Public Information Notice No. 07/133

Public Information Notice: IMF Executive Board Concludes 2007 Article IV Consultation with Guinea-Bissau

November 8, 2007

On September 17, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Guinea-Bissau.¹

Background

Guinea-Bissau faces enormous challenges after nearly a decade of conflict, political instability and withdrawal of donor support. For most of the recent period, economic activity has remained sluggish with real GDP growing by less than half its pre-conflict levels. The fiscal balance has widened sharply—-mainly because of an increase in the wage bill—while spending on health and education remained lower than the regional average. External assistance dwindled at the same time, leading to mounting domestic arrears and an unsustainable external debt position.

Since mid-2004, Guinea-Bissau has made important strides in overcoming the effects of this protracted period of instability. Nevertheless, Guinea-Bissau remains a fragile post-conflict country. Despite attempts to rebuild the government's administration and address economic problems, continued tensions among the major political parties, frequent changes in government, and lack of accountability and ownership of policies have worsened economic conditions.

Economic activity in 2006 was weaker than expected, as the terms of trade deteriorated because of lower world prices for cashew nuts—Guinea-Bissau's main export—and rising international oil prices. Real GDP growth was less than 2 percent in 2006, down form 3.5 percent in 2005. Government intervention in price-setting in the cashew market, which disrupted the export supply chain, also hurt economic growth and cashew exports. As a consequence, the external current account deficit (excluding grants) widened significantly in 2006 even though private remittances surged. Inflation remained subdued, with the consumer price index increasing by an average of 2 percent, down from 3.4 percent in the previous year.

The fiscal stance severely deteriorated in 2006, reflecting a breakdown in fiscal controls. Weak management led to expenditure overruns, particularly in travel and representation costs, as well as large unbudgeted expenditures, including payment of (unaudited) domestic arrears of previous years, and excessive incentives paid to tax collectors. The wage bill shrunk by almost 1 percent of GDP, but was higher than initially projected due to delays in implementing planned civil service reforms. Shortfalls in expected donor support exacerbated cash flow difficulties, and the government resorted to short-term borrowing from commercial banks and issuing treasury bills. These borrowings were insufficient, however, and large additional domestic arrears were accumulated by the year's end.

Financial activity expanded in 2006 with the opening of three new banks, bringing total banks in the country to four. However, despite an increase in bank deposits, financial intermediation remained low even by regional standards: credit to the public and private sectors was just 5 percent of GDP in 2006. As elsewhere in the region, banks are very liquid as the lack of profitable projects has left financial institutions with excess reserves. A large informal sector, lack of proper financial accounting in most firms, insufficient collateral, and banks only located in the capital Bissau are key obstacles to expanding bank lending.

Public debt is unsustainably high, and rapid accumulation of domestic arrears has stifled economic activity. Guinea-Bissau would remain at high risk of external debt distress even after possible HIPC and MDRI debt relief, while additional donor support is needed to reduce the outstanding domestic debt burden. Total public debt including arrears amounted to 436 percent of GDP in 2006, and scheduled annual debt service was about 58 percent of total government revenues during the same year.

Cashew marketing arrangements are expected to normalize in 2007 and should help economic activity rebound. Real GDP growth is projected at 3.7 percent. Inflation is expected to remain below 3 percent, in line with the West African Economic and Monetary Union (WAEMU) convergence criteria. The current account deficit is projected to narrow to 13.9 percent of GDP in 2007, down from 21.4 percent in 2006, reflecting higher exports of cashew nuts, including from last year's harvest.

The fiscal stance is expected to deteriorate further in 2007. The government's cash flow difficulties worsened in the first half of the year, as fiscal controls weakened further and donors continued to delay much-needed assistance. Tax revenues have been lower than expected in the part of the year. Moreover, delays in concluding a new fishing agreement with the EU has resulted in postponement until 2008 of sizeable annual compensation expected in 2007, and government revenues are now projected some 4 percent of GDP lower than in 2006. Debt service due in 2007 on treasury bills and (uncollateralized) commercial borrowing contracted in 2006 are also adding financing pressures to the budget.

Faced with the extremely difficult fiscal situation and a large financing gap estimated for 2007, the new government implemented in April an emergency program to restore fiscal stability. The action plan envisages policy measures to increase fiscal revenues and restrain expenditures, as well as measures to improve financial management, enhance supervision and monitoring, and address some financing weaknesses. While some measures in the emergency program will have limited quantitative impact in the short run, they have important medium-term implications and signal the government's commitment to reverse the macroeconomic situation in 2007 and beyond. Donors have signaled their support for these measures and have begun to disburse earlier pledges. However, significant additional external financing is needed to close the 2007 financing gap and avoid substantial further domestic arrears.

Executive Board Assessment

Executive Directors commended the authorities for the progress that has been made in overcoming the effects of a long period of political instability in Guinea-Bissau, and they welcomed in particular the emergency fiscal program adopted by the new government. At the same time, the economy and institutions of government remain extremely fragile. Directors considered that the authorities' most immediate priorities should be to re-establish fiscal controls, improve economic management, enhance confidence, and promote further donor support.

Looking ahead, Directors noted that the main challenge will be the implementation of structural reform policies that will lay the basis for sustained growth and external viability, and for an improvement in the standard of living of the population and a reduction in poverty. Directors underscored the need to enhance the investment climate in order to foster private sector development, in particular by strengthening governance.

Directors considered that the new fiscal program is a promising start to restore fiscal stability and transparency and support the needed improvement in fiscal performance. They looked forward to its rapid implementation, in particular the introduction of measures to prevent extrabudgetary spending. Directors recommended that the Treasury Committee be made fully operational, in keeping with the objective of achieving greater transparency in the management of Treasury functions. Directors observed that current levels of fiscal revenues are insufficient to cover the government's financing needs. Given the limitations on increasing revenue collections in the short term, Directors called for a reduction in the civil service wage bill to a level commensurate with the available resources. The further accumulation of domestic arrears needs to be avoided.

Directors agreed that membership in the West African Economic and Monetary Union has served Guinea-Bissau well, providing an important anchor of nominal stability. However, Guinea-Bissau's external competitiveness over the past years has been jeopardized by a weak fiscal policy, infrastructure bottlenecks, and a difficult business environment. Directors encouraged the authorities to focus on fiscal adjustment and productivity-enhancing reforms to boost growth and competitiveness within the monetary union.

Directors encouraged the authorities to reach early agreement on Emergency Post-Conflict Assistance, to be pursued in the context of a strong and credible commitment to fiscal discipline and the restoration of macroeconomic stability.

Directors observed that Guinea-Bissau will remain reliant on the support of donors over the medium term in order to reduce the outstanding domestic debt burden and achieve the country's economic and social objectives. Such support is likely to depend on the authorities' commitment to improve governance, strengthen institutional capacity, and implement key structural reforms. As Guinea-Bissau is severely debt distressed, and likely to remain so even after possible Heavily Indebted Poor Countries and Multilateral Debt Reduction Initiative relief, new financial assistance should be on highly concessional terms—preferably grants—so as not to add to the debt burden.

Directors encouraged the authorities to improve the provision of data for surveillance purposes and strengthen the statistical system. They recommended that the authorities seek technical assistance in this area.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.