Public Information Notice No. 04/138

Public Information Notice: IMF Executive Board Concludes 2004 Article IV Consultation with Guinea-Bissau

December 10, 2004

On November 19, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Guinea-Bissau.¹

Background

Guinea-Bissau's per capita income of US$185 and its ranking among the ten lowest countries on the Human Development Index place it among the poorest countries of the world. Following independence in 1974, centrally planned policies led to high external debt, inefficient public enterprises, and stagnating economic growth. Structural reforms toward a market-oriented economy in the mid-1990s were supported by a Staff Monitored Program (SMP) (1993-1994) and under the Enhanced Structural Adjustment Facility (ESAF) (1995-1998). Despite good economic progress during that period, serious governance issues led to an armed conflict during 1998-99 that caused widespread destruction. In 1999 and 2000, the Fund assisted the authorities' post-war reconstruction effort through Emergency Post-Conflict Assistance (EPCA). The EPCA was succeeded by a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF), which was approved by the Executive Board in December 2000. At that time, Guinea-Bissau also reached the decision point under the enhanced Heavily Indebted Poor Countries (HIPC) Initiative. However, the PRGF-supported program went off-track in early 2001 and expired at end-2003 without the IMF concluding a review, and interim debt relief of the Fund stopped after 2001.

Guinea-Bissau's economic performance has weakened substantially in recent years. Real GDP declined by 7 percent in 2002 and was flat in 2003. Structural reforms stalled after the war and the private sector remained incapacitated because of the destruction of equipment and infrastructure caused by the conflict, and the loss of stocks due to confiscating and looting. This situation was exacerbated by donors' decision to suspend budgetary support, including for two key post-conflict programs—demobilization and re-insertion of ex-soldiers (PDRRI) and clearance of domestic supplier arrears (DASP)—after the PRGF-supported program went off-track and amid serious governance concerns.

The fiscal situation has deteriorated drastically in recent years. Following an initial windfall after the conflict, revenue declined as the economy stagnated, prices fell for the main export product, cashew nuts, and technical capacity in revenue collection weakened. Public sector employment increased sharply after the conflict, which was compounded by a general wage increase in 2000, and expenditure management weakened amidst increasing extra budgetary expenditure. As a result, in addition to external arrears, the budget started accumulating domestic arrears, including, especially after mid-2002, in wages.

In 2003, the external current account deficit, excluding official transfers, halved relative to the previous year, to 6.7 percent of GDP, reflecting higher cashew nut exports and stagnating imports. The terms of trade deteriorated slightly (by 1.5 percent) in 2003, owing mainly to higher import prices for petroleum products. Due to low domestic inflation, the real effective exchange rate depreciated slightly.

Guinea-Bissau is a member of the West African Economic and Monetary Union (WAEMU) and monetary and exchange rate policy is conducted at the regional level for the zone as a whole. The Central Bank for West African States (BCEAO) reduced the discount rate from 6.5 percent since 2002 to 4.5 percent in March 2004, in response to the fall in inflation, the decline in interest rates in the euro area, and its high level of international reserves. Two main banks did not reopen after the conflict, and Guinea-Bissau has just one bank, operating out of its only office in Bissau.

Guinea-Bissau remains one of the most heavily indebted countries in the world. Interim debt relief under the HIPC Initiative was halted by most creditors after the PRGF-supported program went off-track; however, the African Development Bank and the World Bank continue to provide interim debt relief. There are no arrears to the IMF, but debt service to most bilateral creditors continues to fall in arrears.

Executive Board Assessment

Guinea-Bissau faces enormous challenges in embarking on a path of sustained growth and poverty reduction in the face of deep-seated economic and social problems. Directors welcomed Guinea-Bissau's orderly transition in May 2004 to a government elected on the basis of a broad reform platform, which offers the best prospect in recent years for an effective return to normal economic activity.

