June 28, 1999

Mr. Michel Camdessus
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Camdessus:

1.  On November 27, 1996, the Executive Board of the International Monetary Fund approved a three-year arrangement under the enhanced structural adjustment facility (ESAF) in support of Madagascar's macroeconomic and structural adjustment program, as well as the first annual arrangement thereunder. While the macroeconomic aspects of the program were successfully implemented during the first annual arrangement, which ended in November 1997, in the intervening period, the government encountered difficulties in boosting the collection of tax revenue and maintaining strict control over government expenditure execution, while the implementation of some key structural reforms slipped behind schedule. Since the latter part of 1998, substantial progress has been made in all these areas. In particular, the tax base has been broadened significantly and tax and customs administration has been tightened; an action plan is being implemented to strengthen budget control; and key enterprises are in an advanced stage of privatization, including the remaining public bank, the petroleum company, the national airline, and the telecommunications corporation. One of Madagascar's public banks, BFV, was privatized in December 1998.

2.  The attached memorandum on Madagascar's economic and financial policies describes the economic objectives and policies which the Malagasy Government intends to pursue for the three-year period 1999-2001, and, more specifically, the objectives and specific measures for the economic program covering July 1, 1999-June 30, 2000. In support of these objectives and policies, the Malagasy Government hereby requests a second annual arrangement under the ESAF, in an amount equivalent to SDR 27.12 million (22.3 percent of quota). The Government also requests an eight-month extension of the original three-year ESAF commitment period to accommodate the twelve-month period covered under the second annual arrangement.

3.  The Malagasy Government, in cooperation with the staffs of the Fund and the World Bank, has updated and extended the policy framework paper to cover the 1999-2001 period. This paper is being sent to you under separate cover.

4.  On the basis of a debt sustainability analysis formulated in collaboration with Fund and World Bank staff, Madagascar is expected to face a heavy external debt burden. To reduce this debt to sustainable levels, the Malagasy Government hereby requests assistance under the HIPC Initiative at the earliest possible date.

5.  The Malagasy Government will provide the Fund with any information it may request regarding the progress achieved by Madagascar in implementing its economic and financial policies and in attaining the objectives of the program.

6.  The Malagasy Government believes that the policies and measures set forth in the attached memorandum are adequate to achieve the objectives of its program, but it stands ready to take any additional measures that may prove necessary for this purpose. During the period of the second annual arrangement, the Malagasy Government will consult with the Fund on the adoption of any additional measures that may be appropriate, either at its own initiative or at the request of the Managing Director. In addition, after the period covered by the second annual ESAF arrangement, and while Madagascar has outstanding financial obligations to the Fund arising from loans granted under this arrangement, Madagascar will consult with the Fund periodically, at the government's initiative, or whenever the Managing Director requests such a consultation, on Madagascar's economic and financial policies.

7.  In any event, the Fund and the Malagasy Government will carry out a first review of the 1999-2000 program, which will be completed no later than March 31, 2000. There will also be a final review of the program to be completed no later than July 22, 2000.

1.  The Malagasy government began to implement market-oriented reforms in 1994. It liberalized the exchange, trade, and price systems; eliminated restrictions in key economic sectors, such as petroleum, food, and transportation; and began to tighten fiscal and monetary policies. In the course of 1996, the government adopted a medium-term adjustment strategy, which has been supported by a three-year arrangement under the Enhanced Structural Adjustment Facility (ESAF) that was approved in November 1996.

2.  This memorandum briefly reviews the implementation of policies under the first annual arrangement; summarizes economic and financial developments in 1998; highlights key elements of the authorities' medium-term strategy, which is detailed in the Policy Framework Paper for 1999-2001; lays out the economic policies and structural reforms for 1999; and describes the key elements of the policies to be implemented in 2000. In support of its program for 1999-2000, the government is requesting assistance from the IMF in the form of a second annual arrangement under the ESAF, from the World Bank through a second Structural Adjustment Credit (SAC-II), as well as from other multilateral institutions and bilateral donors and creditors, including through debt relief.

