Cotonou, July 30, 1999

Dear Mr. Camdessus:

1.  On behalf of the government of Benin, I am pleased to attach the memorandum on economic and financial policies, which describes the progress made in implementing the structural adjustment program supported by the second annual arrangement under the Enhanced Structural Adjustment Facility. The memorandum also defines the measures to be taken during the rest of the program period.

2.  As indicated in paragraph 16 of the memorandum, all quantitative performance criteria for end-March 1999 were observed and all measures constituting structural performance criteria were implemented, albeit somewhat late. In this regard, the government is seeking waivers for noncompliance with the performance criteria on the restructuring of the tax unit in charge of large enterprises (performance criterion for end-January), the adoption of an action plan to eliminate the deficit of the pension fund for the civil service (performance criterion for end-March 1999), and the introduction of a new compensation system the civil service, including a new wage scale and a performance appraisal system (performance criterion for end-March 1999).

3.  The government believes that the policies and measures indicated in the attached memorandum will enable it to meet the program objectives. As part of program monitoring, the government stands ready to provide the International Monetary Fund with any information the Fund may request on progress made in policy implementation and the achievement of the program objectives. A second review of the program is also to be completed no later than end-November 1999.

Attachment: Memorandum on Economic and Financial Policies for 1999

1.  In accordance with the provisions of the second annual arrangement under the Enhanced Structural Adjustment Facility (ESAF), the government of Benin and the staff of the International Monetary Fund carried out the first review of the program covering the period from October 1, 1998 to September 30, 1999. The discussions were held in Cotonou from May 6-20, 1999 and covered program implementation during the fourth quarter of 1998 and the first quarter of 1999, and the outlook and measures planned for the rest of 1999. This memorandum on economic and financial policies describes measures the government is determined to implement in order to achieve the objectives set out in the memorandum on the economic and financial policies of December 21, 1998.

2.  The 1998-99 program was prepared in the context of the medium-term strategy set out in the policy framework paper for 1998-2001. This strategy aims at ensuring sustainable economic growth and medium-term financial viability by strengthening financial policies and opening up the economy. It seeks to promote national saving and private investment and increase the resources allocated to the priority sectors (education and health).

3.  The main macroeconomic assumptions underlining the program for 1998-99 are: real GDP growth rising from 4.4 percent in 1998 to 5.7 percent in 1999, inflation declining to less than 3 percent, and the external current account deficit narrowing to less than 5 percent of GDP over the two years. At the same time, the primary fiscal balance is to pass from a small surplus to a deficit amounting to 1.4 percent of GDP, in order to make additional resources available for priority sectors and investment.

4.  Preliminary estimates indicate that macroeconomic performance in 1998 was broadly satisfactory, and in line with the program objectives, despite the power shortage that affected Benin from March to June 1998. Real GDP grew by 4.5 percent, as anticipated owing mainly to a strong performance in the agriculture and service sectors. The power shortage resulted in temporary increases in the price of petroleum products, transport and food. Hence, the consumer price index rose by 5.6 percent during 1998, but fell by 1.8 percent in the 12 months ending in March 1999.

5.  The external current account deficit is estimated to have widened to 5.3 percent of GDP in 1998, instead of narrowing to 5 percent as anticipated under the program. The volume of exports fell by 6.3 percent, mostly because of a drop in cotton exports, whereas the volume of imports rose by 7.2 percent, spurred by the purchase of generators and increased demand for petroleum products during the energy crisis. These developments offset the positive impact of an improvement in the terms of trade (5.7 percent) stemming from a much larger drop in oil import prices than in cotton export prices. Net capital inflows were lower than expected, partly because some disbursements of program-related loans and grants were delayed to early 1999 as related structural reforms were implemented late. Hence, the overall balance of payments was close to equilibrium, whereas a surplus equivalent to 1 percent of GDP was anticipated in the program, and Benin contributed less than expected to the net foreign assets of the BCEAO.

6.  As called for under the program, Benin reached a debt-relief agreement with Russia in September 1998 on terms comparable to those granted by the Paris Club creditors in 1996 (Naples terms applied to the entire stock of debt, including arrears, after cancellation of 70 percent). A debt-relief agreement reached with Argentina in February 1999 will be finalized once endorsed by the Paris Club.

