MADAGASCAR ECONOMIC UPDATE: WHY HAS THE MALAGASY ECONOMY NOT YET COLLAPSED? World Bank July 26, 2010

Transcription

1 MADAGASCAR ECONOMIC UPDATE: WHY HAS THE MALAGASY ECONOMY NOT YET COLLAPSED? World Bank July 26, 2010 The Madagascar s economy has suffered but not collapsed since the beginning of the political crisis in early This resistance is viewed mainly as the combination of: (i) the modest rebound in private activities due to the quasi-absence of violence over the past few months; (ii) the surge in informal activities pushed by the strong performance of the rural sector (which in turn led to a reduction in the local price of rice); and (iii) official aid flows, still equivalent to 5% of GDP, that have been directed to vulnerable population and communities. The global situation remains nonetheless fragile, especially on the fiscal front, where limited revenues and direct financing have restricted public spending and investment, with both short and longterm negative implications on the delivery of social and infrastructure services. Private Sector: A surprising resistance The domestic private sector has suffered since the beginning of the crisis, but some activities have weakly rebounded over the past few months even though they remain far from their precrisis levels. Concurrently, the informal sector has been vibrant fueled by the relatively good performance of the primary sector and by the emergence of new trading activities in both urban and rural areas. While official data do not converge on the health of the economy in , a closer look at the performance of the largest enterprises registered in the country confirmed that they went through a severe adjustment during the first twelve months of the current political crisis. The sales of the 100 largest enterprises (accounting for about 1/3 of GDP) declined by 25% in real terms. This decline was not homogenous since some banks and service industries increased their turnover by about 5-10% during this period. With the near absence of violence in recent months, industrial activities and domestic demand have picked up. Energy and electricity consumption (especially to the industrial sector, Figure 1), new vehicles orders (up by 7.1%), and cement sales increased during the first semester of 2010 compared to their levels in Even the tourism sector weakly rebounded during the January-May period of 2010 with an 11.5% increase in tourism arrivals (still 43% down compared to 2008, Figure 2). This rebound did not include the textile sector 2 and construction activities that are still suffering from the negative external environment and the collapse in public investment. Actually, credit to the private sector collapsed during the first five months of 1 The 2010 Law of Finance reported a GDP growth rate of 0.6% while the National Statistical Agency (INSTAT) and the Central Bank estimated respectively a decline of 3.7% and 4.6%. 2 A recent survey conducted by the Groupement des Entreprises Franches et Partenaires (GEFP) indicates that 25,000 jobs were lost in this industry during the first semester of

2 2010, with accumulated increase of only 34 billion of Ariary, compared to 78.7 and billion respectively in 2009 and 2008 (see Figure 3). Source: OMH; JIRAMA; Ministry of Finance; Ministry of Tourism; Central Bank; and Bank s staff calculations Any evaluation on the economic performance of Madagascar should include the informal sector. For many observers such as the UN, the resistance of the economy has been linked to the surge in informal activities. Using the methodology suggested by Schneider, 3 it can be estimated that informal activities increased by about 13% in real terms during 2009, partly offsetting the decline in official GDP. Those statistics on the informal sector should be viewed as indicative rather than conclusive about the combination of: (i) the relatively good performance of the primary sector (agriculture and forestry) and small mining that remains to a large extent outside the scope of official statistics, (ii) growing informal trade in urban areas as the result of unemployed workers from the textile and tourism sectors, 4 and (iii) rising illegal trading of natural and protected species (e.g., rosewood). The positive impact of the informal sector on the performance of the economy in 2009 can be further emphasized by the record breaking rice harvests over the past two years (up by 40% between 2007 and 2009) 5 that have led to a decline in prices in all areas; especially in urban centers. Those high production levels have been the result of good policies and, above all, exceptional climatic conditions. When rice is available at affordable prices, poverty rates decrease (at least in the short run) because it accounts for about 40% of the consumption basket of poor households. 3 See, Andreas Buehn and Friedrich Schneider, Shadow Economies and Corruption All Over the World: Revised Estimates for 120 Countries, Economics: The Open-Access, Open-Assessment E-Journal, Vol. 1, The share of the informal sector was estimated equal to 39.7 % of official GDP in 2000, which is used as a benchmark. Subsequent values of the informal economy are then simulated by assuming a constant relationship between currency in circulation and official GDP over time. It was found that Informal activities (calculated in nominal values) increased from 3119 million Ariary to 3813 million Ariary between 2008 and This has been evidenced by the recent household surveys conducted by the UN System/UNICEF in Antananarivo. 5 Source: FAO that estimates an increase in the production volume of paddy rice from 3000 to 4200 tons over the past two years. 2