3.  Real GDP growth reached 3.7 percent in 1997, up from 1.7 percent in 1995. Inflation dropped to approximately 5 percent in 1997, from 49 percent in 1995. During the same period, the Malagasy franc remained stable, while the country's external position improved substantially. Fiscal consolidation supported financial stabilization, with the fiscal deficit (on a commitment basis and including grants) declining from 6.2 percent of GDP to less than 2.5 percent of GDP between 1995 and 1997. A broadening of the tax base and strengthening of tax administration achieved a major increase in tax revenue, whereas spending overruns attested to unresolved problems in expenditure monitoring and control. Returning confidence, nurtured by steady progress in financial stabilization and some advances in structural reforms, boosted domestic financial savings and investment. Key accomplishments in the area of structural reforms included the elimination of export taxes and the remaining restrictions on external transactions; the strengthening of banking supervision; the rehabilitation of the two state-owned banks; the liquidation of the state-run vanilla marketing company; the adoption of legislation allowing the privatization of key public enterprises; and the start of civil service reform.

4.  The government's economic program for 1998 charted a faster pace for structural reforms, emphasized institutional improvements aimed at strengthening public finances, and established an agenda for enhancing regulatory frameworks and enforcing rules in public administration so as to provide an attractive environment for investors and encourage the efficient use of resources. The government's objectives for 1998 in terms of economic growth and inflation were broadly achieved, whereas the central bank's foreign reserve position deteriorated sharply in the wake of a major shortfall in foreign aid, triggered mainly by delays in implementing the privatization program and strengthening tax administration. In the latter months of 1998, decisive progress in both areas helped recover some of the lost ground and set the course for improved results in 1999.

5.  Real GDP growth of almost 4 percent in 1998 (an increase of more than 1 percent of GDP per capita) was led by a rise in investment, and an expansion in export zone manufacturing and services (including tourism). The moderate rise in inflation to an average of 6.2 percent in 1998 is explained by the broadening of the VAT base, temporary price hikes in anticipation of crop damage, and, more generally, by strong domestic demand boosted by rising household incomes, and, at times, exchange rate pressures. Weaker-than-anticipated domestic financial savings of the private sector, together with lower-than-expected export growth, left the external current account deficit (excluding official grants) virtually unchanged at close to 8 percent of GDP. To stem exchange rate pressures, the central bank intervened in the interbank foreign exchange market and, in September 1998, tightened monetary conditions by raising its base rate from 9 percent to 10 percent. The situation was exacerbated by the deferment of balance of payments aid, so that the central bank lost SDR 87.0 million in international reserves (equivalent to 1½ months of imports), reducing its holdings to SDR 121 million (2 months of imports).

6.  In the course of 1998, major fiscal reforms were initiated, aimed at strengthening, for the medium term, the government's capacity in revenue collection and expenditure monitoring and control. The underlying budget deficit (including grants and on a commitment basis) reached 4.6 percent of GDP, compared with a deficit of 2.4 percent in 1997. In addition, the budgetary accounts also incorporated the (mostly transitory) costs of structural reforms. Including those costs, and the repayment of domestic arrears as well, the overall budget deficit amounted to 6.3 percent of GDP, and was financed mainly domestically. The main weakness of the 1998 budget execution was the failure to achieve the tax revenue target. It was mainly the granting of ad hoc exemptions from VAT and customs duties, terminated only in late 1998, and the late abolition of the VAT exemptions granted under the old investment code that eroded the revenue gains expected from a streamlined VAT and increases in excise and petroleum taxes. Recognizing the weaknesses in customs and tax administration, the government began, in the latter part of 1998, to reorganize the tax department and improve coordination between revenue-collecting units on the basis of an action plan developed with technical assistance from the Fiscal Affairs Department (FAD) of the Fund.

