Monetary Policy Report. MONETARY POLICY REPORT (under paragraph 3 of article 18 of the Organic Law)

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1 MONETARY POLICY REPORT (under paragraph 3 of article 18 of the Organic Law) Banco de Cabo Verde May 2012 Banco de Cabo Verde / Maio 2012

2 BANCO DE CABO VERDE Department of Economic Studies and Statistics Avenida Amílcar Cabral, 27 CP Praia Cabo Verde Tel: / Fax: Banco de Cabo Verde / Maio

3 MONETARY POLICY REPORT Index Executive Summary 4 I. National Economic Activity in Recent Months 1. External Environment of the Cape Verdean Economy 8 2. Indicators of Demand and Production Prices External accounts Budgetary Position Monetary and Financial Policy and Position 24 II. Prospects for Economic Development in Framework Hypotheses Projections for the Cape Verdean Economy Monetary Programming Monetary Policy for the Coming Months 37 III. Statistical Annex Banco de Cabo Verde / Maio

4 Executive Summary The global economy suffered a considerable deceleration in 2011, reversing the trend of recovery from the financial and economic crisis which started in The slowdown of global economic activity reflected, in large part, the impact of the sovereign debt crisis and the problems of the European banking sector on the real economy, as well as a general decline in the confidence of economic operators. In addition, it reflected the impacts of the earthquake and tsunami in Japan on the production chain and, also, the unexpected rise in oil prices, resulting from the wave of political and social instability that plagued the Middle East and North Africa. In a context of deterioration of the external environment, the rhythm of growth of economic activity declined from 5.6% to 5.1%, due to the sharp drop in net external demand. Note that the national economy has proven quite resilient to the financial crisis in the euro area, supported by an ambitious public investment policy and strong growth of the tourism sector and, more recently, private business investment. The economic indicators, however, suggest a slowdown in domestic demand in the first quarter of Prices in Cape Verde showed an upward trend over the course of 2011, reflecting the evolution of international prices for energy goods and processed food products, which are mostly imported. In early 2012, however, the trend reversed and the average inflation rate declined from 4.5% in December to 4.1% in March. External accounts deteriorated significantly in 2011 as a result of increased imports of goods, a significant decline in official transfers and reduced exports of air transportation services, in a context of decreasing foreign direct investment and net disbursements of external public debt. As a result, the country s net international reserves fell 33 million Euros, ensuring 3.2 months of imports (in 2010, they ensured 4.2 months of imports). Preliminary estimates point to an improvement in external accounts in the first three months of 2012 caused by growing tourism revenues, reduced imports of goods, and an increase in the supply of fuel and food at ports and international airports. The evolution of external accounts in 2011, resulting in a significant decrease in net foreign assets, caused a moderate money supply growth. Despite the reduction in external inflows, the banking system continued to ensure, for the most part, growth in credit granted to households, non financial enterprises and the public sector, resulting in a 10% and 13% increase in credit to the economy and to the general government, respectively. In terms of policy, in order to correct the downward trend of foreign reserves, which began Banco de Cabo Verde / Maio

5 in April 2011, and to strengthen financial system stability, among other measures, BCV broadened the base for establishment of Minimum Reserve Requirements, including general government deposits and, in December, it approved a 150 basis points increase in the key interest rate, as well as a 2p.p. increase in the reserve coefficient (from 16% to 18%). In the context of a worsening external environment, fiscal policy focused on expenditure restraint and improved tax efficiency, especially in the second half of As a result, the budget deficit including grants reached 13,263 million Cape Verde escudos, decreasing 2.2 percentage points of GDP, to 10.1%. The public deficit was financed using both internal and external debt, whose stocks reached 20.3% and 67.2% of GDP, respectively. For March, the government finance statistics available indicate a deterioration of public accounts year on year, mainly as a result of a significant reduction in grants and strong slowdown in tax revenue. The recent evolution of the economy and a number of environment assumptions supported the revision of macroeconomic projections for Regarding the external environment, the International Monetary Fund s (IMF) April 2012 projections suggest that the external environment of the Cape Verdean economy remains unfavorable. Global growth is expected to fall from 3.9% in 2011 to 3.5% in 2012 and the Euro area will contract 0.3%. The IMF also forecasts that labor market conditions in the main host countries of emigration from Cape Verde will remain unfavorable. It should also be noted that inflationary pressures increased in the first months of the year, due to rising oil prices. With regard to the internal environment, expectations of changes in the economy remain conditioned largely by the economic and financial developments of the country s main partners, the evolution of oil prices, the adjustment of the banking sector to an environment of reduced excess liquidity and tightening monetary conditions, and developments in public finance. In this context, the central projection scenario, which assumes maintenance of current monetary and fiscal policy guidelines, admits a slight deceleration of GDP growth in real terms over 2011 to the [4 to 5%] range. It is expected that the average annual inflation will be within the [3.5 to 4.5%] range at the end of the year and that net international reserves will stabilize at around 3.1 months of imports. Banco de Cabo Verde / Maio

6 Fonte: Banco de Cabo Verde. Nota: P Projecções de Maio de Table 1: Selected Economic Indicators Unit P Real sector Real GDP change in % 5,6 5,1 [4,0 5,0] CPI average change in % 2,1 4,5 [3,5 4,5] Monetary sector Net Foreign Assets change in % 6,4 17,1 3,1 Credit to the Economy change in % 8,5 9,8 4,2 Money Supply change in % 4,7 2,1 4,6 External Sector Current and Capital Account Deficit in % of GDP 11,8 16,4 12,7 Current deficit in % of GDP 14,4 17,2 13,3 RIL / Imports months 4,2 3,2 3,1 Banco de Cabo Verde / Maio