A.  Fiscal Policy

7.  The government has continued to implement measures to improve tax administration, consolidate government revenue, and contain government expenditure. As a result, the primary deficit was eliminated in 1998, as projected, while the overall deficit (payment order basis and excluding grants) declined from 4.2 percent of GDP in 1997 to 1.3 percent in 1998. Total revenue was slightly higher than targeted, at 15.5 percent of GDP, even though the state enterprise in the cotton sector (SONAPRA) was unable to meet all of its tax obligations, owing to cash flow problems. Total expenditure declined by 2 percentage points of GDP in 1998 to 16.8 percent, a drop that was slightly less than had been anticipated because the authorities improved the utilization of budget appropriations. The wage bill was kept below the programmed ceiling equivalent to 4.9 percent of GDP in 1998. However, recruitment was lower than anticipated, with the wage increase granted in November 1998, effective retroactively to January 1, 1998, being phased in over several months as civil servants provided the required documentation.

8.  The government continued its fiscal consolidation efforts during the first quarter of 1999, which led to an estimated primary surplus of 1.1 percent of GDP, compared with a target of 0.5 percent of GDP. Fiscal revenue was significantly higher than anticipated owing to the measures implemented since June 1998 to improve the efficiency of the tax administration. On the expenditure side, budget execution reflected the authorities' efforts to speed up the utilization of budget appropriations, especially for the priority sectors and investment expenditure. As a result, by end-March 1999, total expenditure was close to the projected level. Nevertheless, the cost of the legislative elections held in March 1999 was slightly higher than expected. Furthermore, owing to SONAPRA's cash-flow difficulties, the treasury granted the enterprise an advance of CFAF 5 billion at end-March to pay cotton producers.

9.  The government continued its efforts to settle domestic arrears in 1998 and 1999, clearing CFAF 7.4 billion in the first half of the program, compared with a target of CFAF 6.6 billion. However, there were some delays in the settlement of domestic arrears at end-1998, in order to verify their validity.

10.  After taking into account grants and loans related to the investment program and amortization payments on the external debt, the financing requirements amounted to CFAF 29.2 billion in 1998, and CFAF 4.7 billion in the first quarter of 1999. The financing requirements were largely covered by external financing related to the program (CFAF 36 billion) and by debt relief granted by Russia (CFAF 37 billion). Hence, the government reduced its net borrowing from the banking system by more than programmed during 1998 and the first three months of 1999.

B.  Money and Credit Developments

11.  Broad money contracted by 2.7 percent in 1998, reflecting largely a revision in the data on currency in circulation. At the same time, the net foreign assets of the banking system fell by 3 percent of the beginning-of-period money stock, while net domestic assets were largely unchanged. The net claims of the banking system on the government contracted by 44.6 percent, compared with the 22.6 percent planned under the program. In contrast, bank claims on the nongovernment sector grew by 40.6 percent during 1998, owing to a sharp increase in bank credit to the cotton and trade sectors. Furthermore, deposits and loans of the savings and loan associations increased rapidly in 1998, but resulted in a notable increase in nonperforming loans.

12.  During the first quarter of 1999, broad money expanded by 12 percent, owing to the strong growth of bank deposits. This expansion was accompanied by a large increase in credit to the nongovernment sector, especially the cotton sector, while net credit to the government continued to fall.

13.  The commercial banks generally observe the prudential ratios set by the Banking Commission. However, at the end of 1998, no bank respected the ratios for medium-term assets to medium-term liabilities and for portfolio structure, and one bank did not comply with the liquidity ratio. The government is especially concerned that one-third of bank credit to the nongovernment sector was concentrated in the cotton sector at the end of March 1999. Nevertheless, based on the financial statements for 1998, the banks' profits remained satisfactory. Overall, the commercial banks had excess liquidity in 1998 and participated actively, as net lenders, in the regional interbank money market and the WAEMU treasury bill market.

