Mission Concluding Statement 

TUNISIA

Preliminary conclusions of the IMF 2000 Article IV mission

October 29, 2000

1. The process of reform and gradual liberalization of the Tunisian economy has contributed to a strengthening growth performance, averaging 5½ percent per year over the past five years. Encouraged by more liberal exchange, trade, and regulatory regimes, the private sector has expanded rapidly in the export and tourism sectors, while domestic demand has been sustained by the rising real incomes of a large middle class. This economic success is also the result of coherent and prudent macroeconomic policies, pursued in a medium-term perspective. Combined with progressive social policies, this approach has produced remarkable growth rates, as well as significant advances in social indicators.

I. Short-Term Outlook

2. Economic performance in 2000, and projected for 2001, confirm these trends. Despite the drop in agricultural output, due to drought conditions this year, economic activity remains robust, thanks to the growing diversification of the economy. Real GDP growth is expected to reach 5 percent in 2000 (6 percent excluding agriculture) based on solid export performance and strong domestic demand. An expected rebound of agricultural activity, as well as sustained growth in domestic and foreign demand, should push GDP growth past the 6 percent mark in 2001.

3. Although inflation has risen slightly, mainly because of higher food and petroleum prices, underlying inflation remains stable at about 3 percent per year.

4. The external current account deficit (3.2 percent of GDP in 2000) has widened relative to 1999, mainly because of a sharp increase in the volume of imports and the rise in oil prices (the energy balance is slightly negative in volume terms). The current account deficit should narrow somewhat in 2001.

II. Macroeconomic Policies in 2000

5. The fiscal deficit target set by the 2000 Budget Law is likely to be comfortably met, as supplementary spending on petroleum price supports have been offset by a significant increase in tax revenue and in some nontax revenues. The budget deficit in 2000 should thus fall to around 3.5 percent of GDP (excluding privatization proceeds and grants), down from its 1999 level of 3.9 percent of GDP.¹

6. Similarly, monetary policy is largely on target, in so far as credit and monetary aggregates have grown roughly in line with GDP (correcting for observed portfolio shifts from government bonds into time deposits).

7. The flexible approach in managing exchange rate policy, in the face of the pressures observed on the Euro, has helped to avoid an excessive real appreciation of the dinar against the Euro, and thus a loss of competitiveness on the European market. This pragmatic approach illustrates the authorities' ability to react and adapt rapidly to economic policy challenges, and constitutes an important asset in Tunisia's successful economic management.

8. In recognition of Tunisia's good economic performance, its international credit rating has improved enabling Tunisia to borrow on the international markets in 2000 at a much lower margin (130 basis points on a 10-year Yen issue) than in 1999 (280 basis points on a 10-year Euro issue). Access to international financial markets has allowed Tunisia to build up a level of reserves equivalent to three months of imports and 90 percent of short-term financial liabilities.

III. A Medium-Term Growth Scenario

9. Discussions with the Tunisian authorities focused mainly on the prerequisites for moving to a higher growth rate, consistent with a gradual reduction in the unemployment rate, which is still far too high, and with continued improvements in real wages and living standards. In this regard, the mission elaborated on the issues addressed during the May 2000 staff visit, whose conclusions are also posted on the IMF Website.

10. A macroeconomic framework reflecting these objectives is presented in the attached table. It envisages a progressive increase in real GDP growth to 6.7 percent by 2006. About half of this growth would come from productivity gains and investments in human capital. The average growth rate in employment would be close to 3.5 percent per year and the fixed investment rate would rise from the current level of 26 percent of GDP to 29 percent of GDP by 2006. Assuming an average annual increase of 80,000 people into the labor force, this scenario forecasts a drop in unemployment from 15.5 percent in 2000 to 11 percent by 2006. Achieving these objectives will call for:

• Higher growth in the volume of exports, averaging around 6¼  percent in 2001-06. Such growth will require sustained gains in market shares and consequently in competitiveness.²

• A significant decline in the fiscal deficit (excluding privatization revenues) to contain pressures on the external current account balance related to the significant growth of investment.³

IV. The Growth Strategy

11. The attainment of these objectives is closely linked to completing the transition of the Tunisian economy to a market economy fully integrated into the world economy. While the decision to open the manufacturing sector to European competition by 2008 (under the Association Agreement with the European Union (AAEU)) is a central component of this strategy, additional actions are nevertheless necessary if the anticipated productivity gains are to be fully realized.