7 NATIONAL ECONOMIC ACTIVITY Banco de Cabo Verde / Maio

8 1. External Environment of the Cape Verdean Economy The global economy suffered a considerable deceleration in 2011, reversing the trend of recovery from the financial and economic crisis initiated in Estimates from the International Monetary Fund (IMF) indicate an overall growth rate of around 3.9% in real terms in 2011, that is, 1.4 percentage points below the rate of growth in The slowdown in global economic activity reflected, in large measure, the impact of the sovereign debt crisis and banking problems in Europe on the real economy, as well as a general decline in the confidence of economic operators. In addition, it reflected the impacts of the earthquake and tsunami in Japan on the production chain and, also, the unexpected rise in oil prices, resulting from the wave of political and social instability that plagued the Middle East and North Africa. The performance of advanced economies was affected the most, resulting in a growth of around 1.6%, compared to 3% in The Japanese economy contracted 0.7% according to the IMF, having the worst performance in the group. The Eurozone, the country's largest economic partner, grew at a rate of 1.4% in real terms, representing a deceleration of 0.5 percentage points over the previous year. The US economy grew 1.7%, compared to 3% in Figure 1: GDP and Unemployment in percentage 6,0 4,0 2,0 0,0 2,0 4,0 6,0 US Eurozone 1st trim. 08 2nd trim. 08 3rd trim. 08 4th trim 08 1st trim.09 2nd trim.09 3rd trim. 09 4th trim. 09 1st trim. 10 2nd trim. 10 3rd trim. 10 4th trim. 10 1st trim. 11 2nd trim.11 3rd trim. 11 4th trim. 11 1st trim. 12 in percentage of active population 12,0 11,0 10,0 9,0 8,0 7,0 6,0 5,0 4,0 3,0 Eurozone Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Apr 08 Jul 08 Oct 08 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11 Oct 11 Jan 12 US Fonte: Banco de Portugal; Federal Reserve; US Department of Labor. The dynamism of developing and emerging economies offset the poor performance of advanced countries to some extent. Indeed, in developing and emerging markets, the economy remained robust (growing 6.2%), although considerably disparate between regions. The rising prices of raw materials stimulated the performance of the economies of Central and Eastern Europe, whose gross domestic product grew from 4.5% to 5.3%. Economic activity in Sub Saharan Africa also remained robust, growing by 5%. However, the Banco de Cabo Verde / Maio

9 political and social instability, which still persists in some countries of the Maghreb and the Middle East, had a negative impact on their performance. These countries had a real growth of 3.5%, compared to 4.9% in Also noteworthy is a slowdown in the growth rate of the three largest economies in the group of emerging and developing economies China, India and Brazil reflecting, on the one hand, the adoption of restrictive monetary policy measures to cope with inflationary pressures and, on the other hand, the reduction in global demand. In real terms, Brazil, Russia, India and China grew at a rate of 2.9%, 4.1%, 7.4% and 9.2%, respectively, in 2011, compared to 7.5%, 4.0%, 9.9% and 10.4% in The available estimates for the first quarter of the year suggest that the prospects for global growth are gradually improving, reflecting the favorable performance of the U.S. and stabilization of financial conditions in Europe, as a result of implementation of a set of monetary policy measures starting in December. 1 The JPMorgan All Industry Output Index suggests that the growth rate of the global economy in the first quarter was the strongest since February 2011, consistent with an overall growth of around 3%. The acceleration of the economic growth was stimulated especially by the performance of the services sector and caused a growth of about 1% in employment. 2 The U.S. was the driving force behind global growth and an improved labor market in the first quarter of The U.S. gross domestic product grew 2.1% year on year, compared to 2.2% in the first quarter The slight slowdown in the world's largest economy was caused by the slowdown in private investment in stocks and reduction of private nonresidential investment. Private consumption, exports and residential investment, however, saw gains. Regarding the labor market, official statistics indicate an average growth in employment (excluding agriculture) of around 212,000 per month and a reduction in unemployment rate, to 8.3% (compared to 8.7% in the fourth quarter of 2011). 3 1 With the intensification of the financial crisis in the 3rd and 4th quarters, the ECB lowered the refi rate to 1%, increased the limit of credit facility to the banking system, announced additional measures to support smaller banks (which includes long term refinancing operations and expanding the portfolio of collateral eligible for loans) and lowered the reserve requirement rate from 2% to 1. 2 The JP Morgan All Industry Index is based on surveys conducted on a representative sample of industrial and service sector companies from countries like the United States, Germany, France, UK, Italy, Japan, China, among others. The indicator covers about 80% of the world gross product. 3 In March, the unemployment rate reached 8.2% of labor force (February 2009 levels), with the private sector creating 120,000 jobs Banco de Cabo Verde / Maio