C.  Structural Reforms

14.  Implementation of the structural reforms was satisfactory during the second half of 1998. In September 1998, the National Assembly passed the law defining the main components of a merit-based pay system for civil servants. On the basis of public offerings, the government signed concession agreements for a cement and a sugar enterprise jointly owned by the governments of Benin and Nigeria, and for the management of a hotel. An agreement was also signed for a private investor to purchase 55 percent of the capital of the state enterprise distributing oil products (SONACOP). After some delays during the first quarter of 1999, reform implementation has regained momentum since then. Nevertheless, the government was unable to organize auctions for the sale of seed cotton to private ginning companies; the introduction of the WAEMU import classification was postponed as the government sought a waiver from the WAEMU Commission for certain products; and the action plan adopted for the civil service pension fund (FNRB) was insufficient to eliminate the deficit. Also, the government adopted the specific elements of a new compensation system for the civil service three months later than anticipated.

15.  In summary, for the program, the benchmarks for end-December 1998 and end-March 1999 and the quantitative benchmarks for end-March 1999 were observed, with the exception of the end-December 1998 benchmark on payments of domestic arrears. As regards the structural measures, the contract for the sale of 55 percent of the capital of SONACOP was signed on April 2, 1999 (benchmark for end-March 1999); the restructuring of the unit in charge of the taxation of large enterprises was completed in February 1999 (performance criterion for end-January 1999); the action plan adopted by the government to eliminate the FNRB deficit (performance criterion for end-March 1999) requires additional work; and the new wage scale, compensation and performance appraisal system for civil servants was adopted in July 1999 (performance criterion for end-March 1999).

16.  The macroeconomic targets for 1999 have been modified from those spelled out in the memorandum of December 21, 1998 to reflect recent developments. The real growth target was revised from 5.7 percent to 5.0 percent, considering the decline in cotton production and the ending of crude oil production, but the inflation target was maintained at 3 percent. The external current account deficit is projected at 6.3 percent of GDP, compared with the 4.4 percent originally programmed, as the combined effect of the rise in import prices--especially oil prices--and the decline in cotton prices is expected to lead to a deterioration of more than 13 percent in the terms of trade. Likewise, the overall balance of payments surplus should amount to 0.3 percent of GDP, instead of the 1.4 percent initially programmed.

17.  To reduce the external debt burden further, the government will continue to seek out grants and highly concessional loans. In this context, it will refrain from contracting or guaranteeing new foreign loans with a maturity of less than one year, with the exception of short-term credit for regular import financing. Moreover, the government will not contract loans with a grant element of less than 35 percent. All new loans contracted or guaranteed by the government will be subject to prior authorization from the Minister of Finance.

A.  Fiscal Policy

18.  The government intends to continue implementing a fiscal policy consistent with the program objectives. In spite of a large increase in social and investment spending, the primary deficit will be contained to 1.5 percent of GDP and the overall deficit to 2.7 percent, as programmed. The government will pursue its efforts to broaden the tax base in order to raise the target for revenue to 15.5 percent of GDP, despite the uncertainties regarding the contribution of the cotton sector to government revenue. To this end, the government has implemented the fiscal measures adopted with the 1999 budget, which include unifying the rates for the prepayment of the profit tax at 5 percent of imports and improving the simplified tax regime. Furthermore, beginning in July 1999, the government will implement the new WAEMU import classification, in accordance with the decision to be issued by the Council of Ministers of the WAEMU in June 1999. This measure is expected to increase total government revenue by 0.3 percent of GDP on a full-year basis. Also, with the sale of SONACOP being based on its value at end-1997, the enterprise's net profits for 1998 (CFAF 6 billion) are to be transferred to the treasury. In addition, the envisaged strengthening of tax administration will facilitate meeting the revenue target. Measures include restructuring the tax unit in charge of large enterprises, increasing the control over customs valuations, computerizing the monitoring of exemptions, and installing a computer network linking the customs department and the enterprise in charge of import preshipment inspections. In addition, given the economic importance of Benin's relations with Nigeria, the government will study the specific features of trade between the two countries, with the assistance of development partners, and define an appropriate tax regime for it. The recommendations of this study, which will be completed by end-September (structural benchmark), will be reviewed with Fund staff at the time of the discussions on the 2000 budget.