Directors noted that continued political instability, as evidenced by the recent military rebellion, as well as adverse exogenous shocks, have contributed to depressed economic activity, widespread poverty and deteriorating social indicators, and increased macroeconomic imbalances. In addressing these problems, the key challenges for the Guinea-Bissau authorities in the period ahead will be to restore fiscal discipline, rebuild public administration, and improve the climate for private investment and economic diversification. Meeting these challenges will require a combination of peace, firm commitment to sound policies by the authorities, improved governance and transparency, and the technical and financial support of the international community.

Against this background, Directors welcomed the new government's economic program for 2004-08, which they considered a good basis for beginning to address Guinea-Bissau's problems. They endorsed the program's focus on strengthening the fiscal position and pursuing structural reforms to boost growth and reduce poverty. They were encouraged by the authorities' commitment to the program, as evidenced by the initial progress made in restoring rules-based fiscal management.

Directors considered that expenditure control will be a key element of the fiscal effort in the short term. While acknowledging the importance of clearing tensions with unions and the military left by inadequate past policies, they expressed concern that the recent large increase in the budget's wage bill risks new arrears, could further squeeze already very low poverty reduction expenditure, and complicate relations with donors, who had provided emergency budget support earlier in 2004. Directors urged the authorities to seek further offsetting measures, including by rapidly following up on the civil service census to remove ghost workers from the payroll. Expenditure also needs to be re-oriented to priority areas.

Directors agreed that priority should be given to rebuilding public administration and restoring basic public services. Strengthening revenue administration and broadening the tax base as well as better expenditure management will be key elements in this effort, to be followed by the preparation and implementation of a comprehensive public sector reform program. In the meantime, the authorities should continue strong efforts to find additional resources and to reduce nonessential expenditure.

Directors welcomed the emphasis in the government's medium-term policies on boosting economic growth through structural reform. They stressed the need for rapid deregulation of the economy, which would be a low-cost measure yielding quick results. Deregulation and other structural reform will help strengthen Guinea-Bissau's external competitiveness in the context of the fixed exchange rate system of the West African Economic and Monetary Union. Other key reforms will be improving the investment code, strengthening the legal system, pursuing the privatization program, and rebuilding the banking system.

Directors welcomed the authorities' track record in remaining current on repayments to the Fund. Resolution of external debt service arrears will require resumption of debt relief in the context of the enhanced Initiative for Heavily Indebted Poor Countries (HIPC Initiative). Directors urged the authorities to engage creditors with the aim of seeking solutions to the mounting external debt service problems until they can be addressed under the HIPC Initiative. They also urged caution in further borrowing by Guinea-Bissau and increased emphasis on the use of grant financing.

Directors welcomed the government's emphasis on the importance of the Poverty Reduction Strategy Paper. They urged the authorities to ensure that the final document is based on broad domestic consultation, and stressed the importance of prioritization and costing of poverty programs.

Directors stressed that in order to overcome its serious economic problems in a reasonable timeframe, Guinea Bissau will need to rely on substantial technical and financial assistance from the international community. Noting that long-standing governance concerns had resulted in a sharp decline in such assistance, they urged the authorities to pay particular attention to implementing the governance-related reforms in their economic program. They also urged the preparation of a country-wide technical assistance plan.

Directors stressed that the Fund should remain engaged in Guinea-Bissau. Most Directors agreed that the next step in the Fund's engagement could be emergency post-conflict assistance. Considering the breadth of Guinea-Bissau's problems, such assistance would need to be part of a concerted international effort. A few Directors considered that, given Guinea-Bissau's heavy debt burden and the time that may be needed to build the foundation of a stable political framework, the issue of whether Fund financial assistance should only be in the form of a concessional PRGF, possibly preceded by a Staff-Monitored Program, should be given further consideration.

Directors welcomed the ex post assessment of Guinea-Bissau's performance under IMF-supported programs. They observed that the country's experience confirmed the importance of good governance, proper sequencing of reforms, strong ownership, and political stability for a successful Fund-supported program. Looking forward, they felt that renewed international assistance should emphasize institution and capacity building, to which the Fund should stand ready to contribute in its areas of competence, including fiscal management and macroeconomic statistics.