3 Public Sector: Austerity but The public sector was the driver of economic growth during the period , with a boom in public investment. Since the beginning of the political crisis, fiscal austerity has led to a sharp decline in public spending (down by 47% between 2008 and 2010, see Figure 4). This adjustment concentrated in capital outlays, while wages and debt payments were fully paid over the period. Over the first semester of 2010, the wage bill accounted for 51% of total committed expenditures, while capital expenditures were equivalent to only 10%. The level of fiscal revenues attained approximately billion Ariary between January and May 2010, up by 13% compared to the same period of 2009 but still down by 11% with respect to 2008 (Table 1). All taxes generated fewer revenues in 2009 and 2010, reflecting the slowdown in (official) economic activities and imports, except for the excise and Value Added Taxes on domestic transactions. The increase in the collection of the excise tax is explained by higher rates (from 150 to 250%), while higher VAT revenues (up by 42% between 2008 and 2010) are hard to elucidate without detailed information on tax evasion and rebates. The Government can rely in principle on non-fiscal revenues Table 1: Tax revenue performance, year-to-date variation May May that include royalties from 10/May 09 10/May 08 Domestic revenue 11.8% 8.0% mining and forestry activities as of which: Direct taxes (income and profits) 13.5% -10.2% well revenues from its Property taxes 23.3% -30.3% participation in enterprises. Indirect taxes (VAT, excise) 11.4% 39.3% -VAT 1.9% 42.2% Those revenues have been -Excise 39.9% 40.9% historically low in Madagascar, -Others 6.8% -33.3% reaching only 0.3% of GDP in Customs revenue 16.0% -30.2% 2008 against 2% of GDP in of which: Import Duties 10.8% -29.9% VAT on import 9.4% -28.4% Senegal or even 5% of GDP in Duty on Petroleum 3.9% -32.1% Kenya. Similarly, official figures VAT on Petroleum 58.4% -33.6% were only equal to 6 billion Total 13.4% -11.1% Ariary during the first quarter Source: Ministry of Finance and Bank s staff calculations of 2010 even though mining royalties and duties were increased dramatically in early Those low figures may reflect serious underreporting by the Treasury, raising suspicion on the widespread use of out-of budget procedures and so possible corruption. Transparent budgetary rules are crucial at the time when several operators have expressed growing 3

4 interests in the mining (e.g., Chinese) 6 and natural resources sectors (e.g., rosewood) in Madagascar. Following the trend observed in 2009, the use of domestic financing by the Government has been restricted during the first semester of 2010, in line with its modest needs. The amount of T-bills has only increased by 5%, with both bank and non-bank holdings rising, compared to its level at the end of December 2009 with little variations in their rates of return around 10% for one-year maturity bonds- over the past few months (see Figure 5). During January-May, the Government borrowed a meager Ariary 3 billion from the Central Bank but reconstituted deposits with commercial banks, for an overall quasi-neutral net position with the banking system Contrary to public perception, Madagascar continued to receive official aid inflows during 2009 and early Recent estimates (from the UN system and the Prime Minister office) reveal that the country benefited from about US$350 million in 2009 (and about US$ 60 million during the first quarter of 2010) or about the equivalent of 5% of GDP. Although this amount was about half as the one reported in 2008, it remains higher than the average ratio observed in Sub-Saharan African countries (net aid inflows were equal to 4% of GDP in 2008), at par with Kenya and Chad and not far from Ghana, Zambia or Senegal. External assistance has been increasingly delivered outside the public sector directly to NGOs or communities, but it contributed to reduce the pressure on public spending. Money is fungible meaning that direct public support from the budget is less necessary for areas/groups targeted by external funds. The cut in official aid has mostly occurred in direct budget support and large infrastructure projects, while humanitarian or social sector assistance has been globally at par or even on the rise (partially compensating for lower public spending these areas). Financial sector: Stability and Caution Base money rose by 1.6% in January-May, with a decline in net foreign assets and a higher level of open market operations being more than offset by a rise in other items net. The Central bank pursued its policy of regularly mopping up excess liquidity. Broad money rose by a modest 1.5 % in the first five months of the year, with an ebbing of net foreign assets more than offsetting a modest rebound in private sector credit (up 1.7 % compared to end-2009). Cautious fiscal and monetary policies have helped to maintain inflation at 9.1 % on year-to-year basis at end of May 2010, in line with seasonal trends (Figure 5). The price of first necessity products declined by 0.8% between April and May but renewed pressure on imported goods is expected in view of the recent decline in the local currency value (i.e., gasoline). 6 China s third largest steel company Wuhan Iron and Steel Corporation (WISCO), in a joint venture with two others companies, received approval from China s National Development and Reform Commission to explore for iron ore deposits in Madagascar s southwest (Soalala project). 4