10 Unlike the U.S., the Eurozone had the worst performance among the regions that are part of the sample of the JPMorgan All Industry Output Index. The available information reinforces the signs of a shrinking private sector, and therefore suggests that the euro area s economy entered into a technical recession in the first quarter of the year. Individually, the performance of virtually all countries that are part of the euro area was unfavorable, except for Ireland, whose growth rate was the highest in the last 11 months. The region's biggest economy, Germany, had its worst performance in the last three months. France had its first contraction in four months, while Italy and Spain remained in recession. Unemployment in the Eurozone continued to break records. In February, the unemployment rate was 10.8% (10.6% and 10.0% in December and February 2011, respectively). Spain and Austria reported the highest and lowest unemployment rate (23.6% and 4.2% respectively). With regard to the major emerging economies, the available information indicates strong growth in activity and employment, though slowing in India, Brazil and Russia. In the first quarter, the Chinese economy grew at the weakest pace in the last three years (around 8%), conditioned by the evolution of fixed capital investments. 4 The first quarter of 2012 was also marked by increased inflationary pressures, instigated particularly by the behavior of oil prices. In commodity markets, the price per barrel of brent increased year on year 13.2% and 9.1% in February and March, respectively. However, after reaching the maximum value in the last 15 months ($128.4 per barrel) on March 1, prices fell, though remaining above the levels recorded in March Oil prices have been influenced by optimism about the recovery of the U.S. economy, the announcement of increased imports by China, and the decision on the second bailout for Greece. Also, the price of oil has been largely driven by the imminent effect of sanctions against Iran, in a context of interrupted production in Syria, Yemen and South Sudan. Food prices, in turn, remained on a downward trend. The FAO Food Price Index recorded an annual decrease of 5.3%, reflecting a reduction of 13.3%, 10.1%, 8.9% and 7.6% in the price of sugar, cooking oil, dairy products and grain, respectively. 4 Investment in fixed capital is the engine of the Chinese economy. It slowed down in the first quarter to levels last seen in early Banco de Cabo Verde / Maio

11 Figure 2: Commodities Price 60,0 40,0 20, brent change in % 0,0 20,0 40,0 1/2010 3/2010 5/2010 7/2010 9/ /2010 1/2011 3/2011 5/2011 7/2011 9/ /2011 1/2012 3/2012 USD crude 60, ,0 100,0 Cereals Price Index Sugar Price Index Oils Price Index Jan 10 Mar 10 May 10 Jul 10 Sep 10 Nov 10 Jan 11 Mar 11 May 11 Jul 11 Sep 11 Nov 11 Jan 12 Mar 12 Fonte: FAO; Bloomberg. Notwithstanding the temporary acceleration of cost push inflation, the inflation rates of various regions have followed a trend of stabilization or slowdown compared to the same period last year. Particularly in the Eurozone, where the productive capacity remains high, the inflation rate has remained stable (at 2.7%) since December, supporting the current accommodative monetary policy. In the U.S., in turn, year on year inflation was reduced from the 3% observed in December to 2.6% in March. Banco de Cabo Verde / Maio

12 2. Indicators of Demand and Production In the context of a deteriorating external environment for the national economy, the pace of economic growth slowed down in Estimates of Banco de Cabo Verde indicate a real growth of gross domestic product of 5.1%, compared to the 5.6% estimated for This less favorable performance of the national economy was determined by the sharp drop in net external demand, due to the significant increase in imported goods and services. Indeed, the contribution of net external demand to economic growth was 5.1 percentage points of GDP (compared to 0.2 percentage points in 2010). The contribution of domestic demand to economic growth was, in turn, very positive, having grown from 5.8 to 10.2 percentage points, driven by the dynamics of private consumption and investment. This highlights the dynamics of private business investment in 2011, offsetting to a large extent the slowdown in residential investment and the drop in public investment. Figure 3: Evolution of Consumption Indicators (year on year rates of change of the moving average in the last 3 months) in percentage 16,0 14,0 12,0 10,0 8,0 6,0 4,0 2,0 Imports of Consumer Goods in percentage 2,0 1,5 1,0 0,5 0,0 0,5 1,0 1,5 Sales in Retail Establishments, Base Indices = 100 0,0 2,0 Mar 11 Apr 11 May 11 Jun 11 Jul 11 Aug 11 Sep 11 Oct 11 Nov 11 Dec 11 Jan 12 Feb 12 Mar 12 2,5 3,0 Source: Directorate General of Customs; National Statistics Institute; calculations by Banco de Cabo Verde. For the first quarter of 2012, the economic indicators suggest domestic demand will likely slow down. The indicators of domestic demand produced by Banco de Cabo Verde point to a slowdown in private consumption, despite the acceleration in imports of consumer goods, seasonally adjusted, from 1.9% in December to 14.4% in March. 5 It should be noted that the volume index of sales in retail trade, an indicator compiled by Banco de Cabo Verde with data from the National Statistics Institute s consumer survey, fell by 0.2% in the first quarter, after increasing 1.2% in the last quarter of 2011, indicating a slowdown in pri 5 According to consumer survey results, the increase in imports of consumer goods in the first quarter may be closely related to replenishment of stocks. Banco de Cabo Verde / Maio

13 vate consumption. Figure 3: Evolution of Investment Indicators (year on year rates of change of the moving average in the last 3 months) 2,5 2,0 2,5 2,0 Order book in the Construction and Public Works Sector, Base Indices = 100 in percentage 1,5 1,0 0,5 0,0 0,5 1,0 1,5 Mar 11 Apr 11 May 11 Jun 11 Jul 11 Aug 11 Imports of Construction Goods Sep 11 Oct 11 Nov 11 Dec 11 Jan 12 Feb 12 Imports of Capital Goods Mar 12 in percentage 1,5 1,0 0,5 0,0 0,5 1,0 1,5 Imports of Transportation Equipment 2,0 Source: Directorate General of Customs; National Statistics Institute; calculations by Banco de Cabo Verde. The evolution of investment indicator in the first quarter of 2012 also points to a deceleration in the growth rate of Gross Fixed Capital Formation (GFCF). Indeed, in annual terms, imports of transportation equipment experienced a significant slowdown (from 94.7% in Q4 to 30.7% in the first quarter of 2012), while imports of equipment decreased 15.7% in the quarter ending in March ( 5.8% in December). Imports of construction materials showed an opposite trend, accelerating from 0.5% in December to 12.9% in March. The behavior of this indicator notwithstanding, the order book in construction and public works sectors maintained the downward trend it has been showing since December 2010, influenced especially by the evolution of the public works component. Preliminary estimates indicate an increase in net external demand in the first quarter, primarily as a result of reduced imports of goods and acceleration of services exports. In terms of supply, the economic climate indicator, which is produced by INE and reflects the assessment of economic operators in different sectors of economic activity, showed an unfavorable outcome in the first quarter of The behavior of this indicator can be attributed mainly to the downward trend of confidence indicators in trade, industry and tourism sectors. Banco de Cabo Verde / Maio

