Public Information Notice No. 06/99

Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with Guinea-Bissau

August 17, 2006

On July 31, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Guinea-Bissau.¹

Background

A devastating armed civil conflict during 1998-99 and the ensuing prolonged political instability and governance deficiencies took a heavy toll on Guinea-Bissau's economy. The physical infrastructure was destroyed, the economy stagnated, government administrative capacity virtually collapsed, social conditions worsened and poverty increased. For most of the post-conflict period, economic activity remained sluggish with real per capita GDP declining by an annual average of 2 percent until 2005. The fiscal situation deteriorated sharply and external assistance dwindled, leading to mounting wages arrears and unsustainable external debt position.

Since mid-2004, Guinea-Bissau has made important strides in overcoming the effects of this protracted period of instability that ended in mid-2003 with a coup. Parliamentary elections were held in March 2004 and Presidential elections in July 2005. The process of rebuilding the administration and addressing the country's economic problems has begun in earnest. Efforts have also been made to improve budget preparation and tax administration, which has allowed for a significant increase in tax revenues.

Economic activity in 2005 was stronger than expected. Real GDP growth is estimated to have rebounded from an average of 0.5 percent for 2003-04 to 3.5 percent in 2005, driven by good agricultural performance and despite sluggish activity in other sectors. Average consumer price inflation rose to 3.4 percent from 0.8 percent in 2004 as a result of higher import prices of oil and rice. Notwithstanding the strong growth in exports, the external current account worsened in 2005 because of a large increase in imports and a drop in official transfers and private remittances. The fiscal balance improved, but cash flow problems persisted throughout the year. The fiscal deficit (including grants) was lower than budgeted at 12 percent of GDP, compared to 15 percent in 2004, but new domestic arrears accumulated.

Formal financial intermediation was very limited during 2005 even by regional standards, with total deposits amounting to only 8 percent of GDP. Although the only local bank has been increasing its financing of the cashew harvest, average outstanding claims to the private sector during 2005 did not exceed 2.2 percent of GDP; average credit to the government amounted to 1.3 percent of GDP. As elsewhere in the region, the bank is very liquid. The lack of profitable projects has left it with excess reserves that can be used to meet the seasonal needs of the private sector and the government.

Guinea-Bissau's external debt remains unsustainable and can only be resolved through the HIPC Initiative. After most interim debt relief was suspended, external debt service obligations, except those to multilateral creditors, fell into arrears. Total external public debt including arrears amounted to 332 percent of GDP in 2005; scheduled annual external debt service was about 16.4 percent of GDP.

For 2006, real GDP growth is projected at 4.2 percent and CPI inflation at about 2 percent, barring any major supply shocks. The balance of payments deficit is projected to reach 15.4 percent of GDP, which would be financed by donor support, accumulation of arrears, and debt relief. The fiscal program aims at achieving a domestic primary deficit of 3.7 percent of GDP that would avoid the accumulation of domestic arrears. The achievement of this fiscal objective would require progress in keeping current spending in check and intensifying revenue mobilization, but cash flow difficulties could arise if external budget support is delayed.

Progress on structural reform over the past year has been slow, reflecting serious technical capacity constraints and delays in obtaining technical assistance, and the changes in government. The structural reform process is being given a new momentum with an action plan for implementing the long-overdue civil service reform, the security sector reform, private sector development initiatives, and measures to rehabilitate roads, electricity, and water infrastructure.

Executive Board Assessment

Executive Directors noted that Guinea-Bissau has made major strides in overcoming the effects of a long period of political upheaval and were encouraged by the positive turn of economic and financial developments, amid signs of a return to political stability. Directors commended in particular the progress made in rebuilding the administration and restoring fiscal control. Directors concurred that the main challenges now are to consolidate peace and political stability and to lay the foundation for sustainable high growth and significant poverty reduction. This will require Guinea-Bissau to achieve fiscal and debt sustainability and to deepen structural reforms.

Directors noted the favorable macroeconomic outlook and underscored that the strength and timing of the economic recovery would hinge critically on political stability, disciplined fiscal policy, an acceleration of structural reform to promote private sector developments, and the resumption of external financial assistance.

Directors welcomed the authorities' policy framework that was supported by a new staff-monitored program (SMP). They noted that with steadfast commitment to its policy objectives, Guinea-Bissau's prospects for economic recovery and the resumption of external financing appear promising. Directors emphasized that the new SMP would enable Guinea-Bissau to move to emergency post-conflict assistance as soon as concerted international assistance is in place. They advised the authorities to use this opportunity to articulate a medium-term strategy that would aim at achieving fiscal and debt sustainability and bringing about substantive progress toward the MDGs.

Directors observed that the fiscal program for 2006 makes progress in moving Guinea-Bissau toward fiscal sustainability. Nonetheless, they noted that determined efforts will be needed to strengthen revenue mobilization and to keep current spending in check. To this end, they emphasized the need to widen the tax base, reduce exemptions, effectively monitor spending from the commitment stage, and strictly adhere to a monthly cash flow plan consistent with spending priorities. They also noted with concern the continued slippages in the wage bill, which had contributed to the accumulation of domestic arrears in 2005.

Directors welcomed the authorities' launch of a long-overdue civil service reform aimed at achieving a durable reduction in the excessive wage bill. They nevertheless emphasized that the authorities should put in place a donor-supported program to support the integration of retrenched workers into the private sector, so as to maintain social stability. Directors also noted that careful implementation of the planned security sector reform, with the assistance of development partners, should also remove a major constraint on Guinea-Bissau's development agenda.

Directors agreed that membership in the WAEMU has served Guinea-Bissau well, particularly by keeping inflation low. They judged the current level of the real effective exchange rate to be broadly appropriate, but underscored that Guinea-Bissau's external competitiveness would need to be enhanced through further progress on the structural reform agenda. Directors encouraged the authorities to accelerate the implementation of measures to rehabilitate the electricity company, roads and other infrastructure, and to enhance the investment climate. Directors cautioned that these reforms need to be prioritized and managed carefully to ensure that limited technical capacity is not overstretched.

Directors urged the authorities to put in place a strategy to address domestic and external arrears through judicious use of fiscal resources, debt relief, and donor assistance. They advised the authorities to launch a complete audit of domestic arrears and seek external resources to help clear these arrears. Regarding the external debt service arrears, Directors called on the authorities to continue servicing multilateral debt to preserve their eligibility for the Multilateral Debt Relief Initiative once they reach the HIPC completion point, and to embark promptly on discussions with creditors to resolve the external debt problem.

Directors noted the severe debt distress of Guinea-Bissau and underscored that the mobilization of external assistance will be key to the success of the authorities' reform efforts and the achievement of external sustainability. Although debt distress is expected to fall to moderate levels if the HIPC completion point is reached, Directors stressed that new assistance should be provided on highly concessional terms, preferably in the form of grants, to reduce the debt burden.

Directors welcomed the progress made in the preparation of the PRSP through a broad-based consultation process. They called on the authorities to strengthen Guinea-Bissau's statistical system to increase transparency and to allow effective surveillance and monitoring of progress toward the Millennium Development Goals.

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.