$808 million), of which over 40 percent is arrears, mostly to Paris Club creditors and on the private placement.

### Program approval and financing
- IMF Executive Board approved a two-year Stand-By Arrangement (SBA) with total access equivalent to SDR 17.6 million (about US$26.1 million).
- An amount equivalent to SDR 6.16 million (about US$9.13 million) was made available immediately; the balance to be disbursed in seven quarterly installments over the next two years, subject to reviews.

### Key reform measures implemented and planned
- Exchange regime:
  - Elimination of all exchange restrictions and float of the rupee (float introduced on 1 November 2008).
  - On the day of the float the exchange rate depreciated from 8.9 rupees to the US dollar to around 15.
  - CBS to operate in FX market to avoid excessive volatility, meet government FX needs, and accumulate reserves over time, but will not seek to influence the exchange rate level.
- Fiscal policy:
  - Significant and sustained tightening of fiscal policy, including reduction in public employment and replacement of indirect subsidies with a targeted social safety net.
  - Fiscal reforms are heavily frontloaded, with the bulk of adjustment and key measures implemented in Q4 2008.
  - Projected turnaround in the primary fiscal balance from 2007 amounts to about 8 percent of GDP in 2008; projected sustained annual primary surpluses of about 6½ percent through 2011.
  - Government committed to removing tax exemptions, strengthening tax administration and public financial management, and submitting a Public Debt Law before end-2008.
- Monetary policy and financial sector:
  - Reform of monetary policy framework to focus on liquidity management using indirect instruments.
  - CBS introduced active secondary market trading and weekly auctions for Treasury Bills and central bank deposit facility; positive yield curve emerging.
  - Measures to strengthen financial sector supervision and a budget provision for potential recapitalization of state-owned financial institutions.
- Structural reforms:
  - Reduction in the role of the state to boost private sector development via further privatization, enhanced fiscal governance, and tax system review.
  - Replacement of universal subsidies with a means-tested, time-limited Welfare Agency-administered social safety net.
  - Public sector workforce reduction announced: 12.5 percent reduction by 1 January 2009, primarily via voluntary departure scheme with retraining and placement support.
  - Fundamental review of the tax system planned for 2009 with Fund assistance; removal of discretionary exemptions in Trade Tax and Business Tax Acts from 1 January 2009.

### Debt restructuring and external financing needs
- Even with strong fiscal adjustment, comprehensive debt restructuring is required to put public debt on a sustainable path and reduce debt service to levels consistent with long-term payment capacity.
- Government announced intention to seek restructuring of around $US800 million of external debt.
- Authorities hired financial and legal advisors and committed to working with official bilateral and commercial creditors on a comprehensive restructuring based on transparency, inter-creditor equity, and open dialogue.
- IMF-supported adjustment program to provide a basis for discussions with Paris Club creditors (Evian approach indicated).

### Executive Board views and conditionalities
- Directors welcomed upfront liberalization of the exchange regime and float of the rupee as essential to restore credibility and unify parallel and official exchange rates.
- Directors stressed need for strong fiscal policy reforms to maintain sizable primary surpluses over the medium term, including targeted social safety net and continuation of public sector employment retrenchment.
- Directors looked forward to a more comprehensive Debt Sustainability Analysis (DSA) at the first review of the stand-by arrangement and regular updates on financing assurances and safeguards.
- Directors supported strengthening of monetary policy operations, closer CBS–Ministry of Finance collaboration on liquidity forecasting/management, and improvements in public sector governance, transparency, and data quality/timeliness.