14 Figure 5: Evolution of Confidence Indicators (year on year rates of change of the moving average in the last 3 months) Monetary Policy Report in percentage 0 20 Mar 08 Jun 08 Sep 08 Dec 08 Mar 09 Jun 09 Sep 09 Dec 09 Mar 10 Jun 10 Sep 10 Dec 10 Mar 11 Jun 11 Sep 11 Dec 11 Mar Trade Transportation Construction Tourism Industry Source: National Statistics Institute. Banco de Cabo Verde / Maio

15 3. Prices Monetary Policy Report The inflation rate, as measured by average annual change in the Consumer Price Index (CPI), stood at 4.5% in 2011, higher than the previous year by 2.4 percentage points. Continuing the trend started in April 2010, prices in Cape Verde showed an upward trend throughout the year, reflecting the evolution of international prices of energy goods and processed food mainly imported products. In early 2012, however, the trend was reversed and the average inflation rate reached 4.1%, in March. The year on year inflation, in turn, slowed to 2%, the lowest value registered in the last 23 months. The reduction of the inflationary trend in the class of food and non alcoholic beverages and a significant reduction in the prices of communication services explain, essentially, the slowdown of year on year inflation in the period. Figure 6: Consumer Price Index in percentage 12,00 10,00 8,00 6,00 4,00 2,00 0,00 2,00 4,00 Annual rate of change Monthly rate of change 12 month average rate of change Source: National Statistics Institute; Banco de Portugal. Note: YoYRC Year on year Rate of Change. in percentage 6,0 4,0 2,0 0,0 2,0 4,0 Jul 09 Set 09 Nov 09 Jan 10 Mar 10 Mai 10 Jul 10 Set 10 Nov 10 Jan 11 Mar 11 Mai 11 Jul 11 Set 11 Nov 11 Jan 12 Mar 12 CPI Aggregate, excluding Energy, Food and Beverages, Alcohol and Tobacco CPI Aggregate CPI Aggregate, excluding Energy CPI Aggregate, excluding Energy and Non Processed Foods The indicator of underlying inflation (CPI excluding unprocessed food and energy goods) showed a downward trend since January, standing at 1.9% in March. The negative difference ( 0.1 points) between year on year underlying inflation and yearon year inflation in the CPI aggregate suggests that inflationary pressures have been determined by the evolution of energy prices. Excluding energy and processed and unprocessed foods, the year on year change of CPI is less than the year on year underlying inflation, suggesting that the prices of fresh and processed food are mitigating the dynamics of energy prices. It is expected that the inflation trend will be reversed temporarily in the coming months, with the CPI including updates in tariffs and administered prices of electricity, water, and both sea and land (urban and intercity) public transportation. Banco de Cabo Verde / Maio

16 4. External Accounts In 2011, net borrowing, which is measured by the combined deficit of current and capital accounts, increased by 4.7 percentage points of GDP, to 16.4%. The current account deficit increased from 14% to 17% of GDP, while the capital account surplus fell by 2 percentage points (to 0.7% of GDP), with the significant reduction in official grants. The deterioration of current and capital accounts was basically determined by the acceleration of imports of goods (by about 12 percentage points), by the significant decline in unilateral official transfers (47%), and by reduced exports of air transportation services (20.9%). Exports of goods, revenue from tourism and emigrants remittances, however, had a very positive performance, growing 48.5%, 26.4% and 29.4% respectively. The financial account, which represents the channels through which the external financing of the economy is processed, had a net inflow of funds of around 14% of GDP in 2011, that is, 2.3 percentage points less than in The reduction of net financial inflows was caused significantly by a reduction in foreign direct investment (21.6%), in liabilities of financial companies (13.2%) and in net disbursements of public debt (3.3%). The gap between the country s financing needs and inflows of funding led to a net loss of foreign reserves of about 3,675.6 million escudos (about 33 million Euros). At the end of the year, net international reserves ensured 3.2 months of imports. Preliminary estimates point to an improvement of external accounts in early In the first quarter, the current account had a deficit of 2.7% of GDP, representing a decrease of 1.5 percentage points year on year. The lessening of the current account deficit was determined essentially by increased tourism revenues, reduced imports of goods, and increased supply of fuel and food at the country s international ports and airports. Revenues from tourism increased by 22% (18.5% year on year), benefiting from both the increase in the number of hotels and increased tourism demand. 6 6 With the opening of two of the largest hotels in the country in May, the country s accommodation capacity, measured in terms of number of beds, increased by 23.5% in Banco de Cabo Verde / Maio