7.  On the expenditure side, there were spending overruns and problems with adherence to the budgeted expenditure structure. During the second half of 1998, the government began to implement a comprehensive program of institutional reforms, defined with assistance from FAD, so as to enhance transparency, accountability, and efficiency in budget execution and to modernize treasury cash management. Expenditures for structural reform in 1998 were related mainly to the upgrading of judicial services, the start of a program of wage decompression in the civil service, and the restructuring of one state-owned bank (BFV). To facilitate budget financing and tap the growing interest of the nonbank sector in government financial instruments, in November 1998, the government decided to make the treasury bill market more attractive by broadening access to auctions, allowing more flexibility in satisfying demand across different maturities, reducing the required good-faith deposit and the minimum subscription, and enhancing information dissemination on auction results.

8.  In the latter part of 1998, the preparation of key structural reforms gained momentum. One of the two insolvent banks, BFV, was financially restructured and privatized. To minimize the costs of the financial restructuring of the two banks and ensure observance of contractual obligations, the government instituted special chambers in the lower courts in May 1998, offering fast-track procedures to accelerate the recovery of nonperforming loans of the two banks. In the course of the privatization of the BFV, its nonperforming loans were transferred to a debt workout unit (SOFIRE), which is responsible for continuing the recovery effort. The second public bank (BTM) was offered for sale in November 1998. The petroleum company (SOLIMA) was also put up for sale in November 1998. By contrast, preparations for civil service reform continued to lag behind the schedule set out in the first annual ESAF arrangement. The census of employees was completed only in the pilot ministries (education, health, justice, public works, and the two finance ministries); job audits and preparations for both new job profiles in the pilot ministries as well as for a new merit-based remuneration system, were not carried out. On the positive side, the government began preparations to reform the civil service statutes and laid the groundwork for a new disciplinary code of conduct.

9.  The government's macroeconomic program for 1999-2001 assumes that (i) real GDP growth would accelerate, reaching 6 percent (a level required to significantly reduce poverty); (ii) inflation would decline to below 4 percent; and (iii) gross international reserves of the central bank would be equivalent to 3½ months of imports of goods and services, while Madagascar would make considerable progress toward reaching a viable external position. To achieve these objectives, policies would be geared to generating a steady rise in total investment from 13.8 percent of GDP in 1998 to 16.4 percent of GDP in 2001. This increase would be accompanied by an improvement in national savings of more than 4.0 percentage points to at least 13.1 percent of GDP in 2001. Given Madagascar's low income level, the high fiscal costs of the structural reforms and basic social infrastructure needs, domestic savings will need to be supplemented with foreign savings, including direct investment, aid flows, and debt relief. Rising domestic savings will hinge on improved public sector management and tax revenue performance, as well as on financial sector modernization and reforms that generate efficiency gains in the private sector.

10.  To spur the development of Madagascar's productive capacities, the government will focus on improving the quality of basic services by setting public expenditure priorities, pressing forward with civil service reform, and proceeding with the decentralization of government functions and the privatization program, which encompasses the liberalization of key sectors such as telecommunications services, petroleum refining and distribution, and air transport. Furthermore, to stimulate investment in key sectors such as export manufacturing, mining, fishing, and tourism, new transparent regulatory frameworks will set clear rules and limit the scope for discretionary administrative decisions. On a broader scale, the government's strategy takes into account that a strengthened judicial system together with a modernized legislation on economic matters are prerequisites for a strong expansion in efficient private sector activity.

11.  The program for 1999-2000 assumes rates of economic growth of 4.5 percent in 1999 and 5.3 percent in 2000 and targets a reduction in inflation¹ to 6.4 percent in 1999 and 3 percent in 2000. The external current account deficit (excluding official grants) is expected to narrow to 7.3 percent of GDP in 1999 and 7.0 percent in 2000, reflecting a strong export performance and a slowdown in the growth of import volumes. With the resumption of official disbursements of grants and concessional balance of payments loans, and foreign receipts from privatization (the latter totaling 3.3 percent of GDP over 1999-2000), gross official international reserves are to regain a level of 3½ months of imports, up from 2 months at end-1998. Achievement of these objectives will require prudent financial policies and a decisive implementation of structural reforms. The fiscal position will benefit from the measures introduced in the 1998 supplementary budget and the 1999 budget laws, further simplification of indirect taxation, continued improvements in tax and customs administration, and strengthened budgetary discipline. Monetary policy will continue to be geared toward reducing inflation and protecting the external sector. Structural reforms will focus on completing the privatization of the major public enterprises and improving the business environment.

