MADAGASCAR ECONOMIC UPDATE Economic crisis? Not yet but almost there World Bank --May 19 2009 The Malagasy economy is headed toward a severe recession. In the absence of a clear resolution to the current political crisis and the impact of the global financial turmoil, three recent negative trends consolidated during April: (i) the reduced capacity of the Government to collect revenues and to borrow on the domestic market; (ii) the continued gradual decline in production and layoffs in the industrial and service sectors; and (iii) the further depreciation of the local currency coupled with the gradual loss in the Central Bank s international reserves. Time is running out for policy remedies, which should be accompanied by a reduction in political uncertainty to be effective. Spending cuts as a response to lower revenues Lower public revenues and rising interest rates associated to domestic borrowing have forced the authorities to spend less. At the end of April 2009, Government spending was about 1/3 lower than one year ago (US$274 million vs. US$407 million in real terms), impacting negatively on GDP growth since the public sector has been the traditional driver of growth over the past few years. Revenue performance continues to be weaker than anticipated in the 2009 Finance Law with an accumulated shortfall of about Ariary 200 billion since the beginning of year (Table 1). This result arises from the decline in the tax base (notably international trade) and the underperformance of the fiscal administration. Yet, it is worth underscoring the distinct pattern between internal and international revenues. While customs revenues in April were approximately 2/3 lower than their initial target, domestic tax revenues were almost at par with the objective set in the Law of Finance (the gap was only 8% in April). This relatively good performance of the General Tax Directorate (DGI) is partly explained by the payment of tax arrears on wages (that were due in December 2008 and March 2009), which might therefore only reflect a one-time improvement. Table 1: Shortfall in domestic tax and custom revenues As of April 2009 In billion of Ariary Q1 2009 Apr-09 Actual Target Gap Actual Target Gap Domestic tax revenue 195.2 248.6-53.4 82.5 89.5-7 Customs revenue 171 266.6-95.6 36.5 81.2-44.7 Total 366.2 515.2-149 119 170.7-51.7 Source: Ministry of Finance (provisional figures) The significant gap in tax revenues, coupled with the drying up of external funds due to the non-recognition of the Transition Authority by the international community, has left domestic borrowing as the only financing option to the Government. The authorities have been careful by limiting T-bills issuance in April (Ariary 125 billion which is about 1/3 less than during the same period of last year) because of early pressure on domestic 1
Billiion of Ariary 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0-5.0 Austerity...No more public investment in April 2009 Jan-April 2008 (monthy average) Jan-March 2009 (monthy average) April 2009 interest rates has started to be observed, notably on longer term maturities (up from 8% to 12.3%). This increase reflects the thinness of the local market that has been exacerbated by the apparent reluctance of nonbanking investors to purchase Government bonds. On the expenditure front, the fiscal adjustment was brutal in April 2009. If salaries and debt services were paid, as well Faster spending in 2009 by political institutions but as some critical non-wage not by other ministries expenditures such as gasoline, 0.45 transports, and energy bills; all Primature other expenses were stopped. 0.40 Investment spending was close to 0.35 0 between March and April 2009 Finance &Budget 0.30 (even negative if we account that 0.25 some investments conducted by the Presidency were cancelled by 0.20 the new regime). The quasiparalysis of public administration is further reflected in the low execution rate of the allocated budget (14% at the end of April), which is much lower than in 2008 except for the political institutions and the Ministry of Finance and Budget. Execution rate in April 2009 0.15 0.10 0.05 AN HCC Presidence 0.00 0.00 0.10 0.20 0.30 0.40 0.50 0.60 0.70 0.80 Execution rate in April 2008 Further recession in economic activities Although official statistical data are still missing, there is a strong presumption that the slowdown in real activities observed during the first three months of 2009 has intensified in April: The tourism sector remains in disarray as occupancy rates in hotels are very low (e.g., around 15% in Nosy Be), with an estimated cut in turnover that can range from 50 to 80% depending on their location and targeted customers. Recent information on the textile sector is also worrisome. Trade data provided by customs indicates a decline in textile exports of about 25% in value terms 2
