Public Information Notice No. 05/112

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with the Union of the Comoros

August 12, 2005

On July 18, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Union of the Comoros.¹

Background

Following a number of secessionist moves since independence in 1975, Comoros² overwhelmingly approved a new constitution in December 2001. The constitution provides for wide-ranging autonomy to the islands, but relies on the establishment of by-laws for the definition of specific decentralization arrangements, including on financial autonomy and the civil service. After a number of failed attempts, on December 20, 2003, a Transition Agreement on elections and critical arrangements for economic management was reached under the auspices of the African Union. The agreement was strongly supported by the international community gave rise to the establishment of a multidonor trust fund for the implementation of the transitional arrangements. Elections for the island assemblies and the national assembly were held in March and April 2004.

Significant progress has been achieved with national reconciliation and with inter-island cooperation. In early 2005, the Union Assembly adopted the organic law on the delineation of responsibilities and the law containing the revenue-sharing rules, as well as a consolidated budget for 2005. The rotation of the Union Presidency envisaged, in the constitution, is due in 2006.

Economic growth during 2004 remained lackluster, with real GDP per capita declining a further 0.8 percent, due primarily to crop and animal diseases, and to a decline in vanilla production as a result of the collapse on world prices. Inflation increased to 4.5 percent, from 3.8 percent in 2003 essentially due to higher prices for petroleum products and to buoyant domestic demand fueled by a surge in private transfers from abroad. The sharp increase in private remittances, due to an increase in emigrant visits following the availability of direct flights to Europe in the summer of 2004, also more than offset a worsening of the trade deficit, and contributed to an improvement in the external current account in 2004. The deterioration of the trade deficit was essentially linked to a fall in vanilla exports and the higher fuel import prices. The Comoros' foreign reserve position remained at 11 months of imports of goods and services.

Fiscal policies resulted in a primary deficit for the consolidated Union and island governments of 0.5 percent of GDP in 2004, a deterioration of one percent of GDP. The non-implementation of the revenue-sharing agreements between the islands at the beginning of the year, and the lack of administrative capacity following the devolution of tax collection competencies to the island governments, contributed to a decline in domestic revenue as a percent of GDP. Moreover, the wage bill increased significantly due to hirings associated with the new Union institutions, and outlays for goods and services increased as well. The overall deficit (commitment basis, excluding grants) improved by 2 percent of GDP, to 4.4 percent of GDP, on account of substantially lower foreign-financed investment spending. The deficit was financed by a further accumulation of domestic and external arrears. The external debt, at more than 400 percent of exports of goods and services in net present value terms, is not sustainable. It has been accompanied by a continued accumulation of payments arrears.

Monetary policy remained narrowly circumscribed by the Comoros' membership in the Franc zone and the related fixed exchange rate vis-à-vis the euro. These arrangements have provided a firm monetary anchor for the country and imposed a coherent framework on the management and operations of the central bank, including a strict limit on lending to the government.

While there are virtually no quantitative trade restrictions, tariff levels on imports in the Comoros are relatively high by international and African standards. However, given the virtual absence of local production of most goods concerned, virtually all tariffs serve revenue purposes and are not an expression of protectionist policies of the government.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They were encouraged by the consolidation of political stability in the Comoros, and stressed that continued inter-island cooperation will remain key to improving macroeconomic performance and social conditions, as envisaged under the staff-monitored program. Directors underscored the importance of a successful implementation of the program for establishing the conditions for strong economic growth and progress towards the Millennium Development Goals, and laying the basis for a PRGF-supported program and eventual participation in the Enhanced HIPC Initiative.

Although the growth outlook has improved, Directors were disappointed at the lackluster performance of Comoros' economy in 2004 and early 2005, and the continued low level of most social indicators. They acknowledged the adverse impact of the plunge in international vanilla prices, which has resulted in a major terms of trade loss that has been further aggravated by the rise in prices for imported fuel products and led to a deterioration in the external trade balance. Directors stressed that addressing the daunting challenges, which the Comoros faces, will require decisive reform efforts to diversify the economy and take advantage of Comoros' potential in agriculture, tourism, and fishing, along with sound fiscal policies.

Against this backdrop, Directors observed that implementation of the staff-monitored program has been mixed so far. They took note of the fiscal requirements of the new constitution as well as the impact of oil price increases and the decline in the international price of vanilla. While progress has been made in a number of important areas, Directors expressed concern about the early fiscal policy slippages, in particular the failure to keep the wage bill within the program envelope and the accumulation of sizeable arrears. They also noted the seasonally low level of revenues in the early part of the year. Directors welcomed the authorities' decision to take corrective actions in order to observe the fiscal targets, and urged their full implementation, including the containment of wage pressures and arrears, to ensure a satisfactory performance under the program. While recognizing that the program will remain subject to a number of risks, Directors noted the strengthening of ownership at both the central and island level which should also help mobilize increasing support of the international community.

Directors welcomed the progress made on fiscal reforms that will help set the public finances on a sound footing. In particular, they commended the adoption of the revenue sharing mechanism between the islands. To consolidate the fiscal position, Directors encouraged the authorities to work toward the early completion of their reforms of customs administration, public procurement, and strengthening expenditure control. Efforts to strengthen and diversify fiscal revenue, including the introduction of a broad-based consumption tax, will also need to be continued.

Directors underscored the importance of faster progress on structural reforms that will be key to enhancing the supply response and competitiveness of the economy, and supporting economic diversification. They urged the authorities to step up implementation of their program for public enterprise reform and privatization, and to enhance efforts to improve the business environment in order to foster private sector development and investment. Directors supported the priority accorded by the authorities to reforming the judiciary and improving governance. They looked forward to close cooperation between island governments to accelerate structural reforms.

Directors commended the authorities on their endeavors to update the 2003 Interim Poverty Reduction Strategy Paper (I-PRSP), and stressed its importance as a means to consolidate national dialogue and island cooperation. They noted that the Strategy Paper would benefit from better coverage of social indicators and tracking of pro-poor public expenditure. Better targeting to the specific needs of the islands will also be important.

Directors noted that Comoros' membership in the Franc zone has provided a firm monetary anchor and contributed to low inflation. At the same time, however, they stressed that the loss of external competitiveness over recent years underscores the need for consistently prudent macroeconomic policies, as well as progress with structural reforms. Directors also underscored the importance of preserving the independence of the central bank, including by maintaining tight limits on monetary financing of the budget.

Directors called for further steps to strengthen and develop the financial sector. The high loan concentration to the vanilla sector should be monitored carefully, and Directors emphasized, in this connection, that regulatory supervision should be extended to the two microfinance institutions. Directors also were of the view that the Postal Company should extend its financial services only after proper training of its staff. They stressed the need to act expeditiously on restructuring the Comoros Development Bank. Directors also encouraged the authorities to ensure implementation of anti-money laundering laws, and to consider steps to facilitate the transfer of remittance flows through the financial system.

Directors underscored the importance of continued efforts to address the country's heavy external debt burden and its vulnerability to external shocks. This will require particular attention to prudent debt management policies, including a strategy to clear external arrears, and measures to foster export growth and diversification. Directors urged the authorities to persevere in their efforts to strengthen their track record of policy implementation with a view to prospective debt relief under the Enhanced HIPC Initiative.

Directors encouraged the authorities to maintain strong efforts to improve the quality and timeliness of statistical data, including by drawing on technical assistance.