A.  Public Finance

12.  The targeted reduction in the underlying fiscal deficit (on a commitment basis, including grants, and excluding the net cost of structural reforms) to 2.5 percent of GDP in 1999 and to 1.7 percent of GDP in 2000 hinges on a strong revenue collection effort that should boost tax revenue by 3 percentage points of GDP over the next two years to 12.7 percent of GDP in 2000. Concurrently, noninterest current expenditure will be reduced from 7.8 percent of GDP in 1998 to 7.2 percent of GDP by 2000, while capital expenditure should remain at approximately 8 percent of GDP during the period 1999-2000. Taking into account the payment of domestic arrears and the net cost of structural reforms (approximately 2.2 and 1.0 percentage points of GDP in 1999 and 2000, respectively), the overall fiscal deficit on a cash basis would decline to 4.9 percent of GDP in 1999 and further to 3.2 percent of GDP in 2000. Foreign flows from donor support and privatization will permit a significant reduction in domestic public debt over the next two years, thus easing monetary conditions.

13.  For 1999, a large part of the revenue gains will come from measures adopted in late 1998 (estimated at 0.7 percent of GDP)--the abolition of all ad hoc exemptions, together with the lifting of authority to grant exemptions by administrative procedure; the cancellation of VAT exemptions; and the full-year yield of the broadened VAT base (adopted in the supplementary budget of August 1998). In addition, the 1999 budget includes (i) selective increases in excise taxes; (ii) higher petroleum taxes; (iii) new excise taxes, which, in total, more than compensate for a reduction in border taxation; and (iv) a number of improvements in tax and customs administration (yielding together an estimated 0.7 percent of GDP). The government introduced import duty rates of 5 and 25 percent (in addition to the four-rate system of 10, 15, 20, and 30 percent under the 1998 structure) and shifted many goods into lower-rate categories, which was in line with the objective of moving toward the three-rate structure (5, 15, and 25 percent) envisaged under the Cross-Border Initiative (CBI) for Eastern and Southern Africa. In light of the low revenue level recorded in 1998, the National Assembly adopted a supplementary budget in March 1999 that further increased petroleum and excise taxes, estimated to yield an additional FMG 75 billion (0.3 percent of GDP) in 1999. Reflecting this petroleum tax increase, as well as rising petroleum prices on the world market, the government raised consumption prices for petroleum products in April and June 1999. In addition, at end-May 1999, the government introduced a new system of controls on tax privileges for free zone enterprises.

14.  To safeguard the 1999 tax revenue target of FMG 2,567 billion, the government will--in the event that total tax revenue falls short of the targeted levels² for two consecutive months--implement the following measures as required, listed in order of priority: (i) by way of a budget law, increase the tax on petroleum products; extend the VAT to other, not yet covered products; increase the VAT rate and introduce a statistical tax (taxe statistique) on imports and reclassify certain goods into higher import tariff categories; (ii) step up the collection of tax and customs arrears owed by both public and private enterprises.

15.  In preparation for the 2000 budget, the government will, with technical assistance from the World Bank, assess the economic impact and efficiency of the current system of border taxes and excises, with a view to introducing simplified and economically efficient systems. More generally, the revenue target for 2000 is to be attained through a further broadening of the tax base reflecting the expiration and phasing out of the tax exemptions granted prior to the abolition of the investment code in 1996. Further, the government expects that the efforts now under way to improve tax and customs administration will begin to yield tangible results in revenue collections.

