Public Information Notice No. 06/38

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

April 10, 2006

On March 17, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Socialist People's Libyan Arab Jamahiriya.¹

Background

Since the lifting in 2003-04 of the international sanctions, which lasted more than 10 years, Libya has decided to undertake comprehensive structural reforms and accelerate its transition to a market economy. While progress has been made in recent years to liberalize the economy, it remains largely state controlled and not diversified. Three quarters of employment is still in the public sector, private investment is minuscule (2 percent of GDP), and the oil sector remains dominant.

In 2004, Libya's macroeconomic performance was satisfactory, owing mainly to higher oil prices (31 percent) and increased oil output (5.6 percent). Real GDP grew 4½ percent, while consumer prices declined (-2.2 percent). The favorable developments in the oil market contributed to a significant improvement in the external current account surplus, which reached some 24 percent of GDP. Gross international reserves rose to about 24 months of 2005 imports.

The fiscal stance continued to be expansionary, with a large non-oil fiscal deficit of 33½ percent of GDP. However, reflecting high oil prices, the overall fiscal surplus reached 17½ percent of GDP. Non-oil revenue increased by about 1 percentage point of GDP, owing to strong collections by customs reflecting increased imports and some improvements in revenue administration. Total expenditure and net lending declined by ½ percent of GDP, as the surge in capital expenditure (8 percent of GDP), due to the implementation of a number of public projects, was more than offset by a sharp drop in extrabudgetary current expenditure.

Broad money grew 9.2 percent. As a result of the improved government financial situation, the government's net creditor position with the banking system was about 50 percent of GDP. Overall credit to the economy declined by 1 percent, mainly reflecting a government buy-back of public enterprises' bank debt and a limited increase in credit to the private sector.

In 2005, macroeconomic performance remained relatively strong. Real GDP growth was about 3½ percent, and inflation low (2.5 percent). In contrast to previous years, economic growth is estimated to have been generated mainly in the non-oil economy (4½ percent). While activity in the oil sector grew only 1½ percent, due to output capacity constraints, the pick-up in activity in the non-oil sector was essentially the result of the increase in government spending. The main sectors that registered strong growth include trade, hotels, and transportation (7 percent); and construction and services (5 percent). Gains in agriculture remained modest (2.5 percent), but the manufacturing sector registered its first positive growth in five years (1.8 percent).

Based on preliminary data, the overall fiscal surplus reached 32½ percent of GDP, reflecting strong oil revenues (68 percent of GDP) and reduced expenditure (in terms of GDP). Non-oil revenue is estimated to have declined by about 15 percent, notably because of the nontransfer of the interest on the Oil Reserve Fund balances by the Central Bank of Libya (CBL); and lower collections by customs and local governments, partly reflecting the downside effects of the new tax law and customs tariff. Overall, the non-oil fiscal deficit widened to 35 percent of GDP.

Monetary developments were characterized by strong broad money growth (29 percent). Both money and quasi-money grew markedly, by 33 percent and 20 percent, respectively. These developments also reflect a remonetization of the economy consistent with improved domestic economic conditions and increased public confidence following the lifting of sanctions, and the sharp increase in bank credit to public enterprises (23 percent). With the sustained improvement in the government's financial situation, the government's net creditor position with the banking system reached 70 percent of GDP. While bank credit to the private sector grew only modestly (about 3 percent), most of the private sector credit needs were met by the government through specialized banks.

On the external side, the widening of the current account surplus to 41 percent of GDP reflected mainly strong hydrocarbon exports, which increased by 48 percent to about US$29 billion. Imports grew 24 percent to some US$11 billion, boosted by increased domestic demand. Overall, gross international reserves rose to about 32 months of 2006 imports.

In 2005, the authorities continued to implement measures to reform and open up the economy. The government streamlined the customs tariff, and eased restrictions on external trade by downsizing the negative import list from 31 items to 17 items. The new tariff schedule has only two rates (10 percent for tobacco products and 0 percent for all other products), but all imported goods are now subject to a 4 percent service fee. In the meantime, the production and consumption tax was increased to 25-50 percent for imported goods and reduced to 2 percent for domestically produced goods. Also, the government created an investment fund (IF) to manage part of the government's oil revenues.

In the monetary and banking area, the authorities passed: (i) a new banking law which reinforces the independence of the CBL and gives it the authority to allow foreign banks to operate in Libya; and (ii) an Anti Money Laundering (AML) law. As of August 2005, banks were granted autonomy to determine freely interest rates on deposits and to set lending rates within a band of 250 basis points above the discount rate (currently at 4 percent). The CBL also launched the privatization of Sahara Bank and recapitalized three commercial banks.

As regards structural reform, major progress has been made in simplifying business application procedures. In particular, a one stop-window has been established, and a 30-day limit has been set for application approval with the obligation for the administration to notify any refusal through a notary public. The privatization program and foreign investment's scope of activity have been broadened to include downstream activities in the oil, health, transportation, and insurance sectors. Also, joint ventures between Libyan and foreign investors are now permitted to benefit from the incentives of Law 5 related to domestic investment. Overall, a total of 216 enterprises have been slated for privatization, and 144 are to be liquidated. Thus far, 66 small enterprises have been sold.

Libya has taken steps towards regularizing its relations with external creditors. In 2004-05 disputed claims with creditors in Germany, Spain and the United Kingdom have been settled. Discussions with other foreign creditors are ongoing.