19.  The objective for government spending remains largely unchanged in 1999 at 18.2 percent of GDP, despite slightly higher than planned outlays for the legislative elections. This overrun will be offset by a reduction in nonpriority expenditures, which will be reflected in a revised budget law to be adopted by end-September. Given the importance of following a strict wage policy and allocating more resources to the priority sectors, the government will keep the wage bill at CFAF 70.2 billion in 1999, as programmed. This amount already takes account of the wage increase granted in late 1998 and the impact of recruitment in health and education where budgetary allocations were increased from 5.1 percent of GDP in 1998 to 5.5 percent in 1999.

20.  The government is determined to find a definitive solution to the problem of outstanding domestic arrears. At end-June 1998, the authorities requested all those with claims on the government to contact a private accounting firm hired to make an inventory of all such claims. After their verification, the authorities will define a strategy to settle the claims with the assistance of development partners, who will participate in the financing of the operation.

21.  Taking into account net domestic financing, external financing for projects, and amortization of the external debt, it will remain an exceptional financing requirement of CFAF 46 billion. This will be covered by program-related aid and loans already identified (CFAF 33 billion) and possible debt-relief.

22.  The government is studying with the World Bank and other development partners a series of measures to strengthen budget preparation and execution, in the context of the preparation of the public expenditure reform credit (PERC) by the World Bank and the implementation of the new government budget classification adopted by the WAEMU in December 1998. The aim is to improve the allocation of government resources among the various sectors of the economy and, in particular, to the social sector. To that end, the government intends to increase the responsibility of the line ministries for the preparation and execution of their budgets, and the performance of the ministries will be evaluated on the basis of specific indicators. In turn, the ministries will prepare multiyear budget frameworks covering all spending anticipated by the government in their sectors, regardless of source of financing. This ambitious reform program will be gradually implemented starting with the 2000 budget, if the evaluation planned for July 1999 shows that ministries are technically ready to take on increased responsibilities. During the coming years, units responsible for preparing and executing budgets for ministries will continue to be strengthened through training and technical assistance from the international community. Moreover, the government will improve centralized budget monitoring through a strengthening of the budget and treasury departments' procedures and units; the government will also develop the new information systems required for the Ministry of Finance to continue to strengthen fiscal management. In addition, in the context of the decentralization policy, particular attention will be paid to improving the monitoring and execution of local government budgets.

B.  Money and Credit

23.  The monetary policy conducted at the regional level by the BCEAO will remain prudent, in accordance with the balance of payments objectives. Based on the economic outlook and development of financial intermediation, broad money is projected to grow at 8.0 percent in 1999. However, given the rapid increase in credit to the private sector observed early in the year, the authorities will cooperate with the Regional Banking Commission to ensure compliance with the prudential ratios. Moreover, the government has, with the help of the central bank, taken the necessary measures to strictly monitor bank lending to the cotton sector, as indicated below. Furthermore, the Ministry of Finance will strengthen the units responsible for monitoring savings and loans associations and ensure strict application of the regulations to their activities. In this context, it will ensure that the associations' level of nonperforming loans is rapidly reduced and that their management structure is improved by separating financial controls from other managerial responsibilities. Finally, the efforts under way to recover unpaid claims of the liquidated banks will be vigorously continued and the payment of private sector deposits will be accelerated.

