Public Information Notice No. 05/28

Public Information Notice: IMF Executive Board Concludes Article IV Consultation with The Socialist People's Libyan Arab Jamahiriya

March 8, 2005

On January 28, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Socialist People's Libyan Arab Jamahiriya.¹

Background

The Libyan economy remains largely state controlled and heavily dependent on the oil sector. Since the lifting of the UN and U.S. Libya-specific trade sanctions in September 2003 and September 2004, respectively, the pace of economic and structural reforms has picked up somewhat, with the implementation of measures aimed at enhancing the role of the private sector in the economy. However, these reforms continue to be implemented in an ad hoc and non-transparent manner.

In 2003, real GDP grew by an estimated 9 percent, reflecting a 28 percent rise in oil production and a modest 2.2 percent increase in nonhydrocarbon activities. Deflation, as measured by the official Consumer Price Index, decelerated to 2.1 percent from 9.9 percent in 2002. The avorable developments in the oil market contributed to a significant improvement in the external current account surplus, which reached 15.4 percent of GDP. Gross international reserves increased to about US$19 billion, equivalent to 22 months of 2004 imports.

The fiscal stance continued to be expansionary, with a non-oil fiscal deficit widening to 36 percent of GDP. However, reflecting higher hydrocarbon revenues, the overall consolidated surplus remained stable at about 10.5 percent of GDP. Non-oil revenue declined by 3 percentage points of GDP as a result of widespread tax evasion and low efficiency in tax collection. While capital expenditures were compressed to make room for the payment of one installment (US$1.1 billion) of the Lockerbie settlement, current expenditure, excluding the Lockerbie payment, remained high at 30 percent of GDP.

Broad money increased by 9.4 percent. As a result of the improved fiscal situation, net banks' claims on the government declined sharply, whereas credit to the economy increased by about 13 percent of beginning-of-the-year money stock, reflecting mainly credit to public enterprises. Reform measures in the money and banking area included a further strengthening of banking supervision. Also, the authorities have lowered interest rates across the board in an effort to encourage private sector demand for credit, and developed a strategy to modernize the payment system.

In 2004, economic and financial conditions continued to be favorable. Real GDP growth is estimated at about 4.5 percent, reflecting a deceleration in growth of oil production to 7.5 percent, and a real non-oil GDP growth rate of about 3 percent. For the year as a whole, the authorities expected a deflation rate of about 1 percent.

The overall fiscal surplus is estimated to have reached about 19 percent of GDP, with oil revenue estimated at 52.4 percent of GDP. However, non-oil revenue is estimated to have declined by about 1 percentage point to 7 percent of GDP, partly owing to reduced tax revenue in connection with the new tax law provisions.

Broad money is estimated to have increased by about 8.5 percent in 2004. Given the sustained improvement in the fiscal accounts, the government continued to be a net lender to the banking sector. On the external front, the current account surplus is estimated to have reached about 26 percent of GDP, while official reserves are estimated at $25 billion, equivalent to about 27 months of projected 2005 imports.

Some progress was made on the reform front. Measures taken include the adoption of laws to encourage domestic and foreign private investment, the adoption of a new tax law, the removal of customs duty exemptions enjoyed by public enterprises, the reduction in tariff rates, and the preparation of a new banking law that gives the Central Bank of Libya greater independence in the conduct of monetary policy. In addition, a privatization plan (not including the utilities, the oil and gas sector, and the air and maritime transportation sectors) was initiated in January 2004, which involves the sale of 360 economic units. Thus far, 42 small units have been privatized. In September 2004, the authorities withdrew their participation in the Heavily Indebted Poor Countries (HIPC) Initiative on grounds of lacking political support for ratification. They indicated that Libya is preparing its own debt relief plan, which they intend to discuss directly with the HIPC.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They welcomed Libya's good macroeconomic performance in 2003-04, reflecting the favorable developments in the world oil market. The fiscal and external current account balances registered large surpluses, and international reserves rose sharply. Directors commended the authorities' increased efforts, since the lifting of the international sanctions, to reform the economy, including through measures to encourage foreign investment, enhance the role of the private sector, and liberalize the exchange system and external trade.