12. These additional actions can be grouped under 3 broad areas:

(i) ensuring efficient financial intermediation and improving the credit culture, so as to mobilize private savings more effectively and allocate capital to the most productive uses;

(ii) accelerating the liberalization of the economy and its opening to the private sector in order to generate the necessary investment and productivity gains; and

(iii) pursuing labor market reforms to ensure that growth is rich in employment

13. For macroeconomic policy, the challenge is to maintain internal and external equilibria while adapting to the structural changes in the economy.

A. Public Finances

14. The pursuit of deficit reduction over the medium term in a context of declining trade tariff revenues will require addressing existing fiscal rigidities, especially as the government will need to maintain or even increase spending to modernize public administrations.

15. The main budget rigidity lies in the wage bill (11.6 percent of GDP in 2000), which is high by international standards. Pay raises and wage drift alone produce annual increases of about 5½ percent in the wage bill. The government's intention of limiting recruitment to the higher education and health sectors and, to the extent possible, to meet the demands in other sectors through redeployment of staff is a step in the right direction. However, these measures are likely to be insufficient and other instruments will have to be identified to lighten the burden of the civil service on the budget while improving its efficiency. Because of the long lead-time required for civil service reform, it would be desirable to start considering these issues as soon as possible.

16. Savings are also possible on foodstuff subsidies (0.7 percent of GDP), as the social targeting of this spending is particularly inefficient. The mission supports the authorities' intention to gradually reduce these outlays, and believes that the pause in the foodstuff price increases observed in 2000 should be considered as exceptional.

17. To offset the revenue effect of the trade tariff reductions, compensatory tax measures will have to be introduced, mainly through a broadening of the tax base. The IMF Fiscal Affairs Department is available to help the authorities identify potential reforms. Major steps in this direction were already taken in 1999, in particular by raising the minimum tax to 20 percent. The adoption of a new tax procedures code, to be introduced in early 2002, should also improve tax collection in a context of greater transparency. The mission considers that the rationalization of tax concessions (worth 1.7 percent of GDP) constitutes another avenue of reform which should be explored immediately, particularly since the segmentation between the "offshore" and "onshore" sectors is losing economic rationale in the context of trade liberalization.

18. By capping recruitment, curtailing spending on subsidies, and tightening other current spending, the draft 2001 Budget Law projects a significant reduction in the ratio of government spending to GDP in comparison with 2000. On the basis of prudent tax revenue projections, the 2001 budget deficit would decline to 3.2 percent of GDP (excluding privatization proceeds and grants).

19. Beyond 2001, the macroeconomic framework presented above will require a slightly faster pace of fiscal adjustment, with a view to offsetting the anticipated decrease in the social security fund surplus. In order to halt the structural deterioration of the balances of the social security funds, it will also be necessary to continue the reforms already started in this area.

B. Monetary and Exchange Policies

20. Thanks to prudent monetary management, which has made it possible to reduce inflation while adequately financing economic growth, the monetary authorities have built up considerable credibility. It would be desirable to institutionalize this credibility and to clarify the monetary authorities' policy objectives in order to reinforce the anchoring role of monetary policy. Posting the annual monetary targets of the Central Bank of Tunisia (BCT) on its website is an important step in this direction. It would benefit considerably from being supplemented by an analytical explanation of monetary policy and its objectives.

21. In the short run, the major challenge for the monetary authorities will be to mop up the excess liquidity that may result from a major wave of new privatizations. This will require close cooperation between the Ministry of Finance and the BCT.

22. In the medium term, the development and diversification of Tunisia's economy and financial markets should allow the BCT to rely to a greater extent on interest rates as an instrument of monetary policy. Already, with the strengthening of the banking system, it should be possible to reform the BCT's refinancing windows so as to promote the development of the money market.

23. Flexible exchange rate management remains a key element of macroeconomic policy. However, in a context of trade liberalization, developments in relative consumer prices (against those of Tunisia's trading partners) are becoming less reliable as a measure of competitiveness. In this light, the mission congratulates the authorities for having broadened the range of competitiveness indicators that they use to guide exchange rate policy and encourages them to develop other indicators, such as relative unit labor costs.

