Public Information Notice No. 05/29

Public Information Notice: IMF Executive Board Concludes 2004 Article IV Consultation with Namibia

March 9, 2005

On February 14, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Namibia.¹

Background

Real GDP growth accelerated to an estimated 4¼ percent in 2004, after averaging about 3 percent during the preceding five years. Growth benefited from declining interest rates, as the Bank of Namibia took advantage of declining inflationary pressures and reduced its key policy rate in several steps from 12¾ percent in January 2003 to 7½ percent in July 2004. In the process, the negative interest rate differential vis-à-vis the South African policy rate was eliminated. During the period, inflation fell from around 13 percent to less than 5 percent. Namibia's per-capita growth has lagged behind that of other countries in the region and has been insufficient to generate a sustained reduction in poverty. The unemployment rate continues to exceed 30 percent, and more than one-fifth of the population is infected with HIV/AIDS.

The fiscal deficit more than doubled in 2003/04, to 7¾ percent of GDP, representing a deviation from Namibia's traditionally good record of macroeconomic stability. As a result, the public debt ratio increased by 6 percentage points, to 31 percent of GDP. The rise in the fiscal deficit reflected mainly tax administration problems, a collapse in mining taxes, and a higher wage bill. The fiscal deficit is projected to fall to 2 percent of GDP in 2004/05, as tax administration problems are being addressed, customs union (SACU) receipts experience a one-time windfall, and non-priority spending is being curtailed. The authorities reiterated their commitment to reduce their public debt ratio over the medium term to bring it close to their fiscal rule target of 25 percent of GDP, notwithstanding the sharp decline of SACU receipts projected for the second half of the decade and the new spending pressures related to the implementation of the HIV/AIDS strategy.

Namibia's external current account surplus is estimated to have risen further in 2004, to 5½ percent of GDP, to some extent reflecting a strengthening of exports to the rand area; the Namibia dollar is pegged to the rand, which has appreciated considerably. While external debt remains low, Namibia's capital account has been marked by increasing net outflows over the past few years, which has contributed to a decline in international reserves. This reflected Namibian pension funds and insurance companies seeking broader investment opportunities in South Africa's financial markets.

Executive Board Assessment

Directors commended the authorities for Namibia's continued strong record of macroeconomic stability, and welcomed the recent rise in GDP growth, decline in inflation, and strengthening of the external current account surplus. At the same time, Directors noted that per capita income growth has been slow, HIV/AIDS is taking a severe toll on the population, unemployment remains high, and income distribution is highly skewed. In addition, the recent sharp widening of the fiscal deficit has increased Namibia's vulnerability to shocks.

Directors considered that Namibia's prospects for sustaining the recent higher growth rates are favorable, provided that the authorities press ahead with the implementation of their strategy to combat the HIV/AIDS pandemic and of structural reforms to promote private sector activity. It will also be important to continue to pursue prudent macroeconomic policies. Several Directors also stressed the importance of creating private sector employment opportunities.

Against the backdrop of the deterioration in the fiscal situation in 2003/04, Directors welcomed the authorities' commitment to return to a path of fiscal consolidation and place the public debt ratio on a downward trajectory. They commended the authorities' decision to forgo a supplementary budget for the current fiscal year and to meet spending needs from the contingency in the budget. Directors observed that the projected large decline in customs union receipts and rising spending related to implementing the HIV/AIDS strategy and meeting the Millennium Development Goals call for a determined effort to curtail nonessential expenditure in the years ahead.

Directors accordingly saw ongoing efforts to strengthen expenditure planning and introduce output-based budgeting as welcome initiatives to facilitate the identification of budgetary priorities and enhance the quality of expenditure. They stressed that lasting progress in containing expenditure will require firm action to reduce the wage bill and support for public enterprises, which together account for nearly half of total spending. Recent measures, such as the hiring freeze, are encouraging steps that need to be complemented by decisive action on civil service and public enterprise reforms. Directors suggested that the authorities step up their efforts to improve management of inefficient parastatals, and develop a privatization strategy. Directors also encouraged the authorities to commission an independent review and consider the consolidation of tax incentives aimed at attracting foreign investment. They welcomed the authorities' interest in a fiscal ROSC.

Directors observed that the peg of the Namibia dollar to the South African rand has served the country well given Namibia's close economic ties to South Africa. At the same time, the implications for growth and employment prospects of possible further rand appreciation underscore the importance of accelerating structural reforms to enhance the economy's productivity and flexibility.

Directors underscored the importance of ensuring that Namibia maintains an adequate level of international reserves, including by avoiding a negative interest rate differential vis-à-vis the anchor currency. They supported the authorities' efforts to develop domestic financial markets, which should provide more domestic investment opportunities to the rapidly growing pension funds and insurance companies, and help contain investment outflows. In this context, they called for reconsideration of the proposed regulatory amendments to tighten domestic asset requirements.

Directors welcomed the indications that Namibia's banking system is strengthening, but urged careful monitoring of the surge in consumer lending. They welcomed the authorities' request for an FSAP, which will provide the opportunity to evaluate their recently completed self-assessment of compliance with international banking supervision standards and to analyze other financial sector issues. Directors urged the authorities to move expeditiously in making the supervisory agency for the nonbank financial sector fully operational, and to consider prudential limits on the large equity exposure of pension funds and insurance companies. They welcomed the progress made in drafting AML/CFT legislation.

Directors noted that broad-ranging structural reforms will be key to promoting private sector activity, generating employment, and addressing income inequality. These are also the main objectives of Namibia's "Vision 2030" strategic development plan, and will require well-coordinated and targeted efforts to enhance the quality of education, broaden skills development through vocational training, strengthen the business environment (especially for small- and medium-sized enterprises), and improve access to finance. Directors also underscored the importance of enhancing labor market flexibility and ensuring that Namibia's labor costs remain competitive. They acknowledged the broad support among the government, donors, and the farmers union for an acceleration of the government's land redistribution program. Going forward, it will be important to ensure that the new expropriation policy is implemented based on transparent criteria, including to contain any negative repercussions on production and investment.

Directors commended the authorities for their commitment to trade liberalization. The new Southern African Customs Union agreement allows Namibia to participate in the custom union's policy setting and trade negotiation framework, but also requires enhanced capacity in various areas, including customs administration and statistical compilation. In this context, Directors encouraged the authorities to continue their efforts to address data weaknesses building on the significant progress achieved in recent years.