Directors observed, however, that much remains to be done to transform Libya's economy into one that is market-based. They emphasized that Libya's large surpluses present a good opportunity to speed up economic reforms while maintaining macroeconomic stability, and they looked forward to the early establishment of the inter-ministerial economic team to coordinate policy design and reform implementation.

Directors stressed that proper planning, coordination, and sequencing of policies in the context of a comprehensive reform program will be essential for the success of the reform efforts. Such an approach will help support the high levels of investment in physical and human capital, and the efficient use of available resources required to achieve economic diversification, strong and sustained growth, and to meet the demands of the rapidly growing labor force. In this connection, Directors encouraged the authorities to reassess their one-sector-at-a-time approach to reform, although it was recognized that the pace of reform will need to carefully take into account institutional and capacity constraints. They suggested that Libya could benefit from the experience of countries that have succeeded in the transition from a centrally planned to a market economy.

Directors supported the view that the reform process should focus in the short term on developing market-based monetary instruments, restructuring the banking system, liberalizing prices, strengthening budgetary management and procedures, and reforming the subsidy system. Other reforms to create a conducive environment for more efficient economic activity, including a vigorous privatization program and the building-up of a sound business climate, require significant technical preparation and consensus building to ensure their successful implementation over a longer period.

Directors considered that improving budgetary management and expenditure control in the context of a prudent medium-term fiscal framework is key to maintaining macroeconomic stability. To control the large non-oil deficit, they highlighted the importance of strengthening the non-oil tax base, including by reducing tax exemptions, and of streamlining spending. In addition, the authorities should integrate all extra-budgetary operations into a consolidated budget under the responsibility of the Ministry of Finance, and move toward greater budget transparency.

Regarding oil revenues, Directors recommended that the substantial oil windfall projected over the medium term be largely saved, or partly used to finance human capital investment and structural reform measures, including restructuring public enterprises and the civil service. They also emphasized the need to address the rigidities arising from the mechanical distribution of oil revenues between capital and current expenditures. Directors called for the clarification of the status of the Oil Reserve Fund, and increased transparency and accountability in its operations, including through regular reporting on its accounts and their audit by an independent agency.

Directors encouraged the authorities to expedite their plan to replace the current price subsidy system with a cash subsidy, to be limited to the most vulnerable segments of the population. It will also be important to tackle the issue of implicit subsidies, and in this context, Directors welcomed the recent increase in electricity prices and recommended that the authorities gradually raise domestic petroleum product prices to international levels. The introduction of targeted social assistance would help cushion the effects of these reforms on the poor.

Directors welcomed the authorities' commitment to reform the monetary and banking sector. Key priorities will be to give the Central Bank of Libya (CBL) greater operational independence in the conduct of monetary policy, and for the CBL to increase its reliance on market-based monetary instruments, gradually liberalize interest rates, and eliminate directed credits. Directors also stressed the importance of strengthening bank supervision and ensuring adequate asset classification and provisioning, in line with international best practices. They commended the authorities' intention to privatize public banks and allow foreign banks to operate in Libya. Directors noted that there appeared to be no indication of pressure on the exchange rate. Going forward, the authorities should be prepared to adjust the peg as necessary in response to market developments and keep exchange rate policy under review as reforms progress, to help ensure the competitiveness of the non-oil sector.

Directors welcomed the authorities' commitment to privatize most state-owned enterprises, and urged them to enact a privatization law that would give the privatization agency an independent legal status and an explicit mandate. They encouraged the authorities to seek assistance from the World Bank in this area. Directors also pointed to the need to start the preparatory work to reform the regulatory and institutional framework to support the transition to a market economy.

Directors welcomed Libya's efforts to re-integrate itself into the global economy. In this connection, they urged the authorities to reassess their decision to withdraw from the HIPC Initiative.

Directors called on the authorities to increase their efforts to address the weaknesses of Libya's statistical system and to improve the timeliness and quality of economic, financial, and budget data. They encouraged the authorities to consider participation in the Fund's General Data Dissemination System (GDDS), as a useful framework for statistical development.

Directors welcomed the authorities' close collaboration with the Fund staff. In view of Libya's severe human resource constraints and weak institutions, they supported the authorities' request for technical assistance from the Fund in support of the country's economic and financial reforms, with due regard given to their absorptive capacity. They noted the importance of strengthened efforts to ensure the effective implementation of technical assistance recommendations.