Public Information Notice No. 08/142

Public Information Notice: IMF Executive Board Concludes 2008 Article IV Consultation with Seychelles

November 18, 2008

On November 14, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Seychelles.¹

Background

Seychelles is in the midst of an acute balance of payments and public debt crisis, which jeopardizes its high living standards and economic development. Despite step devaluations in 2006-07, the exchange rate has not been consistent with economic fundamentals for some years. Competitiveness has been undermined by expansionary fiscal and monetary policies inconsistent with the maintenance of the pegged exchange rate regime. External debt rose to unsustainable levels, complex exchange controls and restrictions were progressively introduced and foreign exchange shortages ensued. A parallel foreign exchange market flourished and dollarization rose.

Reform efforts since 2003 have brought about some fiscal adjustment, trade reform and partial economic liberalization, but have been insufficient to address longstanding macroeconomic imbalances and vulnerabilities. In mid-2008, facing the near exhaustion of official foreign reserves, the authorities missed a payment on a privately-placed external debt issue in July and on a Eurobond payment in October. Standard and Poor's has downgraded Seychelles to SD (selective default).

The oil and food price shocks, together with the global slowdown, have exacerbated vulnerabilities. GDP growth, which has been strong since 2005 on account of high hotel-related foreign direct investment (FDI) and tourism receipts, is projected to sharply decline in 2008 due to foreign exchange shortages and less buoyant tourism growth. Inflation has risen rapidly following the increase in world food and fuel prices and the 2006-07 devaluations. The external current account deficit is projected to widen due to lower growth in tourism receipts, the petroleum and food price shock, and higher costs of transportation services. As of mid-October, official reserves had fallen to very low levels and the balance of payments is increasingly financed by external arrears accumulation. In light of these developments, in 2008 the authorities began to tighten fiscal and monetary policy.

The authorities have requested Fund assistance in support of a comprehensive reform strategy aimed at restoring internal and external balances. The reforms include a fundamental liberalization of the exchange regime, involving the elimination of all exchange restrictions and a float of the rupee; a significant and sustained tightening of fiscal policy backed by a reduction in public employment and the replacement of indirect subsidies with a targeted social safety net; a reform of the monetary policy framework to focus on liquidity management based on indirect instruments; and a reduction in the role of the state in the economy to boost private sector development, through further privatization, enhanced fiscal governance, and a review of the tax regime.

Although the authorities' proposed fiscal adjustment is heavily frontloaded and sustained over several years, a comprehensive debt restructuring involving a substantial reduction in the debt service burden consistent with Seychelles' long-term ability to pay will be needed to place public debt on a sustainable path. At almost 151 percent of GDP, public debt is unsustainable. External public debt represents some 95 percent of GDP (US$808 million), of which over 40 percent is arrears, mostly to Paris Club creditors and on the private placement. There is a small amount of arrears to multilateral creditors. Following the missed payments on commercial obligations, the authorities announced that they had hired qualified financial and legal advisors and that they would approach creditors to seek an agreement on a comprehensive debt restructuring, consistent with their ability to pay.

Executive Board Assessment

Seychelles faces a severe economic crisis-characterized by large fiscal and balance of payments imbalances built up over several years, an unsustainable public debt burden, mounting arrears, and dwindling foreign reserves-which has been exacerbated by the global economic turmoil. Executive Directors accordingly welcomed the authorities' determination to undertake far-reaching economic reforms aimed at putting the economy back on the track of sustainable economic growth and development. This reform effort merits the support of the international community, including through comprehensive public debt restructuring.

Directors commended the authorities' upfront liberalization of the exchange regime and the float of the rupee. The removal of extensive exchange restrictions and discretionary regulations as part of the reform program is essential to restore credibility of the currency and unify the parallel and official exchange rates. Several Directors emphasized that, at this juncture, there is little alternative to a floating market-determined exchange rate regime, especially as official reserves are largely depleted. However, further reflection will be required on the best long-run monetary policy framework and exchange rate regime for Seychelles.

Directors saw the significant tightening of fiscal policy in 2008 as a crucial element of macroeconomic stabilization, and welcomed the accompanying provision of targeted support for the most vulnerable groups. Key to program success will be the implementation of strong fiscal policy reforms needed to maintain sizable primary surpluses over the medium term. These include introduction of a targeted social safety net to replace indirect product subsidies and tax exemptions and continuation of the public sector employment retrenchment exercise.

The public debt of Seychelles is unsustainable, even with the significant fiscal adjustment envisaged. Directors welcomed the authorities' good faith efforts to work with official bilateral and commercial creditors on a debt restructuring strategy aimed at reestablishing public debt sustainability consistent with Seychelles' long-term payment capacity, based on the principles of transparency, inter-creditor equity, and open dialogue with all creditor groups. They underlined the importance of steps to strengthen public debt management. Directors looked forward to a more comprehensive Debt Sustainability Analysis (DSA) to be provided at the time of the first review of the stand-by arrangement as well as to regular updates on financing assurances and safeguards.

Directors welcomed the major strengthening of the monetary policy framework under way, notably in enhancing the ability of the Central Bank of Seychelles (CBS) to manage liquidity through indirect market-based monetary intervention. This will require closer collaboration between the CBS and Ministry of Finance to improve liquidity forecasting and management. Directors supported the authorities' efforts to strengthen financial sector supervision, and noted that the budget includes a provision for the potential recapitalization needs of the sector.

Directors commended the authorities for taking several important measures to bolster public sector governance and transparency, and encouraged the authorities to address all areas of concern identified in the safeguards assessment. Steps to address weaknesses in data quality and timeliness with technical assistance from the Fund will also be important.

Directors recognized that a comprehensive and sustained structural reform effort will be needed to underpin economic growth and competitiveness over the medium term, and welcomed the authorities' intention to articulate such a medium-term structural reform agenda in 2009 with input from the Fund, the World Bank, and other partners.

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.