Public Information Notice No. 03/125

Public Information Notice: IMF Concludes 2003 Article IV Consultation with the The Socialist People's Libyan Arab Jamahiriya

October 23, 2003

On August 18, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with The Socialist People's Libyan Arab Jamahiriya.¹

Background

The Libyan economy depends heavily on the oil sector and remains largely state controlled and regulated. The authorities initiated in 2002 steps to liberalize the economy. On January 1, 2002, the dual exchange rate system was unified at a fixed rate of LD 1 = SDR 0.608 and the foreign exchange rationing and import licensing requirements were eliminated. Economic developments in 2002 were impacted by these developments and by the accommodating fiscal and credit policies, in an environment of continuing high oil prices. Real non-oil GDP grew by about 3 percent and deflation continued with a 9.8 percent decline in the consumer price index (CPI). The external current account shifted to a deficit for the first time since 1998, and gross official reserves decreased slightly to about US$13.7 billion (18.7 months of imports).

The fiscal stance remained expansionary in 2002, with the non-oil overall fiscal deficit widening to 32 percent in 2002 from about 29 percent of GDP in 2001. Expenditure growth in 2002 was driven by budgeted capital expenditure growth of 3.2 percent of GDP, mainly on development projects in communications, construction, health, housing, and education. On the revenue side, oil revenue in Libyan dinar terms was boosted by the large devaluation of the official exchange rate at the beginning of 2002. However, tax revenue decreased and customs revenue stagnated despite a surge in imports, mainly as a result of widespread exemptions granted to public enterprises. The overall consolidated budget position registered a surplus of 4 percent of GDP.

The monetary outcome continues to be determined by the non-oil fiscal deficit and a system of directed credit. The government took advantage of the higher oil revenue in Libyan dinar terms to become a net lender in 2002 relative to the banking sector, from a position of net borrower in 2001. Broad money growth decelerated from about 20.5 percent in 2001 to about 5.3 percent in 2002. There was some progress in the banking sector reform agenda with a number of measures adopted to strengthen banking supervision. Two new private commercial banks and one private regional bank were licensed in 2002 and preparations are under way for the privatization of a public bank. Another commercial bank is being considered for privatization. A committee to examine the restructuring of banks was established in 2002.

The authorities were receptive to the Fund's policy advice and implemented important measures recommended by the staff, including the elimination of the Great Man-Made River (GMR) exchange tax, which is levied only on private foreign exchange transactions, and the devaluation of the exchange rate by 15 percent. Also, the advanced import deposit requirements were replaced by a prudential regulation limiting the use of bank credit for import purposes. In June 2003, Libya accepted its obligations under Article VIII of the IMF's Articles of Agreement.

Based on projected increases in oil prices and production, and a less expansionary fiscal stance, economic prospects for 2003 appear favorable. Real non-oil GDP is projected to expand by about 2.5 percent, while prices are projected to increase by about 3.0 percent. Strong external fiscal and current account surpluses are expected, along with a buildup in official reserves to about 24 months of imports. The key challenge facing the authorities in the medium and long term is to achieve sustainable high rates of economic growth to generate employment opportunities for a rapidly growing labor force. The authorities agreed that this goal would not be achievable without a drastic reduction in the dominant role of the public sector.

Executive Board Assessment

Executive Directors commended the Libyan authorities for the reform measures taken to liberalize the economy since the suspension of UN sanctions. They particularly welcomed Libya's acceptance of its obligations under Article VIII, Sections 2, 3, and 4 of the Fund's Articles of Agreement. Directors hoped that these decisions, following the close collaboration with staff during the mission, signal a turning point in Libya's relationship with the Fund.

Directors considered that the main challenge facing the authorities is generating sufficient growth and employment opportunities to absorb the rapidly growing labor force. They, therefore, welcomed the authorities' commitment to the gradual structural transformation of the economy, consistent with Libya's social system, and the recent steps taken toward liberalization and reducing the role of the state in the economy. These measures pave the way for improved resource allocation, enhanced efficiency and competition, and a higher level of economic growth. However, existing controls and restrictions, as well as subsidies and exemptions, continue to distort economic choices and weigh on growth and employment prospects, especially in the non-oil sector.

