Public Information Notice No. 08/138

Public Information Notice: IMF Executive Board Concludes 2008 Article IV Consultation with the Kingdom of Swaziland

October 27, 2008

On October 17, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Kingdom of Swaziland.¹

Background

Growth recovered moderately in 2007 to 3.5 percent, but inflation escalated into double digits—initially owing to high food and fuel prices. Sustained high rates of economic growth remain elusive, clouded by low investment climate, the slow pace of economic reforms, deterioration of preferential treatment of Swaziland's main exports, and arising financial sector vulnerabilities. The years of persistently low growth have led to high unemployment and rising poverty; a situation made worse by the high prevalence of HIV/AIDS that suppresses productivity.

High Southern African Customs Union (SACU) revenue contributed to the second consecutive budget surplus — despite expanded public expenditure, an improved current account and a build-up of international reserves to a comfortable level. The recent depreciation of the nominal exchange rate along with the South African rand, to which it is pegged, impacted positively on the export sector.

Swaziland's inflation rate increased from 9.8 percent at end 2007 to 13.4 percent end-July 2008, reflecting rising food and fuel prices. To mitigate the surge on commodity prices, the government uses a delayed-pass-through policy for some items. Interest rates generally have risen in line with developments in South Africa but the authorities decided in June 2008 not to match the latest 50 basis point increase by the South African Reserve Bank (SARB)

The outlook is subject to several risks: high dependence on SACU revenues, which is unlikely to be sustained; uncertainties about the viability and timing of investment projects; low competitiveness sores; an investment climate that keeps the cost of doing business high; the prevalence of HIV/AIDS; the external environment and emerging financial sector vulnerabilities.

Executive Board Assessment

Executive Directors welcomed the strengthening of Swaziland's current account balance and external reserve position in 2007. At the same time, Directors noted that Swaziland's economic growth is low by regional standards, and that poverty and social indicators remain weak. Fuel and food price shocks have also increased inflationary pressures. Directors cautioned that the global financial turmoil could add to the downside risks and the challenges posed by an HIV/AIDS epidemic and the erosion of trade preferences. Therefore, they recommended continued pursuit of sound macroeconomic policies and determined implementation of structural reforms to stimulate private sector development.

Directors commended the government's achievement of budget surpluses in 2006 and 2007. They urged continued fiscal restraint in 2008 and beyond to ensure medium-term fiscal sustainability in light of the projected decline in revenue from the Southern African Customs Union (SACU), on which the budget is heavily dependent. They welcomed the authorities' intention to save windfall SACU revenues in 2008. Directors encouraged the authorities to press ahead with revenue and expenditure reforms to achieve a sustainable non-SACU fiscal position.

Directors supported the authorities' efforts to broaden the tax base and improve tax administration, in particular through the introduction of a value added tax and the establishment of a Revenue Authority. They stressed the importance of strengthening public expenditure management and re-orienting public spending toward infrastructure and priority social sectors. The on-going enhancements to the procurement system and the forthcoming reform of the Public Finance Management Act were also viewed as crucial. Directors emphasized the need for civil service reform to lower the relatively high government wage bill and achieve better service delivery.

Directors agreed that Swaziland's membership in the Common Monetary Area and the currency peg to the South African rand continue to serve the country well. They supported the build-up of international reserves to maintain confidence in the peg. They noted the staff's assessment that the real effective exchange rate is broadly adequate at present. To improve growth prospects and compensate for eroding trade preferences, Directors encouraged the authorities to accelerate structural reforms.

Directors observed that, notwithstanding limited monetary independence and historical practice, the Central Bank of Swaziland decided in June 2008 not to increase its policy rate to match the increase in the repo rate of the South African Reserve Bank. They encouraged the Central Bank of Swaziland to monitor closely developments in inflation and capital flows, and to stand ready to adjust its policy rate as needed with a view to keeping it as close as possible to the repo rate of the South African Reserve Bank.

Directors observed that the banking sector remains well-capitalized, liquid, and profitable, with low non-performing loans. They welcomed the authorities' decision to privatize the government-owned bank. However, Directors considered the recent growth of non-bank financial institutions, with inadequate regulation and supervision, to be a cause for concern. They stressed that tighter supervision of savings and credit cooperatives is a priority for preserving financial stability. In this connection, they urged timely passage of pending financial legislation and early implementation of the Financial Service and Regulatory Authority. The emergence of pyramid schemes calls for swift and decisive actions, as such schemes pose additional risks to financial stability. Directors also encouraged increased cross-border collaboration among regional supervisory agencies. Most Directors encouraged the authorities to reconsider the requirement that insurance and pension funds invest a portion of their assets locally, noting that it could reduce return on these funds.

Directors believed that the Poverty Reduction Strategy and Action Plan approved last year provides a sound basis for reducing poverty, and advised that its implementation and monitoring strategies be clarified. They welcomed the recently-adopted measures to improve the investment climate and to minimize the impact of the erosion of trade preferences, particularly those to reduce corruption and improve governance, and encouraged further progress.

Directors welcomed the authorities' response to food and fuel price shocks. They recommended that measures to alleviate the impact of high food and fuel prices focus on the most vulnerable population and effectively utilize existing distribution channels to deliver assistance. Prompt and automatic pass-through of international price increases would also help depoliticize price adjustments.

A few Directors supported a review of Swaziland's classification as a lower middle-income country, in light of the country's weak social indicators.

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.