5 US dollars 500,000 Figure 6: Trade balance 400, , , ,000 0 Exports Linear (Exports ) Imports Linear (Imports) Source : INSTAT ; Central Bank; Ministry of Finance; and Bank s staff calculations External sector: lower exports but also imports Trade figures indicate that exports slightly fell by 6% during the first five months of 2010 compared to the same period a year ago but were significantly lower than in 2008 (down by 31%, Figure 6). Concurrently, imports continued to decline by 20% compared to the first five months of 2009, reflecting the slowdown in the economy. Subtracting the known uptick in imports of petroleum products, this point to a further decline in non-oil imports on account of the continued loss in purchasing power of the population. As a result, the trade deficit was reduced by 1/3 (or US$68 million). Table 2: Variations in exports of selected items between first quarter 2009 and 2010 Source: Central Bank The slight decline in the level of exports masks variations across products (Table 2). While most traditional exports declined over the past year (including textile due to the loss of AGOA privileges and most agricultural products such as vanilla), mineral and wood exports surged Products % change Mineral products 7003% Clove (oil) 231% Leather 159% Gems 111% Shirts 30% Wood products 25% Petroleum products 10% Other chemical products 0% Other food processing -8% Processed Fruits and Vegetables cans -15% Other sea food products -17% Vanilla -18% Other textile -18% Cacao -23% Shrimps -30% Tee-shirts and garments -51% Clove -62% Cotton -63% Wood -83% Source: Customs 5

6 dramatically. The significant increase in mineral product is explained by QMM production that only started by mid Without intervention from the monetary authorities, fluctuations in the exchange rate are generally viewed as the consequences of: (i) pressures on the balance of payments; (ii) confidence losses in the local financial sector; and (iii) currency movements on international markets. The recent variations in the value of the Ariary vis-à-vis the US dollar and Euro (Figure 7) are principally the consequence of the instability of major currencies around the world (linked to the fiscal crisis in the Euro zones). Domestic factors have remained relatively stable during this period. The lack of pressure on the balance of payments is reflected by the stability of international reserves held by the Central Bank (around US$960 millions) since end-2009, while the confidence in the local currency on the financial market can be illustrated by the unchanged ratio of local versus foreign currency denominated deposits (around 2.5). This stability illustrates the confidence of most local financial operators in the local currency at least in the short term. Looking forward In the aftermath of the brutal change of power in March 2009, most observers predicted the collapse of the Malagasy economy if a consensual solution to the political crisis was not found in the short run. Private sector confidence was falling, and most donors were ready to suspend their financial assistance. After almost one and half year of political instability, the economy is hurt but not dead. The formal private sector has revealed timid signs of recovery (far from pre-crisis levels) and the informal sector has been vibrant as the result of the good performance of the primary sector and rising trade activities in urban centers. External aid, albeit declining and delivered outside public channels, still counted for about US$350 million or 5% of GDP in This amount has contributed to maintain the delivery of social services and aggregate demand in the country. The economy remains nonetheless extremely fragile as illustrated below: First, the fiscal situation is vulnerable because weak tax collection will continue to reflect the sub-optimal performance of the formal private sector, most notably of largest tax contributors. The authorities have been able to control spending but this might become increasingly difficult in a volatile political environment and growing needs to maintain physical infrastructure. Second, the surge in informal activities is partly the result of illegal trading in natural resources that can hurt badly Madagascar s reputation over time. If, in the short run, those can provide additional resources, they affect negatively the rules of the games and might crowd out serious investors. They are also a source of inequalities that may create further political and social tensions. 6

7 Third, the financial market has demonstrated remarkable resilience but its thinness makes it vulnerable to any shifts or shocks even of little magnitude. For example, an increase in monetary financing by the public sector would almost immediately lead to money creation and possibly to accelerated inflation. Those examples are far from exhaustive and political factors (such as violence, riots, military insurgence) might affect badly the economy. Furthermore, the country remains exposed to a variety of exogenous shocks such as variations in climatic conditions or international commodity prices. The relatively good performance of the primary sector over the past two years has been mostly the consequence of exceptional good weather (i.e., no cyclone since early 2008). While predictions are virtually impossible, recent history indicates that intensive cyclones have hit Madagascar at least every two consecutive years --except for 2009 and Any reversal would therefore test the resistance of the economy and of the large majority of households who live below the poverty level and therefore remain extremely vulnerable. 7