Following its withdrawal from the Heavily Indebted Poor Countries (HIPC) Initiative, Libya has developed its own debt relief plan. Rescheduling agreements were reached with a number of HIPC countries including Uganda, Tanzania, Benin, and negotiations with Nicaragua are ongoing.

Executive Board Assessment

Directors welcomed Libya's continued strong macroeconomic performance during 2004-05, which had benefited from favorable developments in the world oil market. Both the fiscal and external current account balances registered large surpluses, and international reserves increased considerably. Directors commended recent structural reform initiatives, including the streamlining of the tariff schedule, the partial liberalization of interest rates, and the broadening of the privatization program and the scope for foreign investments.

Directors stressed the importance of accelerating progress towards the establishment of a market economy and sustained growth and job creation in the non-oil economy, noting that reform efforts have so far suffered from the absence of a comprehensive medium-term plan that is consistently implemented. Accordingly, they urged the authorities to take advantage of the good opportunity afforded by Libya's comfortable financial situation to pursue their reform agenda vigorously, with the medium-term strategy prepared by staff at the authorities' request as a blueprint. Directors were encouraged by the authorities' recognition of the need to move forward along these lines. They stressed that successful implementation will depend on careful prioritization and sequencing, as well as effective coordination among institutions—in particular between the central bank and the ministry of finance—including through the establishment of a high inter-ministerial oversight committee.

Directors noted that improving budgetary management and implementing a prudent fiscal policy are key to maintaining macroeconomic stability. They recommended that control of fiscal policy be brought under the responsibility of the ministry of finance by unifying the government's budgets and officially abolishing all extrabudgetary operations. The authorities should also persevere with the implementation of fiscal reforms, by strengthening expenditure management and control, streamlining the tax system, and modernizing and improving revenue administration. To ensure long-term fiscal sustainability, Directors urged the authorities to strengthen the management of Libya's oil wealth by replacing the existing Oil Reserve Fund and Investment Fund by a Savings and Stabilization Fund. The revenue and expenditure policies of such a fund should be governed by strict and fully enforced rules, and its performance should be periodically assessed.

Directors supported the authorities' decision to increase public expenditure on basic infrastructure and social services, in order to improve coverage of the population's basic social needs. They stressed, however, that such spending should take into account the economy's absorptive capacity, while institutional capacities and accountability should be strengthened in order to ensure increased efficiency. In particular, budget preparation, execution, and monitoring need to be considerably reinforced and budgetary discipline enhanced. Beyond this, Directors urged that all outstanding government arrears be eliminated and no new arrears be accumulated.

Directors welcomed the partial liberalization of interest rates by the CBL, as well as the new banking law, which strengthens the central bank's independence and grants the CBL authority to allow foreign banks to operate. They encouraged the authorities to move to indirect monetary management, starting with full interest rate liberalization. Other required reforms include eliminating directed credit, reactivating the interbank money market, and strengthening banking supervision in line with international best practices. Directors considered the restructuring and modernization of the banking sector to be key to the development of the financial sector. They urged the authorities to implement a strategy for the restructuring of the state-owned banks, in line with staff recommendations, including the establishment of an independent bank restructuring agency that would take over ownership of public commercial banks.

Directors noted that Libya is well served by the current exchange rate regime pegging the Libyan dinar to the SDR, and that the current rate of the dinar is broadly appropriate. Going forward, due consideration should be given to adjustments in response to market developments, while preserving the economy's competitiveness. Over the longer-run, Directors recommended that exchange rate policy be kept under review as structural and macroeconomic reforms progress.

Directors welcomed the progress made in reforming the trade regime, and encouraged the authorities to terminate the remaining state import monopolies. They recommended that import taxation be streamlined by integrating all taxes and fees on imports in the tariff rates, which would be gradually reduced at a later stage. Directors encouraged the authorities to accelerate preparations for WTO accession discussions, and to seek technical assistance from outside experts in this endeavor.

Directors underscored that economic diversification will require a sustained effort including, in particular, enhancements to the government's privatization strategy, and improved conditions for foreign investment. They urged the authorities to enact a privatization law that will give the privatization agency a legal status and an explicit mandate. As regards foreign investment, Directors recommended replacing the current positive list with a clear and streamlined negative list, and removing the US$50 million floor on investment that, de facto, disqualifies most foreign investments in the non-oil sector. They also encouraged the authorities to gradually streamline the subsidy system.

Directors welcomed Libya's recent decision to participate in the Fund's General Data Dissemination System (GDDS) and to use the latter as a framework for statistical development. They encouraged the authorities to undertake a thorough restructuring of Libya's statistical system, giving priority to the establishment of a National Statistical Council and the creation of a National Statistical Agency.

Directors welcomed the authorities' close collaboration with the Fund staff. They stressed that, in view of its severe human resource constraints and weak institutions, Libya will need further significant technical assistance to advance its economic reform agenda. In this regard, Directors welcomed Libya's decision to cover most of the cost of the country's required technical assistance.

Directors welcomed Libya's intention to participate in the financing of the Exogenous Shocks Facility and the progress made in improving relations with external creditors. They encouraged the authorities to reconsider Libya's withdrawal from the HIPC Initiative and integrate its debt relief plan in the multilateral framework of the latter.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.