during the first quarter, leading to 800 job losses and 1000 temporary unemployed workers. Most operators anticipate a further decline in orders due to the global crisis and the possibility that Madagascar will not qualify anymore to AGOA and, thus, will not benefit from preferential access to the U.S. market. 1 The shrimp sector is suffering from a deep and structural crisis, which has conduced to 700 job losses in one aquaculture firm located in the West of Madagascar. Construction and public work activities are down significantly because of the slowdown in donors financing and lower construction in the mining sites. The Union of construction, building and public work (including 33 of the largest companies) has estimated that about 1500 jobs were lost during the first quarter and that the current crisis might lead to a 40% loss of its members turnover over the remainder of the year. A few notable exceptions can be found, notably in the energy sector since gas oil consumption increased significantly in April 2009, up by 40% compared to February 2009, and almost converging to its 2008 April level. This unexpected increase seems to reflect higher demand by the mining sector. The performance of the agricultural sector is anticipated to be good, with a promising rice harvest thanks to clement weather (no big cyclone in 2009) and an aggressive policy response to the food crisis in the second semester of 2008. With a little delay, the first mining exports operation of QMM/Rio Tinto was realized on May 14, 2009. Nevertheless, the overall slowdown in private activities is confirmed by lower electricity consumption, down by 40 % for the industry sector and 16% for households, and by the decline in credit to the private sector, down by 0.4% between January and March 2009 when it was rising by almost 10% during the same period a year ago. This decline is especially visible in trade credit (resale credits down by 17%, letter of credits by 14% and crop credits by 14% between February and March 2009). If this decline partially translates the prudent behavior of commercial banks, it also highlights lower demand by firms and households. Financial sector and inflation under control The overall banking system continues to be sound and liquid, since commercial banks profitability appears stable (though the latest information available is dated of end December when their return on asset was 3.6%). Deposits only declined by 1 % between January and March, which is about the same pace observed during the same period in 2008, reflecting confidence in the system. Still, non performing loans increased by 6% in nominal terms in March 2009 compared to its level at end 2008. Furthermore, the excess liquidity of the banking system fell by 40% between mid-january and mid-april, indicating some early pressure. 1 US State Department statistics reveal that US textile imports from Madagascar already declined by 17% in the first quarter of 2009. 3
The Central Bank continues to pursue a prudent monetary policy by containing reserve 300 money (down by 5% in April compared to end-december). Such a conservative approach 250 is mostly apparent in the financing of the public deficit, 200 since the Central Bank s credit to Government remained stable 150 (even down by 1%) between end-2008 and April 2009. As a 100 result, inflation remained under control, up by only 0.4% in April or 10.4% on a year-onyear basis. Food prices Inflation Transport Energy declined in April, while housing, water, gas and electricity and transport prices increased slightly (Figure). Inflatio n Housing, water, gas and electricity Rice Toward a Balance of Payment Crisis? During April 2009, the local currency lost 12% and 5% of its value compared to the USD and the EURO, respectively, furthering the depreciation that has started in the last quarter of 2008 (down by 23% and 13% respectively to these two currencies since September 2008). 2,800 2,700 2,600 2,500 2,400 2,300 2,200 2,100 Nominal exchange rate Eur o/ Ar iar y US$/ Ar iar y 2,500 2,400 2,300 2,200 2,100 2,000 1,900 1,800 1,700 1,600 1,500 This decline in the value of the local currency is relatively large but translates significant changes in the fundamentals of the Madagascar economy. Booming exports and capital inflows up to mid-2008 (due to large mining investment and official aid) have reverted in 2009. The global financial crisis (mostly) and the local political crisis have impacted negatively on the export sector, and discouraged potential foreign investors. Quarterly figures of international trade revealed that the decline in main exports products (textile, shrimp and vanilla) exceeded 50% and 40% respectively in volume and value terms during the first quarter of 2009 compared to the same period in 4