C.  Structural Reforms

24.  The government intends to give new impetus to the implementation of the structural reforms. The recently adopted wage policy for the civil service will be implemented by end-1999. After discussions with trade unions, the government will submit the draft law on the wage scale, compensation and performance appraisal system to the National Assembly. The new system should make it possible to finally resolve the discrepancies between wages and grades, resulting from the 1986-92 wage freeze. Furthermore, given the need to have an updated civil service roster to implement the new compensation system, the government will complete the harmonization of the databases of the Ministry of civil service and the payroll department at the Ministry of Finance before end-August 1999 (structural benchmark). As regards the pension fund for the civil service, the authorities have decided to increase the contribution rates from 14 percent to 18 percent for the government and from 6 percent to 8 percent for civil servants. The increases will be discussed with the trade unions and reflected in the year 2000 budget law. Furthermore, the government will undertake a comprehensive restructuring of the pension fund in order to ensure its viability over the long term. To that end, before end-September 1999, it will conduct a census of retired civil servants and their beneficiaries (structural benchmark). On the basis of this information and the results of the ongoing work on the civil service database, the department in charge of the civil service pension fund will prepare a comprehensive database on the fund's members. This will allow the government to prepare, before the end of 1999, the terms of reference for an actuarial study of the pension fund to be carried out by an internationally selected firm. This study is scheduled to be completed by the end of February 2000, so that the government can adopt a new pension scheme by end-March 2000.

25.  The government will continue to implement measures aimed at liberalizing the regulatory framework, reducing the role of the government in production and marketing activities, promoting private initiatives, and developing basic social services. As regards public enterprises, the government completed the sale of 55 percent of the capital of SONACOP to a private company on June 30, 1999. In the meantime, the government conducted an audit of the price equalization and stabilization fund managed by SONACOP. The fund is to remain under SONACOP's management until the end of the year, when the price mechanism for oil products is to be changed. At that time, the resources of the fund will be transferred to the treasury account at the BCEAO. Moreover, as the sale of SONACOP is based on the enterprise's financial position at end-1997, the board of the enterprise voted to transfer all 1998 profits to the treasury. The transfer will take place before end-September 1999, after confirmation of the decision by the Council of Ministers. Profits made during the first half of 1999 will be transferred to the Treasury by end-December 1999. Finally, the government will adopt a more liberal price mechanism for petroleum products by end-September 1999 (structural benchmark) to be implemented on January 1, 2000, after discussions with enterprises in the sector. Within this framework, the government will set price ceilings at world-equivalent price levels, adjusted every three months according to variations in international prices, under which enterprises will be free to set their own retail prices. At the end of the year 2000, the government will assess the new mechanism with a view to liberalize oil product prices fully.

26.  The government adopted a strategy to liberalize the telecommunications sector and a plan to separate the telecommunications branch from the postal and financial service branch by end-June 1999, as planned. For water and energy, the government will adopt a sector reform strategy, including the privatization of the management of the electricity and water company (SBEE), before the end of November 1999, instead of end-July 1999 as scheduled in the program. The implementation will be delayed because the studies required to define the strategy did not begin until June 1999. Following the signing of the concession agreements for the cement (SCO) and sugar (SSS) companies, the government will define the terms and conditions for clearing the domestic and external debts of these enterprises (estimated at 15 percent of GDP) by December 1999. These will be the subjects of discussions with Fund staff at the time of the negotiations of the third year of the ESAF-supported program. Likewise, regarding the creation of a duty free trade zone, the authorities will discuss with the Fund staff the conclusion of the study and its impact on government revenue.

27.  The government is very concerned about the deteriorating financial situation of the cotton sector, which brought to light the management problems in SONAPRA and the need for a timely completion of the reform of the sector. Focusing first on the financial issues, the government has worked closely with SONAPRA at a technical level to develop a monthly cash-flow plan aimed at an orderly and rapid reduction of the claims and liabilities that the enterprise has built up since last fall. It has also instructed SONAPRA to take judicial actions against operators who are late in paying the enterprise. In addition, the government has requested the assistance of the World Bank and other development partners in assessing the current financial position of the enterprise, including claims on private ginning companies and exporters. The assessment would also allow revisions of SONAPRA's monthly cash-flow plan for the rest of 1999. In addition, the government decided to strengthen SONAPRA's management and established a committee in early June which is responsible for monitoring the financial situation of the cotton sector and ensuring satisfactory implementation of SONAPRA's cash-flow plan. The committee, which comprises representatives of the BCEAO, Ministry of Finance, Ministry of Rural Development, and SONAPRA, will meet at least once a month until the end of the year and will submit a monthly report to the interministerial committee responsible for monitoring the adjustment process, as well as to the Fund staff. Furthermore, with the help of the World Bank, the government will hire an international firm to audit SONAPRA's 1998 accounts by end-November 1999.

