More from the IMF Report 2005
Last week we published 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. This week we follow up with two other critical policy recommendations from the international institution.
B. EXCHANGE RATE POLICY
20. The authorities agreed in principle with the staff’s recommendation or a sizable step adjustment in the exchange rate and the establishment or a mechanism that would move the rate in a controlled manner to the market-clearing level. Given the uncertainty about the equilibrium level of the exchange rate and the extent of pent-up demand for foreign exchange, the risk of overshooting could be minimized by allowing the exchange rate to adjust in a controlled manner. Staff advised that the official exchange rate should initially be devalued, and a wide horizontal band be established around the central rate. At the same time, a clear timetable for the phased elimination of the remaining exchange controls should be announced. Such a timetable was discussed in detail with the authorities. In order to allow the exchange rate to find its market-determined level, the exchange rate should be allowed to move &eely within this band. Should the exchange rate remain at one of the edges of the band for several weeks, the exchange rate band would be re-centered at that level. Staff also encouraged the authorities to give further thought to the appropriate exchange rate regime after foreign exchange liberalization.
21. The foreign exchange controls would need to be removed in a phased manner, In order to avoid excessive pressure on the exchange rate. Priority should be given to equilibrate the supply and demand for foreign exchange for all current flows, including the transfer of current dividends and profits. A timetable for the gradual transfer of the stock of unremitted profits and dividends (at the prevailing exchange rate) would be agreed upon with the relevant enterprises.
22. The authorities expressed concerns about the welfare impact from the devaluation. In response, a recent study by the World Bank Indicates that the impact of temporarily higher inflation on poverty should be relatively small and short-lived, as initial poverty levels are low, a significant amount of transactions take place at d1e parallel exchange rate, and as growth should pick up following the implementation of the reform program. Better targeted welfare benefits would help al1eviate short-term negative impacts of the devaluation on the most vulnerable groups of the population while limiting budgetary costs.
C. FISCAL POLICY
23. The fiscal stance in 2006 will loosen somewhat. The 2006 budget aims at a slight overall deficit of 0.4 percent of GDP, reflecting a combination of tax cuts and social spending programs. Whereas trade tax revenue would be permanently lower as a result of the lower tariffs, the budgeted nontax revenue increases hinge on an ambitious projection of dividend payments by parastatals. On the expenditure side, staff warned about the impact of the reduction in public transport prices and of the new home ownership scheme on the finances of the concerned parastatals. The progressive deterioration of the Social Security Fund balance was also a source of concern.
24. A more ambitious fiscal stance win be necessary in order to place public debt on a steady downward path. The staff stressed the need for further fiscal adjustment which would target progressively increasing primary surpluses, in order for public debt to decline from 182 percent of GDP in 2005 to 128 percent by 2010. As tax collection was already high by international standards, the bulk of the adjustment should come through expenditure restraint and a redefinition of the role of the government in the economy. Whereas the size of government has tended to be proportionately larger in small countries due to “fixed costs” of operation,
25. Further actions are needed to strengthen the budget planning process. The staff
welcomed the authorities’ plans to establish a macro-fiscal unit in the Ministry of Finance that wou1d complement the current bottom-up approach to budget preparation with the specification of an overall budget envelope, based on a common set of key macroeconomic assumptions. Staff also recommended that annual budgets be formulated within a rolling medium-term fiscal framework so as to ensure consistency between fiscal objectives and other economic policies and developments.