### Selected economic and financial indicators (2005–2008, as presented)
- Nominal GDP (in millions of Seychelles rupees): 2005: 4,861; 2006: 5,342; 2007: 6,113; 2008 (Est.): 7,878.
- Real GDP (annual change): 2005: 7.5; 2006: 8.3; 2007: 7.3; 2008 (Est.): 3.1.
- Retail price index (annual averages; official index believed to understate inflation): 2005: 0.8-1.4; 2006: 5.7; 2007: 32.2.
- Domestic credit (annual change): 2005: 1.8-9.6; 2006: 8.9; 2007: 6.2.
- Broad money (M2(p), annual change): 2005: 1.7 3.0; 2006: -14.9; 2007: 2.6.
- Reserve money (annual percentage change): 2005: 3.4 32.7; 2006: -23.1; 2007: 3.4.
- Interest rate (average during period, 91-day bill): 2005: 2.8 3.2; 2006: 3.6; 2007: ...
- Gross national savings (percent of GDP): 2005: 14.6; 2006: 14.2; 2007: 9.1; 2008 (Est.): 4.9.
- Gross investment (percent of GDP): 2005: 34.3; 2006: 28.1; 2007: 32.5; 2008 (Est.): 33.6.
- Total revenue, excluding grants (percent of GDP): 2005: 41.1; 2006: 42.0; 2007: 35.9; 2008 (Est.): 35.4.
- Identified expenditure and net lending (percent of GDP): 2005: 40.4; 2006: 49.6; 2007: 46.0; 2008 (Est.): 37.6.
- Current expenditure (percent of GDP): 2005: 35.1; 2006: 41.5; 2007: 40.8; 2008 (Est.): 32.2.
- Capital expenditure and net lending (percent of GDP): 2005: 5.3; 2006: 8.0; 2007: 5.1; 2008 (Est.): 5.4.
- Overall balance, including grants (above the line, percent of GDP): 2005: 1.7-6.2; 2006: -9.8; 2007: -1.8.
- Primary balance (percent of GDP): 2005: 7.3-0.6; 2006: -2.3; 2007: 7.1.
- Total public debt (including arrears, percent of GDP): 2005: 147.1 139.5; 2006: 146.0; 2008 (Est.): 151.3.
  - Domestic (percent of GDP): 2005: 100.5 85.8; 2006: 74.1; 2007: 53.5.
  - External (percent of GDP): 2005: 46.6 53.7; 2006: 71.9; 2007: 97.8.
- Current account balance after official transfers (percent of GDP): 2005: -19.7-13.9; 2006: -23.4; 2008 (Est.): -28.8.
- Gross official reserves (US$ millions, end of year): 2005: 56.1; 2006: 112.7; 2007: 9.8; 2008 (Est.): 18.7.
- Reserves in months of imports, c.i.f.: 2005: 0.7 1.3; 2006: 0.1; 2007: 0.2.
- Reserves as percent of broad money: 2005: 6.3 13.0; 2006: 8.0; 2007: 35.0.

*Public Information Notice (PIN) No. 08/142; Press Release No. 08/282; IMF Executive Board conclusions and related program documentation as presented in the source.*

### Conclusion

### Conclusion

### Government announcement and political support
- President Michel announced the Government’s economic reform program in an address to the nation on 31 October.
- The President emphasised that implementation will be challenging, with recovery from the current economic crisis only possible after a process of substantial adjustment.
- The President stressed that this is a defining moment in Seychelles’ history and highlighted the importance of making a break from the policies of the past.
- The Government’s reform program has attracted broad support politically, amongst the local business community and within civil society.

### Macroeconomic projections and outlook
- Projections show that, through adherence to their comprehensive economic reform program and with the support of the international community:
  - Seychelles’ GDP is expected to contract slightly in 2009 before staging a recovery from 2010.
  - Inflation is forecast to peak in the second quarter of 2009 before declining steadily over the projection period.
  - The current account balance is projected to improve significantly from 2009.

### Structural reform and international engagement
- As the above reforms take hold and macroeconomic stability is restored, the Government will increasingly focus on addressing structural impediments to Seychelles’ growth and development.
- The authorities are working with the IMF, World Bank and African Development Bank on developing a comprehensive medium-term structural reform program.
- Once this work is finalised, the Government intends to request a longer-term engagement with the Fund under a successor Extended Fund Facility arrangement.

### Acknowledgements
- The Seychellois authorities thanked the Managing Director, Deputy Managing Director Kato and Ms. Sayeh for their support.
- The authorities extended their deepest gratitude to the IMF’s Mission Chief, Mr. Paul Mathieu, and his team for their hard work and dedication in assisting the design of Seychelles’ economic reform program.

*Source: _cr08365 - Conclusion*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08365.pdf_