Public Information Notice No. 05/5

Public Information Notice: IMF Concludes 2004 Article IV Consultation with Sierra Leone

January 19, 2005

On November 12, 2004. the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Sierra Leone.¹

Background

The authorities have been implementing wide-ranging structural reforms and pursuing prudent macroeconomic policies, supported by the PRGF arrangement since 2001. With enhanced economic and political stability, real GDP growth has picked up while inflation has remained moderate. During 2003, the economy enjoyed a robust recovery, reflecting robust activity in agriculture, mining, manufacturing, and services, but inflation accelerated. Average inflation in June 2004 reached 12 percent.

Further progress was made in 2003 towards completing Sierra Leone's post-conflict transition. The government concluded the disarmament, demobilization, and reintegration (DDR) exercise in February 2004. Security in neighboring Liberia has improved and will enhance stability in Sierra Leone.

Growth prospects in the medium term are encouraging, largely based on some mining projects coming to fruition, agricultural expansion, and service-related activities. Real growth is projected in the range of 6-7 percent in 2005-07 (with higher growth in 2005 led by mineral exports), reflecting these activities in the country's post-conflict phase. Inflation is expected to revert to low single digits, while the current account deficits would narrow, aided by growth in mineral exports. The projected strong growth will, however, still leave Sierra Leone quite far in terms of achieving the MDGs.

The authorities' overall medium-term strategy for promoting growth and reducing poverty focuses on six key strategic areas: continued strengthening of state security; aiming at a more sustainable fiscal position; raising domestic savings and investment; strengthening infrastructure; agricultural and rural development; and the promotion of the private sector.

Fiscal performance in 2003 was somewhat weaker than envisioned, largely due to domestic expenditure overruns. External program financing (5.5 percent of GDP in the original program) only materialized at slightly over 3 percent of GDP. This led to much larger than programmed domestic financing of the budget, especially from the banking system. Poverty-related outlays were above the programmed level. Fiscal pressures continued in the first quarter of 2004. While the government made an effort to scale down its outlays, this was insufficient to offset the large shortfall in external non-HIPC grants and program loans. Therefore, domestic financing of the budget exceeded the program target by a large margin.

Monetary policy in 2003 was expansionary, as Bank of Sierra Leone allowed private sector credit to continue growing at a rapid pace. Monetary policy also accommodated the expansionary fiscal policy. Treasury bill interest rates began to rise in late 2003 in response to inflation expectations and large government borrowing. As a result, broad and reserve money growth rates were higher than programmed for the year as a whole. A rapid monetary growth has continued in 2004.

The external current account weakened further in 2003. While export performance during the year improved, particularly for diamonds, imports remained high due to continued expansion in reconstruction activities and the high cost of fuel. Gross official reserves fell to 1.5 months of imports, which was well below the program level. The real effective exchange rate depreciated by 17 percent in 2003, partly reflecting the high foreign-exchange demand of the private sector as a result of higher oil prices.

Debt relief agreements with most official creditors have been reached, but there has been little progress with commercial creditors. Debt relief agreements on Naples terms have been signed with Paris Club creditors except Japan, and seven out of eleven agreements on Cologne terms have been signed. Significant reduction in the NPV of debt to exports is expected after Sierra Leone reaches the Heavily Indebted Poor Countries (HIPC) completion point. All non-Paris Club official creditors have agreed to deliver debt relief, or indicated their willingness to do so, even though the terms in some cases fall short of what is expected under the HIPC Initiative. The authorities have also requested the World Bank for a debt buyback operation under the International Development Association facility in order to continue addressing the problem of commercial debt arrears.

The authorities have completed the first draft of the full Poverty Reduction Strategy Paper (PRSP) and have indicated that a final version of the PRSP would be ready by end-2004. The exercise to prepare the document had been undertaken in broad consultation with various sections of society.

Executive Board Assessment

Executive Directors commended the authorities on concluding the disarmament, demobilization, and reintegration (DDR) exercise for over 72,000 former combatants in February 2004, which led to a significant improvement in the security situation of the country. Directors welcomed the United Nations' decision to maintain a presence in the country at least until mid-2005, thus providing additional time for the Sierra Leonean government to train and equip its police and military forces.

Directors noted that Sierra Leone's economic recovery had been broad-based, reflecting improved business confidence. Significant output gains had been made from post-conflict low levels, especially in agriculture, mining, manufacturing, and services. Real output in 2003 is estimated to have increased by 9.3 percent. However, Directors expressed concern that inflation had accelerated resulting initially from higher fuel costs, but later also reflecting expansionary monetary policy and a depreciating currency.

Directors supported the authorities' overall medium-term strategy for sustaining high growth and reducing poverty. The strategy focuses on the strengthening of state security; the attainment of a more sustainable fiscal position; raising savings and investment; strengthening of infrastructure; agricultural and rural development; and the promotion of the private sector. Directors also endorsed the authorities intention to maintain a floating exchange rate system, given the open economy and the need to maintain a competitive external position.

Directors encouraged the authorities to continue addressing structural reforms and governance issues with the aim of attracting both domestic and foreign investors. In this context, Directors welcomed the finalization and imminent adoption of the new investment code. They also commended the authorities on expressing interest in participating in the Extractive Industries Transparency Initiative (EITI), which would address governance concerns and enhance the transparency of reporting on mineral revenues. Looking forward, Directors pointed out that the main risk to the medium term growth strategy lies in the area of saving and investment; therefore, the policy and institutional measures required in this broad area would remain critical.

Directors broadly endorsed the macroeconomic objectives and policies for the remainder of 2004. They concurred with the need to tighten fiscal policy to bring domestic expenditures, excluding as much as possible poverty related expenditures, closer to projected resources. In order to reduce inflationary pressures, Directors also emphasized the need to maintain an appropriately tight monetary policy, including the authorities' planned reduction in government borrowing from the banking system in the second half of the year.

In light of the proposed policy framework for the remainder of 2004, Directors granted waivers for (i) the ceiling on net bank credit to the government, which was exceeded after adjusting for the shortfall in the external program support, (ii) the introduction of new personnel management regulations, which was not introduced by end-May 2004 as envisaged, pending the finalization of a new employment scheme for senior civil servants, and (iii) reconciliation of fiscal and monetary data for 2000-02, which was not completed by the end-May 2004 deadline, as the provision of Fund technical assistance was not forthcoming as projected. In addition, Directors agreed to extend the arrangement for a three-month period.

Directors commended the authorities on the completion of a comprehensive first draft of the full PRSP, which was produced by a relatively broad based national participatory process. Given the requirement to implement the full PRSP at least a year before reaching the HIPC completion point, which is envisaged for end-2005, Directors urged the authorities to complete the PRSP document by end-December 2004. Directors also recommended that the full PRSP serve as an active vehicle for pursuing medium-term objectives as well as the longer term MDGs.

Directors commended the authorities for the progress made in implementing the recommendations of previous statistics technical assistance missions. To further enhance the surveillance of the economy, they urged the authorities to continue their efforts to improve the statistical base, especially the national accounts, through Fund and other technical assistance.