More on the IMF report 2005
RECOMMENDED SOLUTIONS TO
Last week we published in full the memorandum from the Executive Board of the International Monetary Fund, which shows that the IMF directors are extremely concerned with the state of affairs and the lack of any concerns from our Government over the years even though there are clear evidence of decline in the economy. This week we publish below the first part of a comprehensive list of policy recommendations from the IMF to solve the ongoing but worsening economic problems on a long term basis:
III Policy Discussions
A. Challenges and Medium-Term Outlook
14. The medium term outlook focused on the key challenges for the authorities, which remain to tackle the existing macro economic and reinvigorate growth, by taking early and decisive action on exchange rate liberalization, addressing the debt overhang, and reducing the role of the state in the economy. Staff encouraged the authorities to initiate a comprehensive reform process promptly, so as to prevent a further deterioration of the economy. The authorities indicated that they agreed in principle and reiterated their commitment to reform, but noted that major policy initiatives(including addressing the exchange rate overvaluation) would be difficult to implement before the upcoming presidential and National Assembly elections, due no latter than September 6, 2006. They also noted their preference for a slower pace of reform, mindful of social cohesion. In the meantime, the authorities would continue to pursue their strategy of attracting new FDI in the high-end tourism sector, by granting them tax concessions and providing shelter from the foreign exchange allocation constraints. This would generate additional employment opportunities, as well as positive spillovers to other sectors of the economy.
15. In the absence of policies to address the aforementioned challenges, the medium-term outlook would be characterized by further economic decline and increased susceptibility to shocks that could undermine past achievements. Under unchanged policies, real GDP growth would continue to decline in 2006 and beyond, imports would remain compressed, investment would remain low, and private sector credit would shrink. Public debt would remain unsustainable, as the fiscal stance would not be sufficiently tight to bring about any significant reduction in the debt stock (public debt would reach 204 percent of GDP by 2010).Roll-over risk would be significant, as domestic financing needs would imply net annual issues of government securities equivalent to about 7 percent of GDP from 2007 inwards. External arrears would keep accumulating and gross reserves would remain at about four weeks of imports (Table 8)..The economy would also remain vulnerable to external and policy shocks.
16. The staff presented a comprehensive reform program that, if implemented would help bring about a resurgence of economic growth and lead to a sizable decline in public and external debt. The adjustment scenario is premised on (i) an upfront exchange rate adjustment, followed by a gradual move towards its equilibrium market value; (ii) supportive fiscal and monetary policies; and (iii) further economic liberalization. Under such a scenario, GDP growth would rebound to about 8 percent in 2007 as confidence returns, private investment increases, and domestic production reaches higher capacity, given the greater availability of imported inputs. The boost in competitiveness would allow
17. The Main risks to the adjustment scenario are a partial implementation of exchange rate and fiscal measures, a smaller-than-expected growth response, and an unwinding of balance sheet vulnerabilities caused by the devaluation. The authorities might be reluctant to allow for the full adjustment of the exchange rate to the market equilibrium to take place due to concerns about adverse inflation and welfare effects. Such partial implementation would fail to instill confidence and restore competitiveness, leading to lower FDI inflows and a weaker current account response. The fiscal effort required to generate the projected reduction in public debt is also high demanding. The authorities noted that the required primary surpluses might be difficult to achieve, as they would necessitate drastic expenditure adjustment in the face of higher spending on imported goods and services. They also expressed doubts regarding the extent of the response of the private sector, and of overall growth, to the adjustment package. In addition, the devaluation would likely exacerbate currency risk in the public sector and interest rate in the financial sector. (Box 3).
18. Although the implemen-tation of the adjustment scenario would place public debt on a steady downward path, it would remain at a precarious level for many years. Whereas under the baseline scenario, external and public debt remain high, with explosive dynamics potentially triggered by a range of shocks, in the adjustment scenario public and external debt continue to trend downward under most plausible shocks (Box 4, and tables 9-12).” However even assuming full implementation of the adjustment packages, total public debt would still be at about 130 percent of GDP by 2010.
19. The concurrent impleme-ntation of a comprehensive debt strategy would therefore be needed to bring public debt to a sustainable level. As suggested by the authorities, the strategy could include enhanced liability management through targeting early repayment of the more costly collateralized obligations. At the same time, the authorities could engage in good-faith negotiations with external creditors. On the domestic debt front, operations to progressively lengthen the maturity of domestic public debt would provide cash-flow relief, but the impact of any domestic debt strategy on the banking system’s capitalization would need to be carefully considered, as all six commercial banks have large exposures to government instruments, ranging from 45 to 85 percent of total assets.