17 Figure 7: Current and Capital Accounts and Tourism Services million escudos ºTri09 2nd Tri09 3rd Tri09 4th Tri09 1st Tri10 2nd Tri10 3rd Tri10 4th Tri10 1st Tri11 2nd Tri11 3rd Tri11 4th Tri11 1st Tri12 million escudos Imports of Tourism Services (right axis) million escudos Goods and Services Income Transfers Combined Balance of Current and Capital Accounts ºTri09 2nd 3rd Tri09 4th Tri09 1st Tri10 2nd Exports of Tourism Services (right axis) 3rd Tri10 4th Tri10 1st Tri11 2nd 3rd Tri11 4th Tri11 1st Tri Source: Banco de Cabo Verde. In line with the evolution of domestic demand and of investment, in particular, imports of goods fell by about 9% (compared to the 20.5% growth in 1st quarter 2011). By categories of goods, there was an year on year reduction of 8.5%, 1.6% and 47.8% in imports of intermediate goods, capital goods and fuel, respectively, and a decrease of 16 percentage points in imports of consumer goods. The effect of price increases in the evolution of imports decreased from 11.9%, registered on a year on year basis, to 7.5%, despite the increase in fuel prices. The supply of fuel and food to international ships and aircraft continued to increase. It grew 36% YoY in the first quarter, reflecting particularly the dynamism of international air traffic and the commercial strategy of fuel companies, in a context of rising fuel prices. Unlike the evolution of re exports of food and fuel, exports of goods decreased by 14% in the first quarter, with falling exports of fish (15.8%) and of footwear and clothing by freetrade companies (8.4%). Unilateral transfers continued to show an unfavorable trend, mainly due to the behavior of official grants. Indeed, official current transfers declined by 15% in the first quarter(+9.8% in the same quarter last year), while capital transfers fell by 43%. In an environment in which the main bilateral partners are facing adverse financial conditions, there have been no budget support disbursements and transfers to projects financed by international organizations have dropped considerably (about 48%). Meanwhile, emigrants remittances continued to show great dynamism, despite some deceleration. In Q1 2012, they grew 16.7% YoY, down by 4 percentage points, due mainly to Banco de Cabo Verde / Maio

18 the slowdown in transfers from Eurozone countries. The financial account recorded a net inflow of funds of around 4% of GDP in Q1 (3.7% of GDP in the first quarter of 2011), due to the increase in net disbursements of public debt (21%) and demobilization of financial companies assets (around 4%). Figure 8: Official Transfers and Emigrants Remittances million escudos Emigrants' Remittances* (right axis) Official Transfers* Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11 Oct 11 Jan million escudos million escudos Emigrants' Remittances Investment of Emigrants (right axis) Jan 09 Mar 09 May 09 Jul 09 Sep 09 Nov 09 Jan 10 Mar 10 May 10 Jul 10 Sep 10 Nov 10 Jan 11 Mar million escudos Source Banco de Cabo Verde. Notes: * Current and Capital * Current and Capital Foreign direct investment remained on a downward trend, because of a continuous and significant reduction in real estate investments (77% YoY). Emigrant and business investments had an annual increase of about 28% in the aggregate. Figura 9: External Investments and Exchange Reserves milhões de escudos Jan 09 Abr 09 Jul 09 Out 09 Jan 10 Abr 10 Jul 10 Out 10 Jan 11 Abr 11 Jul 11 Out 11 Jan 12 IDE em CV (Total) Inv. dos emigrantes Inv. Imobiliário milhões de escudos ,4 3,6 5 3,2 3,2 4 4,1 4,2 4,2 4,2 2, Dez 04 Dez 05 Dez 06 Dez 07 Dez 08 Dez 09 Dez 10 Dez 11 Mar 12 Stock Reservas em milhões de euros Meses de importação 2 meses Source: Banco de Cabo Verde. The reduction in borrowing requirements, along with an increase of financing funds determined the accumulation of the country s foreign reserves by about 4 million Euros. In March 2012 the net international reserves amounted to million Euros, guaranteeing 3.2 months of imports of goods and services for Banco de Cabo Verde / Maio

19 5. Budgetary Position In the context of a worsening external environment, in 2011, fiscal policy focused on containment of operating costs and improvement of tax efficiency. At the end of the year, the budget deficit, including grants, reached million Cape Verdean escudos, decreasing 2.2 percentage points of GDP, to 10.1%. The 18% reduction in investment spending explains, to a large extent, the reduction of the public deficit in Tax revenue grew 12.3% (+2.8% in 2010), reflecting, to a large extent, the dynamism of economic activity in 2010, increased imports, and improved efficiency in tax collection. In particular, revenues from the Value Added Tax increased by 10.3%, at a faster pace than nominal GDP growth by 1.3 percentage points. Table 2: Evolution of the Budgetary Position in in million escudos Total Balance including Grants 2.091, , , ,0 Total Balance Adjusted to Cyclical Fluctuations 1.497, , , ,0 Current Balance 7.258, , , ,0 Primary Balance 5.985, , , ,0 in % of GDP Total Balance including Grants 1,8 6,8 12,3 10,1 Total Balance Adjusted to Cyclical Fluctuations 1,3 6,4 11,8 10,1 Current Balance 6,3 2,5 2,0 3,7 Primary Balance 5,2 11,7 18,1 11,5 Source: Ministry of Finance. Current expenses, in turn, increased 3.4% (compared to 2.2% in 2010). As a result of increased financing requirements, the Central Government s debt stock (excluding Consolidated Financial Mobilization Securities) reached 87.5% of GDP in late This reflects both the increase in external debt (to 67.2% of GDP) and in domestic debt (to 20.3% of GDP). The government finance statistics available for March point to a slight worsening of public finances in the first quarter. The budget deficit increased by 0.1 percentage points of GDP year on year, standing at billion escudos, essentially due to the significant reduction in grants and tax revenue slowdown. Banco de Cabo Verde / Maio