28.  The government's policy with regard to the cotton sector is to introduce competition at all stages of the production process, and strengthen the organizations representing, and controlled by, the participants in the sector. In order to achieve these goals, by end-August 1999, the government will issue a decree transferring full responsibility for organizing the imports of inputs (insecticides and fertilizers) to producers' organizations, with the technical services of the Ministry of Rural Development responsible for verifying only the type and the quality of inputs. However, for the 2000/01 crop year, the producers' organizations will be assisted by the technical services of the Ministry of Rural Development and at the end of that year, the government will assess whether the association is able to manage the import of inputs without its intervention. As regards seed cotton, the government is committed to letting private ginning companies purchase seed cotton directly from producers' organizations starting with the crop year 2000/01. However, implementation of this measure will depend on designing a mechanism for crop credit, which is currently guaranteed by SONAPRA. For the 1999/2000 crop year (starting in November 1999) the government will adopt a decree before end-September 1999 (performance criterion for end-September 1999), indicating that all private ginning companies, including SONAPRA, will be treated equally and receive seed cotton proportionate to their ginning capacity. The decree will also specify the sale price of seed cotton to the private ginning companies to be slightly above the 1998/99 producer's price of CFAF 225 per kilogram.

29.  The government reaffirms its commitment to all measures promoting regional integration. To this end, it has already adopted and started to implement the following legislation and regulations: a new import classification in accordance with the common external tariff (taken into account in the 1999 budget law and to be applied in July 1999); the harmonization of business laws in the context of the OHADA treaty; a new regional exchange regulations (in effect since February 1999); the CIMA treaty on the supervision of insurance companies (applied since 1998); and the SYSCOA accounting system (applied since 1998).

30.  The government will make every effort to improve the production of economic and financial statistics. Moreover, to prepare for the year 2000, the authorities have begun to inventory the computer equipment requiring updating by December 1999. Owing to the delays in beginning this process, the authorities are seeking assistance from development partners in stepping up their efforts in this area and in taking all necessary measures to ensure that the computer equipment is tested and replaced by then, if necessary.

31.  The program will be monitored by means of quarterly quantitative benchmarks, structural benchmarks and indicators established for the remainder of the program and a second review. The quantitative limits for end-September 1999 constitute program performance criteria, the observance of which is a condition for drawing the third loan under the second annual arrangement. The performance criteria for end-September 1999 include (i) a ceiling on net bank credit to the government; (ii) a reduction of the stock of domestic payments arrears; (iii) the nonaccumulation of new external-payment arrears by the central government; (iv) a ceiling on new nonconcessional foreign borrowing at terms of 1-12 years, contracted or guaranteed by the central government; and (v) a ceiling on new short-term foreign borrowing, with the exception of regular import financing. The ceiling on net bank credit to the government will be adjusted downward (or upward), depending on the amount by which exceptional external assistance, excluding debt relief, exceeds (or falls short of) program estimates, as indicated in the attached Table 1. The structural performance criterion concerns the issuance by end-September 1999 of a decree fixing the producer price of seed cotton to CFAF 225 per kilo, and indicating that seed cotton will be distributed to all ginning companies, including SONAPRA, on a prorata basis, and at a price slightly above the producer price. The structural benchmarks pertain to the adoption of a strategy to reform the energy sectors by end-July 1999; the merging of the databases on the civil service at the payroll department and the Ministry of Civil Service by end-August 1999; the adoption by end-September 1999 of a mechanism for setting price ceilings on oil products that will be at levels equivalent to world market prices and adjusted every three months; completion of a study on Benin's trade with Nigeria by end-September 1999; completion of a census of retired civil service employees and their beneficiaries by end-September 1999; government expenditure on education and health; and minimum recovery of overdue claims of liquidated banks.

32.  The government of Benin is convinced that the economic reforms and measures described in this memorandum, which supplements the memorandum of December 21, 1998, should make it possible to achieve the program objectives for 1998-99. If necessary, it will take the additional measures needed to achieve these objectives.