Public Information Notice No. Press Information Notice No. 98/15

Press Information Notice: IMF Concludes Article IV Consultation with Cape Verde

March 10, 1998

The IMF Executive Board on February 20, 1998 concluded the 1998 Article IV consultation¹ with Cape Verde.

Background

In recent years, the government of Cape Verde has pursed an economic reform program aimed at reducing the size of the public sector and boosting economic growth by increasing the country’s export base. The accomplishments to date include (1) liberalization of most imports and prices; (2) reform of the tax system and improvements in tax administration; (3) an initial restructuring of the financial sector; and (4) privatization or liquidation of 14 important public enterprises. Although real GDP growth rose to an annual average rate of above 4 percent during the period 1992–95, unemployment remained at about 25 percent of the active population. Given the small, open economy of Cape Verde, the authorities maintained a nominal exchange rate peg to control inflation. Despite important efforts at structural reform, lax government fiscal policies during 1992–95 led to a rapid increase in public spending, an accumulation of domestic debt, and the virtual depletion of foreign exchange reserves in early 1996.

In response, the authorities tightened financial policies, and imposed import controls on 26 products in mid-1996. As a result, there was some progress in redressing macroeconomic imbalances, and the stock of international reserves began to increase; however, the economic situation remained fragile. The overall government deficit, on a commitment basis, narrowed from a peak of 16.1 percent of GDP in 1996 to 15.1 percent in 1997. Privatization receipts financed most of the deficit in 1996, while in 1997 the deficit was financed by recourse to domestic bank financing. This brought the stock of domestic debt to C.V. Esc 18.2 billion, or about 46 percent of GDP, at end-1997. Reflecting a persistent drought, real GDP growth was only 3 percent per year in 1996 and 1997. Inflationary pressures persisted, with an annual inflation rate of 9 percent during these years.

A tight credit policy was pursued during 1996 in support of a fixed nominal exchange rate and with the objective of rebuilding foreign exchange reserves; overall domestic bank credit increased by only 10 percent. In 1997, however, domestic bank credit rose by an estimated 20 percent because of a large expansion of credit to government. As a result, the exchange rate came under pressure and foreign exchange reserves began to decline.

The external current account deficit, including grants, narrowed by about 6 percentage points of GDP in 1996 to just under 7 percent, but widened slightly in 1997. Exports continued to grow rapidly, albeit from a small base, but the capital and financial account weakened, reflecting the strengthening of the commercial banks’ external position as the government deposited foreign exchange privatization proceeds in commercial banks. The quantitative import restrictions imposed in 1996 were lifted in November 1997.

The authorities made significant progress in several areas of a structural reform during 1996 and 1997. They accelerated the privatization program and made efforts to strengthen expenditure management. In addition, the government launched in 1997 a civil service voluntary departure scheme, which will enter into full operation in 1998.

Beginning in 1998, the authorities, with the support of the donor community, will undertake a major domestic debt reduction operation. To underpin this effort, Cape Verde has requested a stand-by arrangement with the IMF, which will provide the authorities and donors the means by which to gauge the country’s progress in implementing its macroeconomic program. The authorities have indicated that they do not intend to draw on this arrangement. The budget adopted for 1998 calls for a reduction of the overall deficit to less than 9 percent of GDP in 1998, which is to be entirely financed by concessional foreign borrowing. Total expenditure is programmed to decline from an estimated 54 percent of GDP in 1997 to 50 percent in 1998, with most of the reduction coming from a decline in interest payments and cuts in domestically financed capital expenditure. These expenditure reductions will be supported by administrative measures to strengthen budgetary execution.

Executive Board Assessment

Directors welcomed the authorities' continued efforts in implementing structural reform and economic liberalization measures since 1992. However, Directors emphasized that such measures would be effective in providing a basis for sustainable growth only if they were accompanied by persistent sound financial policies aimed at restoring macroeconomic stability. Directors welcomed the renewed impetus given to these efforts to strengthen structural reforms and improve the climate for private sector growth. They supported the pursuit of these policies in the context of a IMF arrangement.

Directors welcomed the reduction in the overall fiscal deficit envisaged in the government budget for 1998. In their view, this was a key element of Cape Verde's economic program. They cautioned that close monitoring of the budget would be necessary to ensure its successful implementation, and urged the authorities to put in place in the near future administrative reforms aimed at improving budgetary control. Directors noted that the recovery of debt from public enterprises represented an important part of the fiscal improvement expected in 1998 and thus needed to be pursued forcefully. In future years, stronger efforts would be needed to reduce current government expenditure, especially the wage bill. Directors welcomed the domestic debt reduction operation being supported by Cape Verde's donors.

Directors observed that the openness of the Cape Verdean economy, its dependence on emigrant remittances, and the underdeveloped tools of monetary policy available to the central bank suggested that a nominal exchange rate peg would continue to provide an appropriate nominal anchor. However, they stressed the need for the authorities to pursue strong fiscal and monetary policies in order to ensure the sustainability of the exchange rate.

Directors emphasized the importance of accelerating the ongoing structural reform program to foster sustained economic growth. They also underscored the urgent need for improvements in Cape Verde's statistical system.