20 Table 3: Budgetary Position in the First Quarter of st Quarter 2nd Quarter 3rd Quarter 4th Quarter 1st Quarter in million escudos Tax Revenue 7.047, , , , ,0 of which: Value Added Tax (VAT) 2.696, , , , ,0 Income Tax (IUR) 2.282, , , , ,0 Grants 797, , , ,0 327,0 Current Expenses 7.243, , , , ,0 of which: Salaries 3.308, , , , ,0 Transfers 1.955, , , ,0 837,0 Pensions 738, , , ,0 n.d Investment Spending 3.750, , , , ,0 in percentage of GDP Overall Balance (including grants) 1,5 5,6 7,2 10,1 1,6 Current Balance 0,5 1,7 2,5 3,7 1,0 Source: Ministry of Finance. The growth rate of tax revenues fell from 12%, registered in the same period last year, to 1.4%, due to the behavior of taxes on goods and services. Indeed, the increases in revenues from collection of income tax (6.8%) and taxes on international transactions (10.7%) marginally offset reductions in collection of value added tax and special consumption tax by 4.5% and 3%, respectively. It should be noted that, in the same period last year, the VAT and special consumption tax grew 15.9% and 52.8%, respectively. Current expenses decreased 13.1%, compared to a 23.1% growth in the same period last year. The decrease in operating expenses was mainly due to the reduction in transfers to general government ( 17.1%) and subsidies ( 79.5%), the latter due to the base effect related to the payment of tariff deficit and compensation of the cost of diesel power leased by Electra in the first quarter of last year. Meanwhile, the cost of debt interest increased 1.7%, due to the significant increase in interest on foreign debt (62% YoY). The growth rate of investment spending also declined significantly (from 32.3% to 5.7%). These investments were directed mainly to port expansion/modernization projects and social housing and totaled billion escudos in March. 78.6% were financed by foreign borrowing, 18.6% by the Treasury and 2.8% through grants. The financing of public deficit in the first quarter was done mostly using external loans, because there was a slowdown in the growth of domestic financing of 1.3 percentage points. Also noteworthy was the rise in the yield curve for shorter periods, due to the 0.16, 0.25 and 0.62 percentage point growth in the rate of return on Treasury Bills for maturities of 91, 182 and 364 days, respectively. Treasury bond rates, in turn, remained stable in the period under review, ranging between 5.75% and 6%. Banco de Cabo Verde / Maio

21 6. Monetary and Financial Policy and Position In 2011, the monetary and financial position was highly conditioned by the evolution of external accounts. Significant increase in imports, reduction in grants to the Central Government, and reduction in inflows of foreign direct investment led to a fall in the country s net foreign assets, which, consequently, determined the moderate money supply growth. In a context of reduced external inflows, the banking system continued to generally ensure growth in credit to households, non financial enterprises and the public sector. Thus, credit to the economy grew by 9.8% and credit to general government grew by 13%. In terms of policy terms, in order to correct the downward trend of foreign reserves, which began in April 2011, and to strengthen financial system stability, BCV broadened the base for establishment of Minimum Reserve Requirements, including general government deposits (50% in July and 100% in December). Similarly, in the second semester, it restricted the conditions of access to marginal lending facilities, raising the rate in increasing proportion of the amount requested, and set a ceiling for the transfer of funds to banks. The tightening of monetary conditions, especially in the second half of 2011, among other factors, were instrumental in reversing the trend of declining foreign reserves in the last month of the year. In late December, BCV increased key interest rate, the marginal lending facility rate and the deposit facility rate by 150 basis points to 5.25%, 8.85% and 3.25%, respectively; and determined the increase of reserve coefficient from 16% to 18%. These measures came into force in January Information available for the first quarter of 2012 suggests the maintenance of the trend of slowdown in money supply growth, both for December (by 1.4 percentage points) and in year on year terms (by 4.7 percentage points). Table 4: Main Indicators of Monetary Situation (year on year rate of change) December March June September December March Net Foreign Assets 6,4 1,3 24,9 26,0 17,1 13,7 Net Domestic Credit 5,4 10,3 14,7 14,5 10,3 4,8 Net Credit to General Gov 7,6 18,0 35,0 31,6 13,2 3,4 Credit to the Economy 8,5 8,5 10,6 10,7 9,8 6,8 M1 7,4 3,6 1,7 3,9 11,8 10,2 M2 4,7 6,0 3,3 3,1 2,1 1,3 Source: Commercial banks; Banco de Cabo Verde. Banco de Cabo Verde / Maio

