Public Information Notice No. 02/76

Public Information Notice: IMF Concludes 2002 Article IV Consultation with Guinea-Bissau

July 26, 2002

On June 26, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Guinea-Bissau.¹

Background

The military conflict that took place in Guinea-Bissau from June 1998 to May 1999 caused severe damage to the infrastructure and disrupted economic activity, in addition to bringing intense hardship and suffering to the civilian population. In May 1999, the Guinean authorities set out a recovery strategy at a UN-sponsored donor roundtable in Geneva, Switzerland. Supporting this framework, the Fund's Executive Board approved a request for post-conflict assistance in September 1999. Performance under the post-conflict program was judged to be satisfactory. A three-year arrangement under the Poverty Reduction and Growth Facility (PRGF), totaling SDR 14.2 million, was approved by the Fund's Executive Board on December 15, 2000 in support of a program covering the period 2000-2003. Also in December 2000, the IMF and World Bank Boards respectively decided that Guinea-Bissau had fulfilled the conditions for reaching the decision point under the enhanced Initiative for Heavily Indebted Poor Countries (HIPC), and that the interim Poverty Reduction Strategy Paper (I-PRSP) included an appropriate preliminary analysis of poverty in Guinea-Bissau and strategies to alleviate it.

Immediately after approval, the program was found to be substantially off track. Fund missions in early 2001 found a loss of budgetary control during 2000, with large unauthorized expenditures, mainly on defense, financed by credit from the banking system, as well as by promissory notes. These problems continued during the first part of 2001, albeit less dramatically.

With the program off track, the Fund staff and the authorities agreed on a short-term macroeconomic program (STMP) for August-November 2001. However, the STMP targets were missed, owing to exceptional payouts for unprogrammed items. As a result, several performance criteria, structural benchmarks, and performance indicators for end-December 2001 were not observed, and the Fund's interim debt relief under the HIPC Initiative lapsed at end-2001.

In 2001, Guinea-Bissau suffered a substantial slowdown in economic activity, with real GDP growth estimated at 0.2 percent, as a result of a sizable loss of foreign program financing, a drop in the international market prices for cashew nuts of about 30 percent, and delays in implementing the demobilization and pre-2000 domestic arrears settlement programs and receiving the concomitant disbursements.

Discussions centered on the urgent need to establish a sustainable program for government finances, strengthen the revenue base, regain control over public expenditures, and move forward with the programs for demobilization and for the settlement of domestic arrears in an accountable and transparent manner. The authorities acknowledged that, as a result of financial operations during December 2001-January 2002, they were unable to meet obligations currently falling due. Broad understandings were reached with staff on an action plan, comprising (i) a schedule of actions to improve revenue collection; (ii) an expenditure priority policy providing clear funding guidelines for the treasury Committee of the Ministry of Finance; and (iii) a cash management plan for April-July 2002.

Delays in implementing required structural reforms have contributed significantly to Guinea-Bissau's current difficulties. Clearly, capacity limitations have added to the delays, and the authorities may need to ask supporting partners for additional assistance in this area.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They noted with concern that, as a result of the inadequate implementation of the strategy for post-conflict recovery and restoration, economic activity had failed to resume and a substantial part of expected donor assistance did not materialize. While recognizing the difficult challenges that the authorities are facing and the sharp terms-of-trade deterioration, Directors observed that ad hoc expenditure policies and a general weakening of the government finances were the main reasons for the deteriorating public services and weak economic performance.

Against this backdrop, Directors urged the authorities to reestablish sound financial management practices and steadfastly implement a strict treasury cash management plan, as a first step towards discussions on a new annual program under the PRGF-arrangement and extension of interim HIPC relief. However, they noted that fiscal performance continues to fall short in this respect. Overspending during December 2001-January 2002 had exhausted government deposits in the banking system and had resulted in a substantial new accumulation of domestic arrears, including on civil service wages. More recently, the April 2002 collective arrangement which raised the minimum wage by 75 percent and increased the wage bill to the equivalent of 13 percent of GDP, has further undermined the authorities' credibility and confidence in the economy.

Directors stressed that a demonstrated commitment to sound budgetary management will be critical to restoring policy credibility and regaining donor support. This should include a substantial strengthening of the revenue base through efforts to stop contraband trade, collect fishing license revenue from non-European Union sources, enhance tax administration, and complete the implementation of the value-added tax, in conformance with West African Economic and Monetary Union (WAEMU) guidelines.

Efforts to regain control over the government's spending program should be given an urgent priority. Directors urged the authorities to identify a core expenditure program that reflects clear priorities, consistent with the goal of reestablishing regular payment for goods and services delivered. This will require a freeze on civil service wages, hiring and promotions at the November 2001 level and a moratorium on the clearance of non-wage arrears accumulated after December 1999. The authorities should also promptly compile and verify unpaid domestic obligations accumulated during 2000-02 and develop a transparent and realistic plan for settling legitimate claims.

Noting the critical importance of restoring the integrity of the administration of public finances, Directors encouraged the authorities to provide the office of the Inspector General of Finance with the resources needed to fulfill its verification and audit tasks, including the verification of outstanding bons de virement and domestic arrears accumulated during 2000-02; and the issuance of quarterly reports on audit findings, along with a comprehensive annual audit. They also stressed the importance of allowing the Treasury Committee of the Ministry of Finance to manage the implementation of government-established policies without further political interference.

Directors commended the authorities on the progress that has been achieved in moving towards the WAEMU convergence criteria and in conforming to agreed monetary policies. However, they regretted the recent setbacks in the banking sector where two out of three banks had ceased operations, and encouraged the authorities to redouble efforts toward establishing a stable economic and political environment that would attract new entrants to the banking system.

Directors stressed that progress on the demobilization program, on the settlement of domestic arrears, and on improved management and governance of public utilities will be key to establishing a foundation for economic growth and poverty reduction. Noting that even with full interim relief under the HIPC Initiative, Guinea-Bissau will remain highly vulnerable to external shocks due to its continued dependence on cashew nut exports and unrequited transfers, Directors urged the authorities to accelerate key structural reforms that will improve the outlook for growth and employment. They highlighted, in particular, the need to address problems associated with the limited and erratic electric supply, undependable water and telecommunications services, the weak commercial banking sector, and the weak economic and judicial institutions. In view of the capacity limitations, Directors recognized that Guinea-Bissau will need technical assistance in these areas.

Directors commended the authorities on the comprehensive consultative process that is underpinning the preparation of their Poverty Reduction Strategy Paper, and encouraged them to proceed with the design of a strong strategy to be supported by adequate monitoring mechanisms.

Guinea-Bissau's trade policy has become increasingly oriented toward regional integration, primarily through its membership in the WAEMU. Directors were encouraged by the recent adoption of the Unions' common external tariff, and looked forward to further liberalization of the trade regime, including steps to achieve full compliance with the WAEMU's tariff rate structure.

Directors underscored the importance of improving macroeconomic and socioeconomic data for macroeconomic policy formulation and monitoring and for the poverty reduction program. This will require adequate resources for the Directorate of Statistics, as well as appropriate technical assistance.

Directors encouraged the Fund staff and Guinea-Bissau's development partners to stay engaged in helping the country confront the difficult challenges which it is facing.