16.  The government will intensify its efforts to improve revenue collection during 1999-2000 by: (i) strictly adhering to the newly established procedures for granting tax exemptions, which require prior approval by the Council of Ministers and publication in the Official Gazette; (ii) monitoring closely that previously tax-exempt enterprises actually pay taxes; (iii) continuing to review the position of the enterprises enjoying exemptions under the investment code and withdrawing the exemptions if the enterprises have not satisfied all legal requirements or have accumulated tax arrears; (iv) strengthening sanctions against enterprises that do not comply with the tax and customs legislation; (v) ensuring that the refund mechanisms for VAT credits applicable to export or investment operations function effectively, through enhanced supervision and a strengthening of collaboration between the taxpayers and the tax administration service; (vi) simplifying the tax regime for small enterprises with the introduction of a global tax (impôt synthétique) in 2000 that will finance local governments; and (vii) reviewing the system of direct taxation and assessing the effectiveness and revenue impact of the existing investment incentives.

17.  The efforts to improve tax and customs administration will also continue by: (i) recruiting and training new personnel (about 360 agents in 1999); (ii) regular updating of the General Tax Code and Customs Code; (iii) informing taxpayers of their tax obligations and rights (in cooperation with employers' associations); (iv) strengthening the collaboration between the central and regional large taxpayer units; and (v) ensuring that customs collections reflect the value assessed by the preshipment inspection company.

18.  The government will aim at strengthening expenditure control, while shifting resources toward basic social services and infrastructure. It will guard against expenditure overruns by streamlining and computerizing budget execution procedures by end-1999 with technical and financial support from donors. Following the introduction of a new harmonized accounting and budget nomenclature in the 2000 budget law, the finance and budget ministries will adopt a monthly reporting system for current and capital spending, on the basis of both functional and economic classifications at the commitment and payment stages. This monitoring system will make it possible to protect budgetary allocations for priority sectors (education, health, and infrastructure), and help guard against the accumulation of new domestic payments arrears. In line with the schedule for the elimination of domestic payments arrears, the government will repay FMG 28 billion in 1999 and FMG 135 billion in 2000.

19.  The government intends to raise pay levels in real terms to the extent that budgetary resources permit. Consistent with this objective, the wage bill (excluding allocations for wage decompression) would remain at around 4 percent of GDP in 1999 and 2000. The government will recruit additional staff only in priority areas. The net increase will be limited to 3,000 staff in 1999, equivalent to about 2 percent of the civil service. The hiring strategy for 2000 will take into account the requirements arising from decentralization as well as the results of the physical census of civil servants and the job audits to be completed in 1999-2000.

20.  The investment program--developed in consultation with Madagascar's donors--gives priority to the upgrading and expanding of basic infrastructure. For 2000, particular emphasis will be given to meeting the infrastructure and support service needs of the 10 new industrial and tourism zones.

21.  The 1999 budget has made provisions for the costs of structural reforms, corresponding to about 2.2 percent of GDP, which relate to asset restructuring in the banking sector (0.8 percent of GDP), privatization, civil service reform, and modernization of judicial services. These costs are projected to decline to 1 percent of GDP in the year 2000, when they mainly refer to civil service reform and privatization.

22.  As part of the process toward autonomy of the provinces, as envisaged in the Constitution, the government is preparing for administrative decentralization which aims at increasing the capacity for efficiently delivered public services. To this end, the government is seeking technical assistance from bilateral donors and multilateral organizations such as the IMF and World Bank. In the context of the decentralization, the civil service reform strategy will be recast with a new agenda for the medium term to be announced in the context of the 2000 budget. In the interim, a workshop in July 1999 will take stock of the technical preparations for the reform carried out since 1997. In specific, these preparations will make it possible to: (i) implement measures, as of August 1999, that realize wage bill savings drawing on the results of the physical census of civil servants (completed at end-April 1999); (ii) adopt a new code of conduct before end-February 2000; (iii) prepare a draft law establishing a new civil service statute to be submitted to the National Assembly for adoption during its May 2000 session--this statute should standardize treatment across ministries and remove obstacles to the regional redesignation of civil servants; (iv) design strategies for the employment and performance-based remuneration that are to be applied on a priority basis to key posts in pilot ministries in the 2000 budget; and (v) continue the policy of wage decompression in the 2000 budget, provided a target pay scale and remuneration system have been developed in reference to international standards in time for the 2000 budget preparations. In the 1999 budget, FMG 62 billion (equivalent to 7.5 percent of the 1998 wage bill) have been set aside for wage decompression with the aim of achieving a ratio between the minimum and maximum base salaries of 1 to 6 in 1999.