22 Regarding December, the moderate growth of money supply was determined by continuing reduction of net foreign assets ( 4.7%), despite the recovery of net international reserves (increased by 1.8%), the slowdown in credit to general government (13% to 8%), and the slight decrease in credit to the economy ( 0.4%). The evolution of credit to the economy, in particular, may be reflecting some transmission of monetary policy decisions, in an environment of reduced excess liquidity in the banking system. It should be noted that credit extended to non financial corporations increased by 0.6% compared with December, while loans to individuals for other purposes decreased 3.9%, indicating that banks are using more restrictive criteria for loan approval. 7 Figure 10: Lending and Deposit Interest Rates in percentage 13,00 lending rates 12,00 11,00 10,00 9,00 8,00 7,00 6,00 Dec 06 Apr 07 Aug 07 Dec 07 Apr 08 Aug 08 Dec 08 Apr 09 Aug 09 Dec 09 Apr 10 Aug 10 Dec 10 Apr 11 Aug 11 Dec months 1 2 years Over 10 years in percentage 5,50 deposit rates 5,00 4,50 4,00 3,50 3,00 Dec 06 Apr 07 Aug 07 Dec 07 Apr 08 Aug 08 Dec 08 Apr 09 Aug 09 Dec 09 Apr 10 Aug 10 Dec 10 Apr 11 Aug 11 Dec 11 Residents (181 days to 1 year) Emigrants (181 days to 1 year) Residents (91 days to 180 days) Source: Commercial banks; calculations by Banco de Cabo Verde. In turn, there was a slight worsening of financing conditions and, in particular, a significant increase (by 3.3 percentage points) in interest rates for 7 to 30 day loans. Deposits, which are the main source of financing for banks, rose 2.4% over December, but fell 1.4% YoY. The YoY reduction in deposits was determined by falling demand deposits in national currency (11.5%), as time deposits and savings deposits grew by about 8% (7.5% in March 2011), driven by the dynamics of emigrants deposits (rose 10% YoY). 7 In line with what was reported by banks in the qualitative survey on credit policy. Banco de Cabo Verde / Maio

23 Prospects for the Economy in 2012 Banco de Cabo Verde / Maio

24 7. Framework Hypotheses Current projections are based on information on recent developments in the Cape Verdean economy, as well as on a number of assumptions about expectations of changes in key domestic and international economic and financial indicators for the next three quarters of In carrying out the projections, fiscal stance is a key variable. The external environment of the Cape Verdean economy remains unfavorable, despite a relative improvement in the first quarter of The IMF s view is that economic activity will remain weak in advanced economies, and should remain robust in most emerging and developing countries. In this scenario, global economic growth will fall from 3.9% in 2011 to 3.5% in 2012, representing a downward revision (0.5 percentage points) compared to September 2011 projections. The Euro area will contract 0.3%, given the impact of bank deleveraging and fiscal consolidation on the real economy. Conditioned by the problems in Europe, advanced economies should grow 1.4% in 2012 (1.6% in 2011) and labor market conditions will likely remain unfavorable. Table 5: Main International Indicators (in percentages ) Real GDP Inflation Current Account Unemployment E 2012P E 2012P E 2012P E 2012P Advanced Economies 3,2 1,6 1,4 1,5 2,7 1,9 0,2 0,2 0,4 8,3 7,9 7,9 US 3,0 1,7 2,1 1,6 3,1 2,1 3,2 3,1 3,3 9,6 9,0 8,2 Eurozone 1,9 1,4 0,3 1,6 2,7 2,0 0,4 0,3 0,7 10,1 10,1 10,9 Germany 3,6 3,1 0,6 1,2 2,5 1,9 5,7 5,7 5,2 7,1 6,0 5,6 France 1,4 1,7 0,5 1,7 2,3 2,0 1,7 2,2 1,9 9,8 9,7 9,9 Portugal 1,3 1,5 3,3 1,4 3,6 3,2 9,9 6,4 4,2 12,0 12,7 14,4 Japan 4,4 0,7 2,0 0,7 0,3 0,0 3,6 2,0 2,2 5,1 4,5 4,5 Emerging and Developing Economies 7,5 6,2 5,7 6,1 7,1 6,2 2,0 2,4 Brazil 7,5 2,7 3,0 5,0 6,6 5,2 2,3 2,1 3,2 6,7 6,0 6,0 Russia 4,3 4,3 4,0 6,9 8,4 4,8 4,8 5,5 4,8 7,5 6,5 6,0 India 10,6 7,2 6,9 12,0 8,6 8,2 2,6 2,8 3,2 China 10,4 9,2 8,2 3,3 5,4 3,3 5,2 2,8 2,3 4,1 4,0 4,0 Sub Saharan Africa 5,3 5,1 5,4 7,5 8,2 9,6 1,2 1,8 2,0 Source: IMF (2012), World Economic Outlook for April. Notes: The current account is expressed in percentage of GDP. P Provisional; E Estimates The crisis of the Euro will severely affect the rest of Europe; however it is not expected to have significant effects on other economies, except where related to financial volatility. The risks of the current IMF projections are mainly downside, being mainly related to a possible intensification of the crisis in the euro area and an increase in geopolitical instability Banco de Cabo Verde / Maio

25 and consequent escalation of oil prices. 8 The effect of a rapid increase in oil prices on global product will be greater if accompanied by significant financial volatility and loss of confidence as a result of the materialization of the 1 st risk. The IMF believes that policy measures aimed at preventing the materialization of downside risks, particularly in Europe, should adequately consider short term adverse effects and long term favorable effects resulting from fiscal consolidation and bank deleveraging. In particular, the IMF suggests the adoption of measures to limit the links between the financing of sovereign entities and soundness of banks, urging the creation of deposit insurance systems and of a common securities market (in Euro). It also encourages countries with surplus in external accounts, namely China, to rebalance their economy and boost domestic consumption by adopting measures that enable market forces to play a greater role in determining exchange rates. The technical assumptions about the evolution of exchange rates in 2012 admit that the Euro will depreciate 3.3% in nominal effective terms and 4.3% against the dollar, in accordance with the European Central Bank s projections. With regard to external financing conditions, the 3 month Euribor rates, which indexes most external debt to repay, are expected to fall from 1.4% in 2011 to 0.8% in It is noted that the prospects of the European Central Bank in the fourth quarter pointed to a slighter slowdown in interest rates (from 1.4% to 1.2%). The information available in the futures markets points to a temporary acceleration of the annual average price of Brent, from about $110 per barrel in 2011 to $116 in This contrasts with the downward trend in oil prices of the November 2011 Report, and is largely associated with speculation about an increase in demand, as a result of the improved outlook for the global economy in the early months of the year, in an environment of continuing strong geopolitical tension and imminent entry into force of sanctions imposed by the West on Iran. For its part, the expectations in the markets point to a sharper decrease of non energy commodity prices in international markets (10.3%) than expected in September (4.7%). The prospects for national economic development are conditioned by external develop 8 In the scenario of intensifying crisis in the Eurozone, IMF projections indicate that the region s GDP and global GDP will contract 3.5% and 2%, respectively, within next two years. Also, according to the IMF, a 50% increase in oil prices could lead to a reduction in global output by 1.25%. 9 Information on market closing on 24 April Banco de Cabo Verde / Maio