C. Structural Reforms

24. Significant progress has been made in restructuring public sector banks and in reinforcing prudential regulations in the banking sector. The capital asset ratio for the banking sector as a whole rose from 8.9 percent in 1998 to 10.1 percent in 1999 (only one bank still failed to reach the minimum 8 percent ratio). Furthermore, the level of unprovisioned bad loans was reduced to 14.1 percent of total liabilities in 1999 from over 20 percent in 1997. However, the burden of nonperforming loans is still high (20 percent of GDP in 1999) and will continue to affect the cost of financing.

25. Thanks to an improvement in the prudential framework and to the restructuring of public sector banks, the banking system is now better protected against systemic risks. However, the credit culture needs to be reinforced if the allocation of credit is to be improved and the risk of accumulating new bad loans contained. This will require greater corporate transparency, especially in the areas of accounting, financial reporting, and enterprises' ownership structures, as well as greater opening of the banking system to foreign investment (through privatizations and equity participations). Such actions would help improve and align bank and risk management practices to the requirements of a more open economy.

26. Financial intermediation should also be developed through the capital markets, which, despite measures adopted in their favor, continue to play a very marginal role in financing the economy in comparison with bank credit. The development of capital markets would be an important instrument in mobilizing both domestic and foreign savings. The authorities' determination to reform the insurance sector should help promote institutional saving and thus will be an important factor in this effort. The development of the secondary market in government paper (BTAs), which will be facilitated by the introduction of repo instruments, would also provide a boost to capital markets.

Accelerating deregulation and opening up to the private sector

27. The Tunisian economy has significant unexploited areas of productivity and growth potential, especially in the protected manufactured goods and services sectors. The mission believes that the time has come to speed up the deregulation and liberalization processes in order to realize these potential gains by:

• accelerating the privatization program;

• opening up the services sector to competition and private investors (both Tunisian and foreign);

• liberalizing foreign trade on a broader (MFN) basis; and

• simplifying the administrative and regulatory regimes.

28. Some action has already been taken or is underway in these areas, such as the introduction of a single filing system (liasse unique), which should considerably simplify customs clearance procedures. The mission also congratulates the authorities for having lowered by 20  percent customs duties under the MFN regime on some goods that already enjoy free trade with the European Union. It encourages the authorities to continue the liberalization of the MFN regime in parallel with the process of trade liberalization with the European Union.

29. While the privatization and liberalization of the services sector, including through concessions, has continued, the pace has been too slow relative to the existing potential. In this regard, the mission noted with satisfaction the decision to embark on a broad program of liberalization and privatization over the next twelve months. Its implementation should create a critical mass of reforms providing a significant boost to growth and investment.

30. Opening the economy to private sector activity should be all the more effective given the major efforts that have been made to raise the competitiveness of Tunisian enterprises, to improve their management and to increase their intangible investments.

Labor market

31. The mission noted with satisfaction the absolute priority given by the authorities to the issue of employment, which will also be the key challenge for the Tenth Economic and Social Development Plan (2002-06).

32. If growth is to be as rich in employment as in higher productivity, it will be necessary to improve the match between the skills offered and demanded in the labor market. To that end, the government has deployed an impressive array of measures and resources in the form of active labor market policies and training programs.

33. In a market-driven economy, it is also important that the labor market be sufficiently flexible to respond to shifts in labor demand. The mission encourages the authorities to ensure that the labor code meets this requirement. To facilitate the redeployment of resources and the integration of the labor force into the fastest-growing sectors and enterprises, the mission also feels that greater intersectoral and inter-enterprise flexibility will be needed in the wage-setting process.

V. Other Comments

34. The mission congratulates the authorities for the initiatives they have taken to increase the transparency of their economic policies and, in particular, for their decision to continue publishing the preliminary conclusions of the missions as well as the Article IV staff report.

35. The mission takes due note of the efforts made by the authorities towards subscribing to the IMF's Special Data Dissemination Standard (SDDS), which is expected to occur early next year.

36. It also warmly congratulates the authorities on their decision to take part in the Financial Sector Assessment Program (FSAP) in 2001.