B.  Monetary and Exchange Rate Policies

23.  Monetary policy will remain geared toward containing inflation and achieving the balance of payments targets. The monetary program cautiously assumes that the velocity of money remains virtually constant, with broad money growing by 8.8 and 10 percent in 1999 and 2000, respectively. The net domestic assets of the central bank will remain the key aggregate in steering monetary policy, but the central bank also will continue to closely monitor developments in reserve money and broad money. Progress in fiscal consolidation, supported by foreign aid disbursements and substantial privatization receipts from abroad will facilitate a rebuilding of net international reserves, leaving scope for adequate growth in credit. A 25.8 percent increase in credit to the private sector (excluding the impact of bank restructuring) in 1999 will support expanding private sector activity and facilitate the purchase of shares in privatized firms.

24.  The central bank (BCM) will actively manage liquidity. It will limit its intervention in the foreign exchange market to achieving its net foreign asset targets and to smooth fluctuations. In the event of exchange market pressures, the central bank will use its instruments to tighten the monetary stance, while avoiding sustained exchange market intervention. In the reverse situation of sustained appreciation pressures, consultations with Fund staff on the appropriate course of action will be triggered if broad money or net foreign assets exceed specified margins (see the attached Table 1). To facilitate external reserve management, arrangements are in place ensuring that foreign exchange receipts from privatization are directly lodged in government accounts at the central bank.

25.  In its decisions to raise funding through treasury bills, the government will take account of monetary policy constraints and the need to avoid erratic interest rate movements. The treasury's domestic financing needs will be met through treasury bill auctions; in this context, the treasury cash management system (developed with Fund technical assistance) should help fine-tune budget financing. The central bank will also regularly consult with the government on the projected amounts of domestic sales proceeds from privatization so as to adapt its liquidity management accordingly.

26.  The second public bank, BTM, is scheduled to be privatized by September 1999, on the basis of a memorandum of understanding signed in April 1999. The government intends to make a vigorous effort to collect the nonperforming loans of BFV and BTM that have been or will be transferred to debt workout units (SOFIRE in the case of BFV). The intention is to recover a substantial part of the costs of the financial restructuring of the two banks and to send a clear signal on the enforcement of contractual rights. Following up on announcement letters sent to the delinquent debtors of BFV and BTM in mid-1998, the names of debtors whose loan obligations are being litigated by SOFIRE will be published in June 1999 and there will be regular updates, and the same procedure will be followed for delinquent debtors of BTM immediately after the transfer of their obligations to the debt workout unit. The government is also taking important steps to strengthen the jurisdiction of the special courts for loan recovery: the Ministry of Justice will (i) monitor on a monthly basis the judicial proceedings on cases submitted to the special courts; (ii) continue to emphasize to judges that court decisions should be swiftly enforced; (iii) introduce draft legislation in September 1999 that authorizes the special courts to pass judgement on foreclosure on fixed assets.

27.  Measures will be adopted in 1999-2000 to protect the soundness of the banking and financial sectors: (i) the maximum exposure in terms of loans extended to a single or related borrower will be reduced gradually from 40 percent to 30 percent of a bank's capital by March 2001 (ii) solvency requirements will be kept in line with international standards; (iii) any mismatch between the maturities of assets and liabilities will be closely monitored; and (iv) a number of accounting procedures for commercial banks will be revised. All prudential rules will continue to be strictly and uniformly applied. Financial institutions--in particular credit unions and institutions in the emerging micro-finance sector--will be governed by prudential regulations similar to those applicable to banks. Furthermore, in 1999 the government will launch a program to modernize the insurance sector. The government will adopt a revised Insurance Code establishing a competitive and market-oriented framework. On the basis of a financial and technical audit of the insurance sector, two state-owned insurance companies will be privatized. Furthermore, an organizational, financial, and actuarial audit of the social security (CNAPS) and of the civil service pension systems (Caisse de Retraites Civiles et Militaires--CRCM and Caisse de Prévoyance et de Retraite--CPR) will be conducted in 1999-2000 in preparation for subsequent reforms.