26 ments. In particular, the economic and financial situation of the country s main partners (Portugal, Spain, Italy and other EU countries) may have a significant effect on tourism revenues, emigrants remittances, foreign investment and official grants. The government budget anticipates the continuation of the phasing out strategy of the expansionist policy that has been in place since In a context of deteriorating external environment for the Cape Verdean economy, the fiscal framework for 2012 indicates: deceleration in tax revenues; reduction in grants; slight increase in current expenses and reduction in investment spending; reduction in the overall deficit by 0.5 percentage points of GDP, and slight reduction in domestic debt in However, given the unfavorable budget execution in the first quarter, the Ministry of Finance and Planning will adjust expenditures and strengthen the tools that enable greater effectiveness in tax collection. Banco de Cabo Verde / Maio

27 8. Projections for the Cape Verdean Economy The revision of the inflation projection was based on current developments in the consumer price index, as well as the latest updates of prices of regulated goods and services, and assessed the most recent expectations on the evolution of fiscal variables, wages, price of agricultural products, foreign demand, Euro exchange rates, as well as past inflation. 10 Given the weight of imported goods in the CPI, the projected consumer price index reflects the technical assumptions related to the evolution of international prices of energy and non energy raw materials, as well as the expected inflation in the Eurozone and in Portugal, where more than 50% of Cape Verde s imports originate. The current projection points to a decline in the average annual inflation rate to the 3.5% 4.5% range, which corresponds to an upward revision of 0.5 percentage points over November projections. The unexpected rise in oil prices from February to early April, which has already resulted in an increase in domestic prices of fuel, public transportation, electricity and water, justified the revision of inflation projections. Table 6: Framework Assumptions for Projected Inflation P Price of Raw Materials energy 36,3% 27,9% 31,6% 10,3% non energy 15,7% 26,3% 17,8% 10,3% HICP Portugal 0,9% 1,4% 3,6% 3,2% HICP Eurozone 0,3% 1,6% 2,7% [2,1% 2,7%] Source: Statistics Institute; International Monetary Fund; European Central Bank; Banco de Portugal and Banco de Cabo Verde. Notes: CPI Consumer Price Index; HICP Harmonized index of consumer prices P Projections The expectations surrounding the evolution of other determinants of inflation remained broadly stable between November 2011 and April In particular, the expectations of relative fiscal restraint, significant drop in prices of fresh produce and moderate wage growth remained unchanged. 10 In line with the findings of a study carried out by BCV on the determinants of inflation in Cape Verde. This study concludes that inflation in Cape Verde is influenced greatly by agricultural production, wage developments, and inertia resulting from the weakness of the productive sector and other rigidities that affect inflation expectations. Although not conclusive, the analysis shows that periods of fiscal restraint correspond to periods of relatively low inflation. Also, given the weight of trade with the Eurozone and Portugal, it adds that the impact of some imported inflation should not be negligible. Banco de Cabo Verde / Maio

28 The latest projections of Banco de Portugal (Economic Bulletin for Winter 2012) admit an inflation rate of 3.2% for Portugal, which represents a slowdown of 0.4 percentage points over the inflation rate for It is expected that inflation will remain relatively high in Portugal (compared to the Eurozone target of 2%) as a result, on the one hand, of expected developments in oil prices and, on the other hand, the implementation of administrative (affecting only non tradable goods and services) and fiscal decisions, related to ongoing fiscal consolidation. Therefore, inflationary pressures arising from trade with Portugal are expected to soften. Num Against a background of slight contraction in the activity of the country's main economic partners and on the assumption that the current guidelines for monetary and fiscal policy will be maintained, the current projection points to a slowdown in economic growth in 2012, with the real growth in GDP expected to be between 4% 5%. In real terms, a greater contribution from net external demand is expected, supported by a slight reduction in imports. In terms of domestic demand, a slowdown in private consumption is anticipated, coupled with a slowdown in internal and external transfers, wage moderation (due to the freezing of salary updates in Public Administration and expectations of moderate wage growth in the private sector), and a slowdown in consumer credit, in a context where inflation is expected to remain relatively high. This trend contradicts last November s predictions, reflecting, on the one hand, expectations about the latest developments in inflation, and the implementation of restrictive monetary policy measures as of January 2012, on the other. In line with the amount budgeted, public consumption will grow 3.2% in real terms, 1.3 percentage points more than in In real terms, gross fixed capital formation should observe a slight decrease, due to the anticipated reduction in public investment (about 10%) and the slowdown in private investment (business and residential), in line with changing conditions of internal and external financing. The evolution of investment in other sectors should reflect the base effect (given the substantial internal investments made in transportation equipment and materials in 2011), a slowdown in mortgage loans and the continuing decline of foreign investment in real estate. However, investment in transportation and communication is expected to maintain some momentum, as well as in the energy sector, financed mainly with foreign debt. Banco de Cabo Verde / Maio