Press Release No. 98/3

Press Release: IMF Approves Stand-By Credit for Cape Verde

February 23, 1998

The International Monetary Fund (IMF) today approved a 14-month stand-by credit for Cape Verde equivalent to SDR 2.1 million (about US$2.8 million) to support the government’s 1998 economic program. The authorities have indicated their intention not to draw on the credit.

Background

Cape Verde, an archipelago off the coast of Senegal, suffers from frequent drought, insufficient arable land, and periodic locust infestations. This has made farming difficult and has forced much of the population to emigrate. Workers’ remittances are a major source of foreign exchange earnings.

In 1992 the newly elected government launched a reform program to reduce the size of the public sector and to boost economic growth by increasing the export base. Although real GDP growth rose to an annual average rate of more than 4 percent during 1992-95, unemployment remained at about 25 percent, underlining the need to deepen structural reforms.

Given its small, open economy, Cape Verde has maintained a nominal exchange rate peg as an anchor and as the main instrument to control inflation. However, weak fiscal policies during 1992-95 led to a rapid increase in public spending, a subsequent accumulation of domestic debt, and the virtual depletion of foreign exchange reserves. This critical situation prompted the authorities in 1996 to tighten financial policies and impose import controls on certain products. Though average annual inflation declined to about 6 percent in 1996 from a peak of 8.4 percent in 1995, and international reserves rose, the economic situation remained fragile. With a persistent drought, economic growth was only 3 percent a year in both 1996 and 1997, and inflationary pressures remained. However, the fundamental cause of the continued macroeconomic imbalances was weak fiscal discipline, with the overall fiscal deficit around 15 of GDP in 1996 and 1997.

The 1998/99 Program

The macroeconomic program envisages real GDP growth of 4 percent in 1998, compared with 3 percent in 1997, and an average inflation rate of 3.5 percent in 1998, compared with 8.9 percent in 1997. The external current account balance, excluding transfers, is targeted at a deficit of 15.7 percent of GDP in 1998, compared with a deficit of 16.4 percent in 1997.

The most important element of the program is a tightening of fiscal policy to reduce the overall fiscal deficit to 8.7 percent of GDP in 1998 from 15.1 percent in 1997. The deficit is to be entirely financed by concessional foreign borrowing. Total expenditures will fall, mostly through reductions in interest payments and cuts in capital expenditure. Administrative measures to strengthen budgetary execution will be introduced.

The authorities of Cape Verde intend to maintain a pegged exchange rate, and thus monetary policy will be geared to balancing the private sector’s credit needs against the reserve accumulation targets of the program.

The Stand-by Arrangement underpins a donor-supported domestic debt operation, which will mobilize the equivalent of US$180 million to reduce the government’s debt-service burden. Although the operation will not expunge the debt, it will eventually relieve the current budget of its large domestic debt-service burden.

Structural Reforms

Structural reforms entail an acceleration of the privatization program, as well as legislative and regulatory reform aimed at creating a favorable environment for private sector development. The program calls for the privatization or restructuring of 23 state-owned companies, including two commercial banks, as well as reforms of the civil service, fiscal administration, and trade. The government will strengthen the regulatory framework in numerous areas, including civil aviation, maritime transport, urban transport, energy and water, and communications.

Exports, particularly of services, are the key to sustainable growth in Cape Verde and are expected to continue to grow rapidly. In addition, the government intends to further liberalize the trade regime by replacing the few remaining import quotas with tariffs and then rationalizing and reducing overall tariffs.

Addressing Social Costs

Cape Verde’s objectives in the social area and in poverty alleviation are to be achieved through higher growth, lower inflation, and continued budgetary support of efforts to improve primary health and education. Job creation will depend on sustained economic growth brought about through firm implementation of structural reforms and fiscal objectives.

The Challenge Ahead

The authorities have successfully put together a large donor-supported domestic debt-reduction operation, reflecting the confidence of the international community in Cape Verde’s ability and resolve to implement its fiscal program. An ongoing challenge will be the need to further compress noninterest recurrent expenditure in the coming budgets, in particular, throughthe program for voluntary departure from the civil service and through the program to rationalize government institutes, with a view to making them financially self-sustaining.

Cape Verde joined the IMF on November 20, 1978, and its quota¹ is SDR 7.0 million (about US$9.4 million). Cape Verde currently has no outstanding use of IMF financing.