C.  External Sector Policies

28.  The balance of payments projections indicate that Madagascar will need substantial external assistance to reach targeted economic growth, notwithstanding progress in improving its external current account balance and large capital inflows related to privatization and direct investment in both 1999 and 2000. After taking into account disbursements under existing loans and expected grants, as well as the targeted level of gross international reserves, the external financial gap for 1999-2000 is expected to reach SDR 915.4 million. New commitments of balance of payment assistance from multilateral institutions and bilateral donors, together with debt relief, are expected to cover this gap. To this end, the government will seek an extension of the current rescheduling agreement from Paris Club creditors as well as an extension of the deadline for signing bilateral agreements.

29.  In light of the country's heavy external debt burden, the government will not contract or guarantee any non-concessional loans, except for normal short-term import-related credits. The government will continue to attach priority to remaining current with its external financial obligations, and will avoid incurring new external payments arrears. It will also normalize its relations with its creditors by concluding all bilateral agreements with Paris Club creditors (including Russia) and by seeking comparable agreements with other bilateral creditors.

30.  The government will continue to liberalize trade and investment under the Cross-Border Initiative; in particular, it remains committed to reducing tariffs on intra-regional trade, subject to reciprocity of treatment. As indicated earlier, in the 2000 budget the government will reduce the number of customs duty rates in line with CBI objectives. The government will not impose any restrictions on payments and transfers for current international transactions, and will not impose or intensify any import restrictions for balance of payments reasons.

D.  Structural Policies

31.  The structural reform agenda focuses on: (i) the privatization of the key public enterprises; (ii) the removal of impediments to growth and barriers to competition, particularly in high potential growth sectors, such as mining, fishing, and tourism; and (iii) the improvement of the legal framework and the strengthening of the judicial system. The government intends to work in these areas closely with the World Bank in the context of the Structural Adjustment Credit and sector-related lending.

32.  The government plans to complete by June 2000 the sale or liquidation of the remaining 37 small and medium state-owned enterprises that were included in the list of the 46 firms slated for privatization published in 1997. A new list of firms scheduled for privatization in 2000-2001 will be prepared at that time. Regarding the three large enterprises that are well advanced in the process of privatization, the various distribution and refining activities of SOLIMA are expected to be privatized by mid-1999. In July 1999, the government will publish the new retail price formula for gasoline products, which will apply following SOLIMA's privatization. This formula establishes ceilings below which the private petroleum companies will set the prices freely. These ceilings will be adjusted monthly by the "Office Malgache des Hydrocarbures"(OMH) to reflect movements in oil import prices, the exchange rate and taxation, while taking into account distribution costs and margins. After offering Air Madagascar for sale in February 1999, a sales contract is likely to be concluded by the end of the third quarter of 1999. While the charter air transport segment has been fully liberalized over the past five years, Air Madagascar will continue to have exclusive rights for another five years on its current routes (i.e., precluding the entry of other Malagasy couriers whereas foreign companies can continue to operate on the basis of existing bilateral agreements). Thereafter, open skies will prevail. In the telecommunications sector, since end-1998, four cellular operators have been sharing the market. The government will reduce its share in the only fixed network operator, TELMA, below a controlling minority stake. The privatization of TELMA is expected to be concluded by early 2000, and bids will be launched for a second fixed network operator in the subsequent few months.