Directors welcomed the recent elimination of the exchange tax levied only on private foreign exchange transactions, the devaluation of the exchange rate, and the elimination of the advanced import deposit requirements. These measures simplify the exchange system and will reverse some of the appreciation in the real effective exchange rate that has taken place since 1999.

Directors were encouraged by the recent declarations of the Libyan leadership stressing the need to reform the public sector and accelerate the pace of privatization. These are indications that the process of reform has become a renewed priority, and that the slowdown in the pace of reforms following the exchange rate unification in 2002 has now been reversed.

Directors emphasized that the generally favorable medium-term macroeconomic outlook does not diminish the need to implement key structural reforms if higher sustainable growth is to be achieved. Building on the recent measures, the authorities should take advantage of the current favorable macroeconomic environment to implement at an accelerated pace more wide-ranging reforms, in the context of a coherent and well-sequenced medium-term policy framework. Directors noted the importance of prioritizing reforms and publishing the intended reform agenda.

Directors noted that, in the short run, the reform agenda should aim at improving macroeconomic management, removing remaining trade restrictions, bringing domestic prices in line with world prices, and addressing explicitly in the budget the impact of price realignments on vulnerable groups, public enterprises, and public banks. In a second stage, structural reforms that require longer technical preparations would need to be implemented, including restructuring public banks and public enterprises; reforming the system of subsidies and transfers; legal and regulatory reforms; and civil service, tax, and customs administration reforms. Efforts to align education and training with job market requirements also would help to support employment. The authorities' approach to privatization should be reassessed, perhaps with World Bank assistance.

Directors noted that fiscal policy, the key to macroeconomic stability in Libya, continues to be shaped by the availability of oil revenues. They urged the authorities to implement stricter control over all extra-budgetary funds, particularly the Oil Reserve Fund, and reassess the mechanical distribution of oil revenue between capital and current expenditures. Directors welcomed the efforts to rationalize the tax system, broaden the tax base, and strengthen tax administration. They also welcomed the less expansionary non-oil fiscal stance projected for 2003, but emphasized the need for expenditure restraint to be realistic. They urged the authorities to move toward greater budget transparency and to cast the budget within a coordinated medium-term framework that takes into account the nonrenewable nature of Libya's hydrocarbon resources.

Directors welcomed the authorities' intention to develop money markets and introduce effective instruments for liquidity management. They urged the authorities to consider establishing a permanent monetary policy committee to assess monetary developments and design a monetary policy framework.

Directors emphasized the need for prompt action to correct weaknesses in banking supervision. They welcomed the steps taken to combat money laundering and the financing of terrorism, and urged the authorities to speed up the preparation of the Anti-Money Laundering Law.

Directors encouraged the authorities to keep the exchange rate system under review with a view to encouraging domestic production of non-oil exports, in conjunction with the implementation of structural reforms. They should continue to show flexibility and stand ready to promptly adjust the rate as warranted by overall developments.

Directors encouraged the authorities to reduce tariff dispersion and remove remaining trade restrictions, by scaling down the list of import and export bans, eliminating import monopolies, phasing out bilateral payments agreements, and initiating a program of multilateral liberalization.

Directors welcomed the authorities' initiatives to integrate Libya into the regional and global economy, and their intention to enter free trade agreements with Arab countries, and to join the World Trade Organization. They welcomed the authorities' efforts to regularize relations with creditors and encouraged them to expedite the clearing of all remaining external arrears. They commended Libya's participation in the Highly Indebted Poor Countries (HIPC) Initiative, and looked forward to further progress in Libya's collaboration with debtor countries that have reached the completion point.

Directors welcomed the improvements in Libya's statistical database. They emphasized, however, that its further strengthening should be accorded a high priority. They encouraged the authorities to participate in the Fund's General Data Dissemination System. In view of the need to strengthen the statistical data and to assist Libya in the design and implementation of reforms, Directors supported the authorities' request for technical assistance from the Fund in the areas of statistics, as well as on financial programming, development of money markets and financial instruments, and tax reform.