2008 (Table 2). Imports also declined during the same period by 44% and 24% in volume and in value terms, respectively. This decline is more pronounced in capital goods and raw materials, reflecting lower investment by local firms, while consumption goods imports remained more stable. Table 2- Comparison of trade flows Volume Value Jan 08/09 Feb 08/09 Mar 08/09 Jan 08/09 Feb 08/09 Mar 08/09 Total Exports -40% -56% -51% -31% -27% -55% Textile -32% -24% -26% -28% -11% -30% Shrimp -72% -36% -27% -73% -44% -54% Vanilla -80% -98% -94% -78% -97% -94% Other export goods -39% -58% -52% -21% -25% -59% Total Imports -43% -14% -69% -22% 1% -51% Food -25% -6% -12% -27% 3% -12% Energy -42% 7% -93% -66% -44% -94% Capital Goods -31% -63% -71% -9% 18% -51% Raw material -54% -16% -62% -23% 8% -40% Other imported goods -23% -4% -87% -9% -1% -41% Source: Customs General Directorate office (preliminary figures) The magnitude of the adjustment in the balance of payments has still to be determined, but it is taking place. Under these circumstances, the depreciation of the local currency is a natural adjusting mechanism. It increases the competitiveness of Malagasy exports in international markets, and makes imports more costly. Concurrently, a decline in the local currency value makes foreign investment more attractive you get more for each dollar invested. Policy makers in Madagascar are faced to two interconnected issues. One is to control expectations; second is to have the instruments to manage the speed of the adjustment. If economic agents anticipate a further loss in the value of the currency, there is risk that the depreciation becomes self-fulfilling in the sense that economic agents purchase less local currency because they expect that it will depreciate in the future, precipitating the decline. Such a behavior might lead to an overshooting in the loss of the value of the local currency, as demonstrated three decades ago by the famous former MIT Professor R. Dornbush. This risk is today exacerbated because monetary authorities have relatively little international reserves at hands to manage the variations in the exchange rate. Those reserves have already declined by 15 % since end-december 2008 and were only equivalent to 2.5 months of imports at end-april. At this stage, policy makers should act to reduce uncertainties. The good news, as mentioned earlier, is the remaining confidence in the banking system since overall deposits have remained stable and, above all, no portfolio shift has yet occurred away from local currency deposits toward foreign currency deposits 2. Prudent monetary and 2 Deposits in local currency have increased by 6 %, when deposits in foreign currency went down by almost by 5% between December2008 and April 2009. 5
fiscal policies have also helped contain domestic inflation and limit the decline in the value of the local currency in real terms. Looking forward Time is running out for policy makers. Not only has economic growth lost steam since the beginning of the political crisis; but all economic and financial indicators seem to indicate that the situation has worsened during April. Private sector activities, such as textile, construction and tourism, have continued to suffer significant losses (generating unemployment), and their medium term perspectives appear even somber, notably for exporting firms that will start to feel fully the effects of the global economic turmoil. The only comforting factor has been the relatively good behavior of the agricultural sector, notably with the perspective of a good rice harvest. In most countries, the slowdown in the private sector is partially compensated by the adoption of a fiscal stimulus, aimed at pushing global domestic demand notably by an increase in investment projects and public employment. In Madagascar, such a counter-- cyclical policy is not feasible due to the current budgetary constraints that have imposed an austerity program. During April, all public spending were cut at the notable exceptions of wages and debt service. The dilemma for the Malagasy authorities is serious. On the one hand, fiscal austerity is necessary to preserve fiscal sustainability and to keep interest rates and inflation under control. Otherwise, operators might loose confidence in the financial system, precipitating an uncontrolled depreciation of the local currency and, ultimately a balanceof-payments crisis. On the other hand, pursuing fiscal austerity will feed the recession and create further social and economic tensions, notably job losses and a worsening of poverty. Soon it might even be envisioned that the Government will have to cut priority expenditures (such as wages) if tax collection continues to fall and access to domestic borrowing becomes more costly. More than ever the pressure is on politicians: either they find alternative channels of public financing (with eventual reputational costs) or they reach an agreement that could help bring back confidence in the transition toward the return to democracy and the restoration of external aid. 6