33.  Concerning the net costs associated with privatization, the 1999 budget provisions FMG 494.9 billion (about 2.2 percent of GDP) for expenses on severance payments, administrative outlays, transfers to a regional social development fund to cushion the social impact of privatization, and compensation payments for former expropriation, as well as the costs of the financial restructuring of the BTM. All the financial transactions related to privatization will be recorded in a transparent fashion in the government budget, with the proceeds from the sale of assets or shares deposited in a special account with the BCM. Privatization proceeds will be classified as a financing item below the line, and the uses of these proceeds to cover the costs of privatization operations will be registered as expenditure items above the line, implying that the unspent balance will be saved. Monthly transfers will be made from the privatization account with the central bank to a commercial bank account of the privatization committee to cover privatization-related expenses. The remaining credit balances in the privatization account at the central bank will be used--after consultation with the central bank on liquidity requirements in the banking system--to repay domestic public debt. As a result of the privatization process, the government will reduce the total of its own shares and those held by the share warehousing fund to no more than 32 percent of a company's capital. This warehousing fund will begin in 2000 to gradually sell its shares to local investors and small savers.

34.  The government will work in close collaboration with the World Bank and the European Union on developing competitive fishing and mining sectors by establishing transparent and competitive allocation systems for licenses and regulatory frameworks. This work will lead to a bidding system for fishing licenses as of 2000; in the meantime no new fishing licenses will be granted. Moreover, the role of the Fishing and Agricultural Development Fund (FDHA) has been redefined, with most of the receipts from license fees now accruing to the government budget rather than to the FDHA. Fishing license fees were, on average, doubled for 1999, and the recovery of overdue license fees was made a condition for license renewal. The National Assembly should approve shortly a new mining code, which offers standardized procedures for the granting of mining rights and sets forth a legal and tax framework that will enter into force shortly. For very large mining projects, the government will submit to the National Assembly a bill to establish a special tax regime that will constitute the legal framework for all such investments.

35.  With a view to facilitating private economic activity and investment, the government will streamline the procedures for the concession of long-term land leases, so that the delay in the government's response to a lease request does not exceed three months. The procedures for company registration will be simplified and the business law will be streamlined by end-1999. The National Assembly recently passed legislation governing arbitration procedures and dispute resolution.

36.  A key component of the government's strategy to eradicate poverty in Madagascar is the targeted improvement in the delivery of essential services, such as health care, primary education, and basic infrastructures. The 1999 budget has raised the allocations for these sectors to 3.4 percent of GDP, and the government intends to increase them by at least 0.4 percentage point of GDP in the 2000 budget. An in-depth review of health and education expenditure, carried out in 1998 with the World Bank and other donors, serves as a basis for improving the quality of service delivery and cost-effectiveness. The soon-to-be-applied improved expenditure monitoring system will help ensure that these spending areas receive the highest priority and that allocations are in fact used for increasing the operating resources of primary schools and the effectiveness of the services of health care districts. Moreover, the government will continue to encourage the activities of non-governmental organizations (NGOs) and charitable institutions working to improve the welfare of the most vulnerable groups.

37.  Program monitoring will be carried out, inter alia, by means of quantitative criteria, indicative limits, and structural benchmarks for the period July 1999-July 2000, and by means of two reviews. The quantitative criteria (set forth in the attached Table 1) will constitute benchmarks for September 1999 and March 2000, and they will represent performance criteria for December 1999 and June 2000. The structural benchmarks and performance criteria as documented in the attached Table 2 will apply during the program period.

38.  The government of Madagascar will conduct a first review with the Fund before end-March 2000, which will focus on the 2000 budget and its macroeconomic framework; review the reform strategy for the civil service, which the Government intends to adopt in view of the decentralization of the public administration; and examine the financial framework governing the decentralization of the public administration to be defined before end-1999. The quantitative criteria for June 2000 will be set definitively in the context of the first review. The second review, to be completed before July 22, 2000 will analyze economic and financial performance throughout the first half of 2000, evaluate progress in civil service reform, and review the plan for the reform of the civil servants' pension system, which is to be completed by July 2000.

39.  With a view to facilitating the formulation and monitoring of economic and financial policies, the government will give priority to statistical development and data dissemination. In this regard, it will seek technical assistance from the international community, will increase the authority and resources of the compiling units, and will implement necessary measures to improve the quality and timeliness of macroeconomic statistics and social data.