Public Information Notice No. 06/46

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with Namibia

April 28, 2006

On March 24, 2006 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Namibia.¹

Background

Namibia recorded robust real GDP growth, falling inflation, a strong external current account surplus, and continued low external indebtedness over the last two years. Real GDP grew by 6 percent in 2004, as new marine technologies prompted a surge in diamond production and most other sectors of the economy showed solid economic activity, aided by a decline in interest rates. Growth slowed in 2005, as diamond production fell relative to the high production base of the previous year and growth rates in other sectors moderated somewhat. The appreciation of the currency throughout much of 2004-05 hurt the fishing and commercial agriculture industries in particular, while higher oil prices affected the transportation sector. Inflation moderated in 2004-5, due to good rains and the strengthening Namibia dollar, which appreciated in tandem with the South African rand to which it is pegged. Average inflation fell to 4¼ percent in 2004 and only 2¼ percent for January-November 2005.

Namibia's external current account remained solidly in surplus, peaking at more than 10 percent of GDP in 2004. Surging diamond exports and buoyant customs union (SACU) receipts, which increased by one-third in 2004, more than offset a large increase in imports, including oil imports. Outflows on the capital and financial accounts remained high as banks, pension funds, and insurance companies invested heavily in South African financial markets. As a result, international reserves fell to below 2 months of imports. Total external debt is estimated to have fallen to 23 percent of GDP at end-2004.

Although improving significantly over the previous year, the fiscal deficit for 2004/05 was 4 percent of GDP, higher than expected and higher than the deficits of Namibia's southern African neighbors. A one-time windfall in SACU receipts and increased tax revenues from personal income and diamonds contributed to the improvement over 2003/04. By contrast, VAT collections were 2¼ percent of GDP lower than budgeted owing to continued administrative problems. Similarly, the government wage bill was ½ percent of GDP higher than budgeted as the hiring freeze was not implemented consistently across all ministries. These developments pushed the public debt ratio to 33½ percent of GDP, well above the government's target of 25 percent.

Despite the overall positive macroeconomic performance, major challenges—including widespread poverty, high unemployment, and HIV/AIDS—remain. One-fourth of the population does not get sufficient dietary consumption, the unemployment rate exceeds 20 percent, and the prevalence of HIV/AIDS is about 20 percent.

Executive Board Assessment

Directors commended the authorities for overall prudent macroeconomic policies, which had contributed to the recent strong economic performance, with robust growth, declining inflation, a large current account surplus, and continued low external and public indebtedness.

Directors considered that Namibia's medium-term economic prospects remained promising, provided that the authorities maintain a stable macroeconomic environment and implement, on a timely basis, structural reforms to address key challenges. These challenges include pervasive poverty, high unemployment, and a high prevalence of HIV/AIDS. In this context, they welcomed the debate within Namibia aimed at deriving a structural reform agenda to deal with these problems, raise the country's long-term growth potential, and make progress toward meeting the Millennium Development Goals (MDGs).

Directors welcomed the reduction in the fiscal deficit since 2003/04. They commended the authorities for their commitment to further fiscal consolidation under the 2006/07 budget and the medium-term expenditure framework, which should help avoid a further rise in government debt. Directors reiterated the importance of realistic budgets and the need for more sustained efforts to shore up revenue and reprioritize spending.

On the revenue side, Directors emphasized the need to strengthen tax administration. This was important in view of the volatility of customs union (SACU) receipts. In this light, Directors urged the authorities to take steps to enhance their own auditing functions, with a particular focus on large taxpayers. Making good use of technical assistance in such areas will be important.

Directors urged the authorities to develop a concrete strategy to allow a reorientation of expenditure toward priority areas, such as health, education, poverty reduction, and infrastructure. In particular, Directors stressed the need for specific measures to contain the civil service wage bill, which is well above the levels in terms of total spending and share of GDP in other countries in sub-Saharan Africa. They also called for progress in developing a roadmap for restructuring and/or divesting public enterprises, as subsidies had contributed to past fiscal deficits and diverted resources from higher return projects. Moreover, Directors encouraged the authorities to consider new approaches to alleviate poverty, including well-targeted cash grants, to the extent these are deemed appropriate.

Directors agreed that the peg of the Namibia dollar to the South African rand had served the country well in light of the large trade and capital flows between the two countries. The peg has successfully anchored macroeconomic policymaking and helped reduce inflation, with Namibia benefiting from South Africa's inflation-targeting framework. Although available indicators do not suggest that the recent appreciation of the rand had negatively impacted overall exports, economic growth, or employment, Directors urged the authorities to monitor competitiveness closely.

Directors reiterated the importance of ensuring adequate levels of international reserves. They considered that the creation of domestic investment opportunities would be the most promising avenue to keep a large share of Namibia's sizable savings at home. Directors welcomed the elimination of the negative interest rate differential with respect to South Africa, and most Directors urged the authorities not to rule out establishing a positive differential, if necessary. Directors also recommended that the authorities increase international reserves through sterilized foreign exchange purchases.

Directors welcomed Namibia's conclusion of a review under the Financial Sector Assessment Program (FSAP). They also welcomed the authorities' intention to take action on the recommendations, including upgrading the supervisory and regulatory framework and improving access to financial services. In this regard, Directors noted the importance of addressing regulatory gaps, especially with respect to nonbank financial institutions. They advised caution with respect to any domestic investment requirements that could lower returns and raise risks for pension funds and insurance companies. The authorities were encouraged to put in place an appropriate AML/CFT framework as soon as possible.

On the structural front, Directors agreed that strengthening the quality of education would be key to maintaining social cohesion and achieving a noticeable dent in poverty and unemployment. They also urged the authorities to continue efforts to enhance the flexibility of labor markets. However, Directors expressed concern regarding regulations that could increase labor costs, such as the envisaged increase in leave days under the new Labor Act. It was noted that unduly restricting immigration of skilled labor would be detrimental to efforts to raise the economy's growth potential and make Namibia a more attractive destination for investment.

Directors emphasized the importance of improving the business climate to promote private sector led growth. Steps to simplify business regulations and remove other impediments to entrepreneurship could help diversify the economy and provide jobs. Directors commended the authorities for efforts to enhance governance through the establishment of an Anti-Corruption Commission, which should be provided with sufficient resources to do its job. Directors also underlined the benefits from further trade liberalization and the conclusion of the free trade agreements with key trade partners.

Directors considered that any changes in the current structure of land ownership should be based on objective and transparent criteria and continue to be in accordance with the Constitution, so as to encourage investment and increase output in agriculture.

Directors observed that Namibia's core statistics are generally adequate for surveillance purposes, but noted that weaknesses remain in some areas. They recommended increased efforts to collect data on the labor market, employment, and wages and to reconcile international investment position data with the balance of payments and those of South Africa.

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.